In an attempt to bolster income tax repeal efforts in states like Oklahoma, Kansas, and Missouri, supply-side economist Arthur Laffer recently teamed up with an Oklahoma-based group to perform an analysis that predicts huge economic gains as a result of cutting state personal income taxes. A new report from the Institute on Taxation and Economic Policy (ITEP) shows, however, that the analysis is fundamentally flawed.
Bear with us as we guide you through a few methodological weeds.
At issue here is what’s called a regression analysis – a statistical tool used to explain the relationship between one set of variables and another. In this case, Laffer has attempted to explain how state income tax rates affect economic growth, and, according to Laffer’s regression, the effect is enormous. He shows an inverse relationship between taxes and growth. That is, the lower the tax rates, the greater the economic growth. Repealing Oklahoma’s income tax, he therefore predicts, will more than double the rate of personal income growth and state GDP growth, and create 312,000 jobs in the process.
If this sounds too good to be true, that’s because it is.
As ITEP’s new report explains, Laffer performs a data sleight of hand to produce his result. He includes federal tax rates in an analysis supposedly aimed at explaining a state tax system. And as it turns out, this decision hugely distorts the results. It allows him to include in his overall “tax rate” figures the Bush tax cuts – which caused a 4.1 percent drop in the top federal tax rate. At the same time, his measure of economic growth just happens to be taken from the early 2000’s, when the country was climbing out of the post 9/11 recession. That is, the economic growth indicators were improving just as the Bush tax cuts were going into effect.
Laffer essentially creates a bogus measure (federal and state tax rates combined) and maps it onto an exceptional moment in economic history. This allows him to create the illusion that cuts in state tax rates between 2001 and 2003 fueled economic growth later in the decade. If the analysis is refocused on just state tax rates, the findings fall apart entirely, as the regression no longer shows any relationship between state tax rates and economic growth.
But Laffer’s analysis is plagued by more problems than these. Also notable, as covered in an earlier report from ITEP, is its complete failure to measure the impact of other factors, from sunshine to oil production, that contribute to state economic growth. The flaws in Laffer’s analysis are so fundamental that its findings cannot be taken seriously.
ITEP’s two companion critiques of why Arthur Laffer’s analysis should not be trusted can be found here.
Photo of Art Laffer via Republican Conference Creative Commons Attribution License 2.0