Reducing state income tax a counter to recession
Today at 8:30 a.m., the U.S. Bureau of Economic Analysis will release second quarter GDP numbers. If it reports negative economic growth as economists expect, then a technical recession has already begun in the United States. Colorado can insulate itself by reducing the state income tax.
Understanding why an income tax reduction would help ease recession pains requires first understanding how we got here.
Attempting to stop the spread of the COVID-19 pandemic in early 2020, governments mandated economic shutdowns and induced recession. To re-stimulate the economy, Congress issued $5 trillion in federal aid. Because the U.S. Treasury did not have that much money, the U.S. Federal Reserve Bank effectively printed it into existence. To encourage the creation of additional money in the economy through borrowing, the Fed also lowered interest rates to near zero.
The policies ballooned the total U.S. money supply from about $15.5 trillion to $21.75 trillion — a 40% increase in just two years. Economists argued that the money creation would increase consumer demand, lift asset prices and bail out the economy. It worked, but they got more than they bargained for.
By early 2021, all the new money in the economy began to push prices up at alarming rates. As inflation persisted and increased throughout the year, the Fed began talking about reversing their “easy money” policies.
In March of this year, the Fed began increasing interest rates to curb inflation. In doing so, they aim to reduce the amount of new money going into the economy, thus reducing demand for goods and services and pushing down prices. The approach risks flinging the economy back into recession, as economic indicators already show.
The U.S. Bureau of Labor Statistics reported earlier this month that the consumer price index hit a new 40-year high of 9.1% in June. The market responded by inverting the so-called yield curve — long-term interest rates dropped below short-term rates. This reflects investors’ belief that more risk lies in the near term than through the next decade.
Other economic indicators echo the yield curve. The price of oil has trended downward for more than a month, the housing market is slowing, and consumer confidence sits at its lowest point since February. Even economists sympathetic to the current administration have sounded the recession alarm.
Fortunately, Colorado can take preemptive action to cushion the blow of a coming recession.
Initiative 31, which will appear on the statewide ballot in Colorado this November, would cut the state income tax rate from 4.55% to 4.40%. If adopted by voters, the measure would reduce the tax burden on the private economy by $382 million or an average of $120 per taxpayer annually. In addition, the Independence Institute has developed a plan to put Colorado on a path to zero income tax.
Income tax reductions come with several benefits, especially during times of recession.
First, tax savings provide individuals, families and businesses with additional income — a nice cushion during tough times. Tax cuts also encourage spending and investment without increasing the total money supply. That means they can provide economic stimulus without the inflation baggage.
An adage in politics illustrates the rationale behind an income tax cut specifically: “If you want less of something, tax it.” People generate income by working and being productive. If you want less of that, tax income. But if you need more productivity to lift the economy out of recession, reduce taxes on income.
Cutting taxes at the state level can also drive investment and jobs from other states to ours. Individuals vote with their feet, and they prefer low-tax states. A comparison of the 2022 State Business Tax Climate Index and data on state emigration shows that high-tax states such as California and New York experienced an exodus while low-tax states such as Florida or Tennessee saw population growth during the recent pandemic-related recession.
Skeptics may be dismissive of the idea that a tax rate cut could yield significant changes in behavior. But tax rates change behavior at the margin. A small tax decrease can go a long way.
Recession is staring us in the face. Lowering the income tax would reduce the direct hardships of inflation and recession while also improving Colorado’s economic competitiveness and long-term economic health.