AMES, Iowa -- Iowa possesses the nation's highest corporate tax rates and also has relatively high marginal income tax and property rates. And according to a recent study by Iowa State University economists, those rates have had a double impact on diminishing the state's labor productivity.
The economists found that because of the taxes, businesses have less money to spend on capital investments that are critical to attracting the most skilled labor prospects, who then opt to go elsewhere for employment. And because of that compounding effect, the study reports that Iowa's tax structure ranks 48th and last in the continental United States in terms of adverse effects of its taxes on labor productivity.
"High marginal tax rates have a double dose on retarding the state's labor productivity," said Peter Orazem, a University Professor of economics at Iowa State who presented the study, which includes data from 1977-2004, at a recent Southern Economics Association meeting. The study's authors -- who also include Joseph McPhail, a former ISU economics master's student; and Rajesh Singh, an Iowa State associate professor of economics -- are updating it and will present it at the Midwest Economics Association meeting in St. Louis on Saturday, March 19.
"Capital investment that is complementary with skill has been a major driver for labor productivity and wage growth for the past 30 years," Orazem said. "If you cannot attract capital, you can't attract the human capital that benefits from those investments. So you lose the investment in human capital as a result."
Data gathered from several national sources
The researchers measured output per worker in terms of Gross State Product, as reported by the Bureau of Economic Analysis. Their study also used marginal tax rates -- defined as "the cost wedges that distort consumer and producer decisions" -- obtained from the National Bureau of Economic Research. They gathered data on state sales and excise tax receipts from the Tax Policy Center. And they also gathered additional data from the U.S. Census Bureau and the Council of State Governments.
The authors report that shortly after 1977, the U.S. began to experience an extended period of rising returns to schooling that has been attributed to rising firm investments in information technologies and other forms of capital. Since they contend that capital and skills are complementary, the rising investments in capital have been shown to increase the employment and earnings of more educated workers in the U.S.
"Consequently, should variation in state and local tax policies alter the incentives to invest in capital across states, these tax policies will also affect the levels of technology adoption and related labor productivity across the states," the ISU researchers wrote.
Their analysis found that taxes on property, corporate profits and consumption are the most damaging to labor productivity. Jointly administered income and capital gains taxes also have smaller but significant effects.
The inefficiency of corporate taxes
The researchers wrote that corporate taxes are particularly inefficient because they generate relatively little tax revenue in comparison to productivity loss. And Orazem points out that Iowa's corporate tax rates are particularly inefficient.
"The state of Iowa has the highest marginal corporate tax rate at 12 percent, with the next highest state's rate being 9 percent," he said. "The corporate rate raises very little revenue and damages labor productivity. They raise relatively little revenue because firms will want to earn their profits elsewhere because the rate is so high.
"One of the reasons we [Iowa] have such high marginal tax rates is that we offer so many special exemptions to the taxes. There are some 450 exemptions for corporate sales tax alone," Orazem continued. "And everyone who doesn't get one of the special deals is paying a higher rate to pay for all those who do. In my mind, the mistake the state is making is that rather than simply reducing the corporate tax rate, we should be broadening the tax base by eliminating all these special deals while lowering the marginal tax rates for everyone."
The authors conclude that the overall effect of marginal tax rates on output per worker is substantial, reducing state labor productivity an average of 19.4 percent. Differential tax rates are responsible for substantial differences in the level of labor productivity across states -- from a minimum negative impact of 11.8 percent in Nevada from 1977-2004, to a maximum of 27.6 percent in Iowa according to the study.
The initial study, presented in November, is available online here.