Executive Summary
For years, the allure of no-income-tax states such as Texas, Tennessee, and Florida has been undeniable, especially for those eager to keep their hard-earned dollars free from the grasp of state taxation. Notably, among the nine states that proudly boast of having no personal income tax, five have secured a place in the top ten for GDP growth over the last decade, while four rank high in net migration rates from other states.[1] In stark contrast, states with hefty income taxes like California, New York, and New Jersey have witnessed a population exodus, as residents exercise their right to vote with both their feet and wallets. Inspired by the success of their no-tax counterparts, an increasing number of states that currently impose income taxes are contemplating a shift away from this tax model through budgetary prudence and the exploration of less burdensome taxation methods.
This paper delves into the economic ramifications and practicality of states gradually phasing out their income tax. Acknowledging the necessity of tax revenue, the analysis is structured around two distinct scenarios. The first scenario envisions a complete revenue replacement via an expanded sales tax, ensuring that the projected total tax revenue remains stable. The second scenario proposes a dual approach that merges a broader sales tax base with a cap on spending growth, maintaining existing government services without permitting their expansion.
The quantitative assessment presented here is conducted on a state-by-state basis, examining how these two reform scenarios affect critical economic indicators—such as GDP, wages, business startup activity, and the migration patterns of high-income taxpayers. Additionally, the study outlines the sales tax rates necessary to implement these reforms under each scenario (broadening the tax base alone versus broadening it in conjunction with spending constraints).
Key insights drawn from existing economic literature reveal:
- Income taxes inflict greater economic harm compared to sales or property taxes;
- The adverse effects of state income taxes contribute to population migration, brain drain, hindered innovation and entrepreneurship, as well as diminished GDP;
- The fiscal repercussions of state income taxes include revenue instability, often leading to “feast and famine” cycles, where states see little to no increased revenue from income tax hikes due to the negative economic consequences they provoke.
Key findings from the CEA’s analysis of state income tax phase-outs include:
- A projected GDP increase of 1 to 1.6 percent for the average state;
- A 16 to 19 percent rise in new startups for the average state;
- An increase of $4,000 in the average wage;
- A notable influx of new high-income taxpayers;
- An average state sales tax rate below 8 percent under full revenue replacement with no spending growth limits;
- An average state sales tax rate of 6.2 percent when spending growth is capped.
[1] States such as Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming impose no personal income tax. Washington, however, does levy a personal income tax on capital gains for specific high earners.
