Wyoming Has Best Taxes - What Does That Mean?

The Tax Foundation, one of America's most influential think tanks, has released their State Business Tax Climate study for 2015. For good reasons, this annual publication attracts a lot of attention from state legislators, policy analysts and media. With its thoroughness and attention to quality and detail, the Tax Foundation sets a high methodological standard for applied policy research.

However, there is one problem with the study. It is often used as an indicator for how well a state should perform economically. States that score well in the study should, at least by implication, also experience high growth in GDP and private-sector jobs. Yet that does not happen. As I explained in July, Wyoming actually represents a perfect counter-example to the idea that a business-friendly tax system – as defined by the Tax Foundation – is growth-friendly. In the 2014 business tax climate study Wyoming had the best tax climate, but also the worst or second worst record for GDP growth and private sector activity.

The 2015 report still ranks Wyoming first, just as we have done for several years in a row. It remains to be seen, of course, what our state GDP growth will be in 2015, but for 2009-2013 the average, annual inflation-adjusted increase in GDP was 0.75 percent. That ranks our state 33^rd; it was only thanks to an anomalous growth spurt in 2013 that we lifted ourselves out of negative growth territory.

In other words, just looking at Wyoming it is difficult to see what the practical implication is of the business tax climate study. But the question mark grows bigger when we correlate tax ranking with GDP growth for all states. Figure 1 reports observations of the tax climate score that each state received in 2012 and 2013, together with the inflation-adjusted GDP growth rate for the same state in the same years.

For these 100 observations, there is no correlation whatsoever between the tax climate score and GDP growth. This raises two questions.

1. Do taxes not matter for economic growth? Yes, they do. It is very well established in the public policy literature that low taxes promote high growth. The question that needs further research is how large a part of a business investment or operation decision is guided by taxes. The answer to this question may vary from state to state, making it difficult to generalize. Nevertheless, there are more broadly designed index studies, such as the CNBC Business Climate Study, that put taxes in their proper context. Their ranking of states differs notably from that in the Tax Foundation study, coming a bit closer to correlating index scores with actual economic performance.
2. Is the State Business Tax Climate study aimed at explaining growth? The Tax Foundation does caution that their study is not specifically a report on tax rates or tax costs. Instead, it is more of a guideline for states considering tax reform. In this capacity the study works well – see the success story out of North Carolina – and the index is also forward-looking. The latter means that the index score for 2012 should be correlated with GDP growth in 2013. But even then it is almost impossible to find a correlation, suggesting again that the index has its merited but limited use.

These are important points to keep in mind, especially here in the state that is said to have the best state business tax climate in the country.