This year several states have introduced, and in many cases enacted, legislation to reduce the tax burden for residents and businesses in their state. Nine states cut their individual income tax rates and are planning more reductions. A handful of states reduced their corporate income tax burdens, and more than 10 states have passed property tax limits or rollbacks. But which of these tax cuts are most reliable and best for state economic growth?
Importantly, reductions in certain types of state tax result in shifting the composition of tax revenues. Aside from federal transfers, the four primary sources of tax revenue at the state and local level are sales taxes, income taxes, property taxes and corporate income taxes. The tax cuts that are the most politically popular might not be the ones that are most economically efficient.
There are several ways to measure what makes one tax economically preferable to another. This piece focuses on two metrics: (1) growth effects and (2) volatility. In other words, which forms of state taxation are most or least harmful to the economy, and which taxes provide the most or least reliable streams of revenue?
Choice of tax matters for preserving economic dynamism
Economists have extensively measured the effects of taxation on economic growth. Nearly two decades ago, the Organisation for Economic Co-operation and Development (OECD) published a paper using industry- and firm-level data to determine which tax structure designs are the most conducive to economic growth.
The authors found that taxes on immovable property were the least distortionary, followed by consumption taxes. They found that individual income taxes were more economically distortionary and that corporate income taxes were the most economically destructive. The authors recommended that growth-oriented tax reform should focus on shifting the revenue base from income taxes to property and consumption taxes.
Another OECD paper used panel growth regressions for 21 OECD countries to answer the question: Do tax structures affect aggregate economic growth? The authors found property taxes to be the most growth-friendly, followed by consumption taxes and then by personal income taxes. Corporate taxes were found to have the most negative effect on GDP per capita. The authors conclude by suggesting:
“A revenue-neutral growth-oriented tax reform would be to shift part of the revenue base towards recurrent property and consumption taxes and away from income taxes, especially corporate taxes.”
One 2021 journal article estimated the effects of exogenous changes in income and consumption taxes to determine whether these different taxes have different effects on economic aggregates such as income, private consumption and investment. The authors find that changes in income tax rates, defined as an aggregate of personal and corporate taxes, have large short-run effects on GDP, private consumption and investment.
In the article’s benchmark model, a percentage point cut in income taxes raises GDP on impact by 0.78 percent and leads to maximal present value multipliers of 2.36% two years after the shock. By contrast, the effects of cuts in average consumption tax rates on GDP and its components are found to be modest and not significantly different from zero.
Some taxes are a lot more reliable than others
To measure which state taxes are the most reliable and which are the most volatile, I pulled state revenue data from the Census Bureau’s Annual Survey of State and Local Government Finances (ALFIN) going back to 2005. I then calculated the standard deviation of annual percent change in real revenue for the typical state.
The steadiest, most reliable source of tax is property tax revenue, as shown in the figure below. Sales tax revenue is also incredibly stable and only slightly more volatile than property tax revenue. Individual income tax revenue is more than twice as volatile as sales tax revenue, while corporate income tax revenue is more than 5 times as volatile as sales tax revenue.
It is worth noting that property taxes are mostly local and not state taxes. About 97% of all property tax revenues are collected at the local level. The next chart shows annual swings in real revenues over time. Corporate income tax is omitted from this chart due to very large swings in volatility that would make other lines look flat in comparison.
These findings are broadly consistent with other examinations of state tax volatility. Pew conducted research in 2024 on tax volatility by state over a 15-year period and found that personal income taxes had a volatility score of 9.9 (compared to my 9.7) for the 15 years ending in fiscal year 2022 and a score of 13.2 for the most recent 5 years.
Pew found general sales taxes to have a volatility score of just 5.1 (compared to my 4.6), while corporate income taxes had a volatility score of 22.5 (compared to my 25.8) for the 15 years ending in fiscal year 2022 and a score of 29.9 for the most recent 5 years. These magnitudes of volatility are very similar to those that I found.
Overall, a broad sales tax produces a more predictable revenue stream than income or corporate taxes, while property taxes are typically the most stable annual revenue source. Corporate income taxes and taxes tied to capital gains, real-estate transactions and natural-resource extraction are the most volatile. Personal income taxes fall in between but can become highly unstable when they depend heavily on high earners, capital gains or progressive rates.
States looking to cut taxes should prioritize income and corporate tax reductions
If policymakers looking to reform their state tax code want to ensure that tax changes don’t reduce growth or expose the state to greater revenue volatility, then their priority should be lowering income and corporate tax burdens, as shown in the figure above.
Cutting sales and property taxes might seem like politically popular options for appealing to the broadest swath of constituents, but the long-term consequences would include a higher dependence on distortionary taxes and more volatile revenue streams.
The ideal tax reform would combine income and corporate tax reductions with sales tax base broadening, while also channeling a share of surpluses to bolster state rainy-day funds and reduce dependence on federal transfers.
FWIW, I, an utter amateur, offer a couple of thoughts:
* Consumption taxes seem to me to be income taxes but limited to stores. Both are nosy as hell to detect evasion. Thus limits on yard sales, monitoring flea markets, worries about barter such as roof work for dental work, online income such as etsy and eBay, and so on.
* Property taxes have one feature I have never seen mentioned, possibly because it doesn't matter now and probably never will: they can be paid anonymously, and the government need not know who owns parcels. All that matters is whether the tax is paid, not who paid it. If it's not paid, they know where the parcel is, and can leave notes, send in the usual SWAT team, whatever the courts will let them get away with, and eventually confiscate the parcel.
A lot of people favor consumption taxes and sneer at property taxes as a wealth tax. I don't buy that; all taxes are paid by people, and property taxes have about as low overhead as is possible, especially in comparison to income and consumption taxes.
Others deride property taxes as paying rent. But that rental aspect matters only because have given themselves priority in collecting property tax debt by confiscating the entire property and selling it no matter how small the tax debt is. These same people holler and scream at any mention of doing away with zoning, which is as bald a control grab as there can be. As long as government can control your land usage, yes, you are paying rent, you do not own that land.
Mercatus Center is a libertarian ideological public-policy oriented "think tanks" (most economics academics don't do any policy research anymore and lack any interest in improving public policy, so most all the fill to that vacuum comes from multi-billionaires like Koch or Koch or Koch funding propaganda that always provides justification for policies benefiting only those wealthy souls. Congress is deluged with their infinite output of government = bad and monopolies are temporary and beneficial. States are definitely in a "race to the bottom" by focusing on bribing business with subsidies, tax breaks, and free infrastructure, all funded via gutting higher ed budgets, hikes in sales taxes, and cuts in public service. We economist know that business will locate near quality work forces, crucial supply chains, market access, and transportation nodes. No bribe can convince a business to locate or expand in the wrong place! But they will shake down ("the winner's curse") their locality for enough to offset most all their economic benefits they generate!