Monday, August 03, 2009

Paul Krugman's Misleading Tax Comparison

Paul Krugman has noted the fact that "Red State" Texas is doing a lot better than "Blue State" California, something which I discussed here. Yet he argues against the obvious conclusions by pointing out that some "Red States", like South Carolina, have problems too.

While it is true that some "Red States" have problems too, Krugman is still misleading his readers big time. First of all, the question here isn't whether the state was "Red" or "Blue" but whether they pursue free market policies. While "Red" States generally are more free market oriented than "Blue" states, exceptions to this rule do exist. For example, taxation is a lot lower in New Hampshire than in South Carolina(the top income tax rate is 7% in South Carolina versus 0% in New Hampshire(for wage/salary income)), despite the fact that New Hampshire was won by Obama and South Carolina by McCain in the latest election.

Secondly, since no one has claimed that taxation is the only factor determining unemployment, one can expect that the empirical correlation will be imperfect and that exceptions to the rule will exist.

And thirdly, the data that Krugman relies on is seriously messed up. It claims for example that Wyoming is the highest taxed state in the country, even though Wyoming is one of the few states that has no state income tax on either individual or corporate income. Another alleged high tax state, Alaska, has a corporate income tax but not an individual income tax. And Alaska lacks not only an income tax but also a sales tax, yet Krugman (by citing that sources) wants us to believe that the people of Alaska face a higher tax burden than California, with a top state income tax rate of 10.55% and a sales tax of 8.25%.

This matters because Alaska, and much more so Wyoming, has a lower unemployment rate than the national average.

If we now look at the specific "taxes" included here, we can see that Krugman's source in its "State Taxes by source" has a category called "other", alongside "property", "selective sales" (for example alcohol or tobacco excise taxes), "sales", "individual income" and "corporate income" taxes. As it turns out, a full 84% of Alaska's income comes from the "other" category, with Wyoming (46.6%), North Dakota (41.4%) and Delaware (38.6%) also receiving extraordinarily high proportion of their income from those sources. The "other" source is not explicitly defined, but judging by the states involved it looks like income from the extraction of oil and other natural resources. This means that the tax burden on normal business activities is greatly overestimated by Krugman's chosen gauge. And that matters, as all four of these states have unemployment rates below the national average (that goes particularly for North Dakota and Wyoming).


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