Personal income is an important economic measure of a state’s well-being. Higher levels of personal income mean that a state’s residents are able to buy more goods and services such as homes, cars, education, and health care. It’s also a very useful way to gauge the ability of a state’s residents to pay taxes.

Fundamentally, personal income comes from two sources: the private sector and the public sector. The distinction between the two is important because only the private sector creates new income. The public sector1 can only redistribute income through taxes and spending.

As I pointed out to a reporter for the cover story of last month’s edition of OKC Biz magazine, there is clear evidence that public-sector spending results in the “crowding out” of the private sector. Oklahoma policymakers should be aware of this as they approach next year’s “budget hole,”2 estimated by some to be as high as $1.1 billion. Attempting to plug this hole with new tax revenues would significantly reduce the size of Oklahoma’s private sector relative to the public sector.

As a consequence of such a tax hike, Oklahoma’s taxpayers would pay a steep price with higher tax bills, lower incomes, and fewer jobs. On the following page, Table 1 shows the impact such a tax hike would have on the average Oklahoma household over three to five years (depending on how quickly the tax hike kicks in and how fast the new dollars flow out). The most immediate impact is that the average household would face an increase in their tax bill of $769. Table 1 also shows the economic cost by county.

Even more troubling, there would be a much higher economic cost to pay in the long run—either in lower incomes or fewer jobs.3 Overall, Oklahoma’s economy would suffer a drop in personal income of $3.1 billion—an amount 2.8 times greater than the tax increase itself.

The drop in personal income could manifest itself in two ways—either lower household income for everyone or fewer jobs. The reality would lie somewhere in between. The economic cost of such a tax hike ranges from:

• $2,198 less personal income for all households with no private-sector job loss; or
• No change in household personal income but the loss of 68,937 private-sector jobs.

In short, a tax hike of this magnitude would be devastating to Oklahoma’s economy at a time when the recovery from the “Great Recession” has been extremely tepid. A better option is to shelve tax increases and instead focus on reducing government spending. This would expand the private sector, which could then get back to work increasing incomes and creating new jobs.

Methodology

The economic loss estimates in this study are derived from the significant positive correlation between per household personal income and the private sector share of personal income for 2009, as shown in Chart 1. Put simply, the bigger the private sector, the greater per household personal income.

States with larger private sectors will grow faster over time than states with smaller private sectors. For example, for a long-run comparison of two states that are virtually identical in every way except for the size of the private sector—New Hampshire and Maine—see: http://nheconomics.org/2010/08/in-the-news-august-27-2010/

The personal income data are from the Bureau of Economic Analysis, and adjusted into “per household” figures using data from the Census Bureau. The economic loss estimates are made on a statewide basis. The losses are allocated by county based on their share of personal income and private-sector employment.

Endnotes

1. More specifically, public-sector spending consists of personal current-transfer receipts (Medicare, Medicaid, Social Security, etc.) and government-employee compensation (federal, state, and local).

2. A “budget hole” is in the eye of the beholder. As Tax Foundation analyst Joseph Henchman points out in “The Perils of Using ‘State Budget Deficit’ Numbers” (http://bit.ly/c6ziOC), “a budget deficit could exist because of overly ambitious spending plans that are whittled down to reality, overly optimistic revenue projections, fiscal irresponsibility, or structural imbalance.”

3. This is not to say incomes will drop or that there will be fewer total jobs, but rather there will be less income or fewer jobs than there would have been in the absence of the tax increase.

Economist J. Scott Moody (M.A., George Mason University) is an OCPA research fellow.