Cutting the Top Tax Rate is Bad Policy

State policymakers continue to discuss cuts to the top personal income tax rate that may take place during a special session sometime in October. Next week, we plan to release an analysis of these competing proposals that will show how much these plans could cost the state and how much taxpayers at different levels of income may benefit (or not).

Regardless of the ultimate cost, proponents of cutting the top personal income tax rate often rely on the idea that lower personal income tax rates lead to more economic growth or business formation. But these arguments are flawed, and the empirical evidence fails to bear them out for several reasons:

  1. States must balance their budget so tax cuts can’t add to the amount of money in the state economy. Every dollar of a tax cut must be paid for either in higher taxes elsewhere, or through reduced spending on government contractors, employees, and other recipients of state funds. This is why the final report of the 2018 Tax Task Force found that cutting the top tax rate would cause “…Output and job growth to turn negative…”
  2. High-quality public services promote economic development, and taxes pay for those services. The quality and availability of education and infrastructure, as well as other public services, affect where businesses and families locate. A reduction in state spending can negatively impact economic growth if it harms the quality or availability of public services. That’s why recent research has found that, “States recently reducing their personal income taxes more likely harmed economic growth and states increasing their personal income taxes more likely spurred their economic growth.”
  3. Tax climate is only a small part of economic competitiveness. All state and local taxes combined represent less than 3 percent of the total expenses for the average business. Interstate differences in other major business costs like the cost of land, construction, and the availability of skilled labor overwhelm the impact of the marginal tax rate.
  4. Personal income tax cuts necessitate increases in other taxes, and those taxes may be levied on those who are least capable of paying them. For example, the share of state general revenue raised from sales taxes is estimated to total more than 40 percent in 2022, up from 35 percent in 2014. During the same time, the share of general revenues collected from income taxes are estimated to fall from 56.7 percent to 52.5 percent. But sales taxes fall hardest on lower-income and working Arkansans.

In fact, raising tax rates on those with higher incomese can instead be a sensible way to generate revenue for key investments to expand early education and child care, improve infrastructure, improve access to and the quality of health care, and other services that can boost the state economy while helping children and families at the same time.