The Poverty of States: Do State Tax Policies AffectState Labor Productivity?

There are substantial differences in output per worker across states that persist over time. This studydemonstrates that differences in state taxation of capital income, capital ownership, and consumption canexplain why differences in labor productivity can persist. First, state tax policies persist with little changein the taxes imposed over time. Second, sales, property, and capital income taxes will all lowerequilibrium labor productivity in the context of a neoclassical growth model. The most negative effectsoccur at the highest marginal tax rates. These theoretical predictions are supported, using data on statemarginal tax rates and output per worker over the 1977-2004 sample period. Over that period, the mix ofstate tax policies has led to a reduction in labor productivity averaging almost 20% per year. The impliedadverse effect of tax distortions on labor productivity across states is substantial, varying from-11.8% in Nevada to -27.6% in Iowa. State tax policies have become increasingly damaging to laborproductivity over time as states have increased their marginal tax rates. On the other hand, governmentexpenditure policies explain none of the variation in labor productivity across states or time.[...]