Income Tax Cut Worked, so Why Stop?

The Wall Street Journal recently praised Democrats — including New Mexico’s own Bill Richardson — for cutting income taxes. Indeed, with neighboring Arizona and Oklahoma (states with Democrats in the role of chief executive) having enacted significant income tax cuts earlier this year, a real trend is developing. Strong economic growth has convinced increasing numbers of Democrats of the need to invest in future economic growth by reducing income taxes.

As economist James Gwartney points out, steeply progressive income taxes, such as the 8.2 percent rate that once burdened New Mexico taxpayers, harm economic growth. They do so for two reasons. First, they reduce the share of additional income that earners are permitted to keep, thus reducing the payoff that people derive from work and from other taxable productive activities. When people are prohibited from reaping much of what they sow, they will sow more sparingly. Secondly, high marginal tax rates can encourage tax shelter investments and other forms of tax avoidance.

Fueled both by ongoing income tax cuts and a boom in the oil and gas industry, the state economy is strong. While oil and gas revenues are largely dependant on factors beyond our control, continuing to cut income tax rates is well within the control of our elected leaders. Currently, the top income tax rate levied by New Mexico rests at 5.3 percent and will drop to 4.9 percent (from 8.2 percent) by the time the income tax cuts are complete in 2008. Given the success of New Mexico’s income tax cutting experiment, it makes sense to keep the tax reductions going past 2008 and to aim at eliminating the personal income tax entirely.

Given our history of high tax rates, it is no surprise that New Mexico’s business climate has been less-than-friendly to business. This is borne out in rankings published by the Washington, DC-based Small Business and Entrepreneurship Council. In 2002, prior to the start of the current round of income tax reductions, New Mexico was ranked a lousy 47th. As of 2005, the last year for which data is available, New Mexico’s ranking had risen to 33rd place.

While recent improvement is welcome, our elected leaders cannot be satisfied with 33rd place. This is especially true since all of our neighbors Colorado (10th), Utah (30th), Arizona (17th), Texas (11th), and Oklahoma (29th), continue to outscore us in small business friendliness. Tax cuts in Arizona and Oklahoma will only make those states more competitive.

Leaving productive activity untaxed is the best possible way to generate economic growth and attract productive citizens. Nine states, including neighboring Texas, charge no income taxes at all. The trend is so pronounced that, as Ohio University Economist Richard Vedder found in a study of data from the U.S. Census Bureau, from April 1, 2000, through June 30, 2004, a net total of 1,318,963 native-born Americans moved into the no-income-tax states (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming) from those states that do tax a portion of people’s income.

The ideal way to really boost New Mexico’s economy would be to simply keep cutting the income tax until it is completely eliminated. New Mexico could eliminate its income tax over time by canceling projects like the RailRunner ($318 million in savings) and the Spaceport ($100 million), adopting cost-saving reforms for Medicaid and education, and eliminating economically wasteful tourism and film subsidies.

If General Fund spending growth was reduced from the rate of growth we have seen under Gov. Richardson (7 percent annually) to a level that closely tracked the combined effects of inflation and population growth (4 percent annually), the state would have been able to shift a total of $150 million to tax reductions in FY 2006 alone. The ability to reduce future tax rates would only grow as fiscal restraint is maintained. Reforms like the adoption of Constitutional limits on taxing and spending similar to Colorado’s would be the best tool for restraining spending over a long-term tax elimination plan.

Instead of increasing spending, creating more welfare programs for out of state billionaires or other economic growth schemes targeted at special interests, our elected leaders should be looking for ways to ensure future prosperity by reducing the tax burdens of all hard-working taxpayers. Taking steps now to eliminate or further reduce the state’s personal income tax is one of the fairest surefire methods available to spur economic growth. It is more than coincidence that the states with no income tax are among the more prosperous.

Siebert Ickler is an adjunct scholar with New Mexico’s Rio Grande Foundation, an independent, non-partisan, tax-exempt research and educational organization dedicated to promoting prosperity for New Mexico based on principles of limited government, economic freedom and individual responsibility.