The Earnings Tax, Marginal Utility, and Our Move
A few articles and blogs have recently criticized the Show-Me Institute for moving to our lovely new location in the Central West End. (One article erroneously cites another blog as having broken the news, when it was actually David Stokes here at Show-Me Daily who reported it first. We’ve also been planning the move for the better part of a year, and it wasn’t a secret.)
Collectively, these pieces suggest that there is some irony in the fact that the Show-Me Institute has long pointed out that the earnings tax creates marginal disincentives for economic growth and location within city boundaries, and yet we moved into the city anyway.
There is a useful economics concept at work here: marginalism. A 1-percent earnings tax is not enough enough of a disincentive to determine the location of all businesses or residents, but all disincentives are marginal to varying degrees. Some number of people at the margin, who would otherwise be near an equilibrium point between the positive and negative aspects of living in the city, will find that the earnings tax tips the balance so that the negatives outweigh the positives, and they move away — or never move to the city at all, despite having considered it as a possibility. For others, the positives will continue to outweigh the negatives. This is something we’ve discussed before here at Show-Me Daily. Work published by the Show-Me Institute has always been careful to note that the earnings tax is only one factor among many in the locational decisions of St. Louis–area individuals and businesses. It serves as a disincentive for nearly everybody, but becomes an actual deterrent only for some.
Taxes on income and production are counterproductive. They diminish the incentive to work (even if only slightly) and encourage business owners to find alternatives for their labor costs, like increasing mechanization. The earnings tax, like an income tax, establishes a marginal incentive for businesses and individuals to find ways around this higher cost for labor and wages in the city, whether that entails moving to a suburb, investing in new machinery, cutting corners in production or service, etc. This all distorts the market to varying degrees. Specific types of taxes on property, on the other hand, are much less distortionary. They encourage development of land and maximization of the property value, bringing (again, marginal) new economic growth to the city.
The earnings tax does not keep everyone out of the city, but it does keep away some. Why this is true is one of the most important insights of the marginal revolution. At any rate, incentives are constantly in flux, and equilibrium points between them change frequently. Right now, it makes sense for the Show-Me Institute to work out of the city. But if the earnings tax hadn’t been in place, who knows? The Show-Me Institute might have moved here five years ago.
“Taxes on income and production are counterproductive.”
And I think if you asked them for their true opinion, partisanship aside, almost everyone would acknowledge that. But chances to make fun of the “other side” are unfortunately not to be missed in American politics.
Comment by David Shane — March 18, 2010 @ 9:31 p.m.
I’ve read the reports and blog posts about your move to St. Louis City. First, there is irony when a group that speaks very loudly about the detrimental effects of the earnings tax chooses to move to the City. It’s not a criticism per se and it shouldn’t be taken as one, but ironic? Sure.
Second, I suppose that marginalism exists in many facets. How many people choose to live in the City based on some of the things that the earnings tax pays for (as in a huge portion of all city expenditures)? Things do need to be paid for. Perhaps another tax or fee could replace the earnings tax, but that would simply rename the funding mechanism and obviously not eliminate it.
Comment by Gerard — March 18, 2010 @ 11:01 p.m.
Gerard,
Show-Me Institute scholars have agreed that the city needs to maintain tax revenue in the absence of the earnings tax. They have also recognized that this revenue would likely come in the form of alternative taxes. The point is that the form of taxes matter. Taxes, by their nature, distort preferences, prices and behavior but different modes of taxation alter behavior in different ways. Our hope is that replacing the earnings tax with an alternative, but revenue-neutral, form of taxation could alleviate some of the negative growth consequences that the earnings tax imposes.
Comment by Abhi Sivasailam — March 19, 2010 @ 11:24 a.m.
And your new alternative form of taxation will alleviate some of the negative growth consequences by sleight of hand? People will still be paying the same amount of taxes. Actually, the burden will likely fall more on City residents as the earnings tax is the only effective way to have those who live elsewhere, but enjoy the benefits of the City to help pay for those amenities. Let’s mend our region’s fractured political structure and THEN I would be all for getting rid of the earnings tax.
Comment by David Johnston — March 19, 2010 @ 2:16 p.m.
David,
In a word, yes. The earnings tax is proportional to income: when a person works more, they have a higher tax burden. A land tax is fixed: it is the same for a piece of property whether it has one store on it or has half a dozen shops and offices. If property is developed (say, in the mixed residence-commercial buildings that are particularly popular now) the land tax is thus divided amongst everyone living there. Thus, it encourages (at the margin) growth and expansion of the city by increasing the incentive to develop land. Not every property owner will have that same urge, but there will be a group that does, and that will help grow the city.
Comment by Caitlin Hartsell — March 23, 2010 @ 8:23 a.m.