Budget & Tax

Oklahoma’s private sector boosts household income

August 10, 2017

J. Scott Moody, Wendy Warcholik, Ph.D.

In the June issue of Perspective (“Oklahoma State Budget Crisis: I Should Say So”), we measured the extent to which the public sector has crowded out the private sector in Oklahoma (see Chart 1). This is important because the evidence is clear that it is the relative size of the private sector that accounts for much of the difference in families’ economic situation across the states.

We have delved deeply into the factors that account for family prosperity across the 50 states in our annual Family Prosperity Index (FPI). The FPI, available at familyprosperity.org, is the first and only index to measure the behavior of the whole person—both the economic and social choices a person makes. The FPI takes objective, public data organized into six major categories of 60 variables, boils them all down to one number for each state, and then ranks the states. Overall, Oklahoma ranks as the 21st best in the country in the 2017 FPI.

One of the things we analyze is the relationship between the size of a state’s private sector and the size of per-household personal income. We have found that there is a significant positive correlation between per-household personal income and the private-sector share of personal income.

Put simply, the larger the private sector, the greater the per-household personal income in that state. As shown in Chart 2, when examining the lower 48 states, on average, a one percentage point increase in the size of the private sector yields an increase in per-household income of approximately $3,300. (We exclude Alaska and Hawaii, which is common practice in state analysis, due to their unique economic characteristics.)

Of course, correlation does not equal causation. However, there are two states that allow for a very strong natural comparison to better show causation—New Hampshire and Maine. These two states are similar in many ways—geography, climate, demographics, and culture—but they diverge significantly in their approach to public policy.

As shown in Chart 3, between 1929 and 1950, Maine and New Hampshire had similar inflation-adjusted per-household incomes (dotted lines) and private sectors as a percent of personal income (solid lines). In 1951, Maine enacted a sales tax, which led to increased public-sector spending and crowded out the private sector. Consequently, New Hampshire’s per-household income began to steadily pull away from Maine.

This trend accelerated in 1969 when Maine enacted its income tax—a few years after the federal government enacted Medicaid. With this new source of revenue, Maine was able to dramatically expand its welfare system, especially Medicaid. In fact, as of fiscal year 2010, Maine had the third highest percentage of the population on Medicaid, at 31 percent.

In stark contrast, New Hampshire remains the only state in the nation not to have enacted a state or local sales tax or state or local income tax.

This difference in public policy has resulted in dramatic differences in the size of each state’s private sector. Between 1929 and 2016, Maine’s private sector shrank by 29 percent—to 65.6 percent from 92 percent—and now has only the 41st largest private sector in the country. By contrast, New Hampshire has seen its private sector shrink by a much smaller 15 percent—to 77 percent from 90.4 percent—and now has the 2nd largest private sector in the country.

As a result, New Hampshire’s private sector in 2016 is 17.4 percent larger than Maine’s—77 percent and 65.6 percent respectively. Consequently, New Hampshire’s per-household income in 2016 is 40 percent higher than Maine’s—$142,747 and $101,602, respectively.

This relationship matters because personal income is an important economic measure of a family’s well-being. Higher levels of personal income mean that a family is able to buy more goods and services, such as a home, a car, education, and health care.

Overall, state leaders know that there are both economic and social costs that harm society, but they struggle to craft policies that will mitigate these costs. With the FPI, leaders no longer have to guess which policies are better than others. In the case of economic family prosperity, they now have a crystal clear roadmap to effective policy solutions—reverse the public-sector crowd-out of the private sector.

OCPA research fellow J. Scott Moody (M.A., George Mason University) is a senior fellow at the American Conservative Union. Formerly a senior economist at the Tax Foundation and a senior economist at the Heritage Foundation, he has twice testified before the Ways and Means Committee of the U.S. House of Representatives. Moody is the co-creator of the Tax Foundation’s popular “State Business Tax Climate Index.” His work has appeared in Forbes, CNN Money, State Tax Notes, The Oklahoman, and several other publications.

OCPA research fellow Wendy P. Warcholik (Ph.D., George Mason University) is a senior fellow at the American Conservative Union. She formerly served as an economist at the U.S. Department of Commerce’s Bureau of Economic Analysis, and was the chief forecasting economist for the Commonwealth of Virginia’s Department of Medical Assistance Services. She is a co-creator (with J. Scott Moody) of the Tax Foundation’s popular “State Business Tax Climate Index.”