Economists: Alabama’s income tax is inhibiting economic growth, should be eliminated

By Dr. Daniel J. Smith and Dr. Stephen C. Miller

According to the Public Affairs Research Council of Alabama (PARCA), Alabama has the lowest taxes per capita in the nation. However, this doesn’t justify tax hikes as many people believe. In fact, it actually highlights the pressing need for tax cuts to make Alabama more competitive.

Let us explain.

What PARCA finds, using Census data, is that Alabama has low tax revenues per person. Many factors can influence this including state GDP, demographics, population trends, and, especially, tax rates. States that adopt competitive tax structures – tax structures that are straight forward, fair, and reasonably low – often foster a flourishing economy that brings in additional tax revenue through population and business growth.

Rather than suggesting that tax rates are too low, our low per person tax revenues actually suggests that Alabama’s tax rates are too high!

Alabama’s per person tax revenues may be the lowest in the nation, but Alabama’s tax rates are certainly not the lowest in the nation. Alabama’s 5% tax rate makes it the 31st highest in the nation (tied with Mississippi, New Hampshire, and Utah). That is higher than Florida, Tennessee, and Texas which all have zero income taxes (though Tennessee does have a 6% tax on interest and dividend income).

When it comes to corporate taxes, Alabama’s 6.5% corporate tax rate makes it the 26th highest in the nation (tied with Arkansas, Tennessee, and West Virginia). Importantly, nearby states such as Florida, Georgia, Mississippi, South Carolina, and Texas all have more competitive corporate tax rates.

Looking at sales taxes, Alabama’s state and local sale taxes make it the 4th highest in the nation. You see a similar story with liquor (Alabama is the 4th highest), wine (Alabama is the 5th highest, tied with New Mexico), and beer taxes (Alabama is the third highest). In fact, there are only a few things taxed in Alabama that have what can be considered, comparatively, a low tax rate, such as property, gasoline, and cigarettes.

What does this mean? It means that Alabama can’t tax its way to prosperity. This approach has clearly failed in Alabama. It also, as the PARCA report shows, hasn’t brought in the revenue state leaders hoped for. That is because other states, including many nearby states, are better situated to draw in state revenue because they are attracting residents and businesses to their states with their more competitive tax structures.

Overall Alabama doesn’t have a revenue problem, it has a competitiveness problem. We can build the best golf courses in the world, but even hard-core golfers will still choose to live in Florida. Because of that, Florida doesn’t just have lower taxes and more revenue per capita than Alabama, Florida has more capita! And, it is people that are the ultimate source of economic growth and development.

Researchers from Florida State University and Ohio University have shown that states with higher taxes than their neighbors have slower income growth. The long-run implication of this research is that lower tax rates can actually lead to higher revenues as incomes rise. Additionally, taxes can be cut without reducing revenue by broadening the tax base at the same time. In other words, tax privileges and exemptions should be reduced or eliminated in combination with tax cuts.

Eliminating the income tax would be ideal, to be competitive with Florida and Tennessee. Failing that, Alabama’s income tax should be reduced and flattened, with only one tax bracket to ensure that everyone pays their fair share. People who earn more pay more under a flat tax. That is because four percent of a million dollar income will always be much more than four percent of 50 thousand dollars.

Alabama needs tax reform. The current tax regime is both unfair and inefficient. More importantly, it’s not competitive with our neighbors and inhibits economic growth. While more prosperity will bring higher tax revenues, tax revenue is not itself the answer to Alabama’s sluggish growth. Alabama has chronic budgeting and spending problems. But the solution isn’t higher taxes. Economic growth doesn’t come from higher taxes.

Stephen C. Miller is the Executive Director of the Johnson Center for Political Economy and the Adams-Bibby Chair of Free Enterprise at Troy University. Follow him on Twitter @stevemillerecon. Daniel J. Smith is the Associate Director of the Johnson Center for Political Economy at Troy University. Follow him on Twitter @smithdanj1