Taxing Its Way into a Depressing Death Spiral

The state of Connecticut is a prime example of the Laffer Curve. Using the back of a napkin, Art Laffer drew a simple display illustrating the point at which collecting taxes falls to zero, “because nobody bothers to earn or report any income,” writes  Francis Menton in the Manhattan Contrarian.

In the 80s, New York State recognized that it had become uncompetitive, and started cutting its top tax rate significantly; and that process continued during the 90s.  By the mid-90s the top New York State rate was under 7%. … (add about 4% additional for New York City — a figure that hasn’t changed much during the period under discussion).

Suddenly Connecticut found itself with income tax rates higher even than New York for people making between $500,000 and $2 million per year and not residing in New York City.  A $1 million per year earner could now actually live in Rye (just on the NY side of the border) and work in New York City, and pay less income tax than if he lived and worked in Connecticut.  (Only New York City residents pay New York City income tax.)

Almost three decades ago, my brother-in-law moved his manufacturing business from Hartford to the right-to-work-state of Virginia. The unions were killing him. Virginia wooed him and flew him and Dick around the state, introducing Dave to properties that could fill his needs. To this day, my brother-in-law’s business is going strong in the Lynchburg, VA area. Hedge fund manager Paul Tudor Jones (personal income of about $600 million/yr) moved from Connecticut to Florida, where there is no income tax. This one move cost Connecticut between $30 and $40 million per year in income tax revenue.

As Mr. Menton explains, Connecticut has a dozen or so cities with population between 35,000 and 150,000, but the state lacks one city that has the ability to be a charismatic draw. The places Dick and I drive by on Interstate-84 are not only in the pathway of the worst traffic we experience driving between Key West and Newport, but also dreary examples of why we race unblinkingly by them. To a one–Bridgeport, New Haven, Hartford, New London, Waterbury, Torrington, Bristol–these former thriving factory towns are now wasted, depressed and depressing has-beens.

To make matters worse, Connecticut now has gone over to the dark side of the moon, or, as Mr. Menton writes, “the back side of the Laffer curve.” In a presentation to the state, Mr. Ben Barnes (Sec. of the Office of Policy and Management [not kidding]) described a “precipitous drop in revenue [that] we experienced in late April.” What caused this precipitous drop?

The income tax, the state’s largest revenue engine, saw the most erosion by far. And the bulk of the latest income tax erosion was tied not to paycheck withholding but to quarterly filings, most of which involves capital gains, dividends and other investment-related earnings.  According to the governor’s budget office, the state’s 100 largest-income taxpayers paid 45 percent less this year than last.

This is happening even as a “coalition of progressive groups, including unions representing state employees, is calling for raising the top income tax rate yet again, to 7.49%, and also imposing a special 20% rate on income from hedge funds,” writes Mr. Menton.

If Connecticut continues to follow the strategy of higher and higher taxes — or even leaving taxes at the current uncompetitive levels — there is not much hope for any of these small cities to revive any time soon.  What they need is new investors, people willing to take a big risk in the hope of having a big success.  But the message that Connecticut sends out is, if you have any meaningful success, we will treat you like a goose to be plucked.

Meanwhile, Connecticut has dug itself into a really deep hole, with no easy way out.  It’s not just that they can’t increase taxes further; it’s that even the current level of taxes has gotten them into a death spiral.

Read more here.