Texas vs. California


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Every now and then, we come across something that is simple and says it all. When comparing California with Texas, U-Haul says it all. To rent a 26-foot truck one-way from San Francisco to Austin is $1,840, and yet the one-way charge for that same truck from Austin to San Francisco is just $676. When more people want to move from San Francisco to Austin than vice versa, U-Haul must recoup the cost of getting empty trucks back from Texas and ready for the next person in the exodus.

The great thing about this example is that it’s a market price set in the real world—you don’t need to rely on a fancy economic model to see the point. People and businesses are voting with their feet, choosing Texas over California.

These population shifts do not reflect some arbitrary change in geographical preferences. People respond to incentives, and people are drawn to Texas by opportunity. Texas’ overall economic growth and income growth have exceeded California’s for the last decade, and since 2009, Texas has been responsible for 45% of the net new jobs created in the United States. In turn, Texas’ impressive economic performance is no accident; rather, it is the result of a strongly pro-growth economic policy atmosphere, reflected in low taxation, restrained government spending, and a less burdensome regulation.

Taxation

Let’s first consider the burden of taxation in Texas and California, beginning in particular with the tax burden on labor. People do not work to pay taxes. People work to earn the highest wages, after taxes. High or rising taxes on labor reduce workers’ after-tax wage, reducing the incentive to work. As a result, people have an incentive to leave a state with high taxes on labor income and relocate to a state where the taxes on labor income are lower, demonstrating George Gilder’s famous maxim: “High tax rates do not redistribute income, they redistribute people.” As people respond to these incentives, income growth, employment growth, and overall economic growth suffer in the state with high or rising taxes

California levies a progressive income tax system—as people’s income increases, the tax rate on the higher income increases. California imposes one of the highest top marginal state income tax rates in the country at 10.3 percent, and the marginal tax rate on the median household is 9.3 percent.

In contrast, Texas does not impose a state income tax. By definition, the marginal income tax rate for both the highest income earners and the average worker are zero percent. The practical result of this is that the median worker in California can achieve an after-tax raise simply by finding a job at the same wage in Texas. Texas derives a clear competitive advantage from its lack of an income tax.

In addition to the negative incentives to work, California’s progressive income tax code largely explains why hard times seem to hit California harder than other states. Tax progressivity exaggerates the normal ups-and-downs of the overall economy: when times are good, California citizens earn more and move into higher tax brackets, thereby giving the state a larger fraction of a bigger pie. But then an opposite effect holds true during recession: People earn less income in general, thereby shrinking the tax base even as many fall into lower tax brackets and pay a smaller fraction of smaller paychecks. If the state committed to a higher than efficient spending path when times were good, budget crises are likely to emerge when times are bad.

Next, consider the variety of taxes that constitute the tax burden on capital. California has an advantage over Texas in that it has a lower property tax rate as a result of Proposition 13. But Texas overwhelms this advantage with lower taxes on corporate income, interest income, and capital gains income. The after-tax interest and capital gains income for a $1,000 investment is 11.5 percent higher in Texas than in California for the exact same investment. As a result, Texas gains a significant competitive edge vis-à-vis California in attracting businesses and investors.

The final significant tax area, the tax on consumption, is essentially a wash between the two states. While Texas has a lower sales tax rate, California has a marginally lower sales tax burden. (Found by dividing sales tax revenue by total state income.)

With every other tax category in Texas’ favor, the Lone Star State clearly maintains a more competitive economic atmosphere with regard to overall taxation than California. Just as important as the current statistics on taxation are the ongoing trends, and again the signs are not encouraging for California. Where Texas’ tax burden, smaller than California’s to begin with, has been falling in recent years, California’s tax burden continues to rise.

Regulation

Texas also gains a significant competitive advantage through limited regulation when compared with California. Just like excessive taxes, excessive regulation raises the costs of doing business, thereby stunting economic growth. For example, high levels of worker’s compensation increase the costs from employing additional workers, increasing unemployment and decreasing a state’s potential economic growth. Texas’ average workers compensation costs are 11% less than California’s, making it significantly more appealing to add workers to a payroll in Texas.

Minimum wage is another significant regulatory policy. Where Texas requires businesses to meet only the federal minimum wage of $7.25 an hour, California mandates that businesses pay a minimum wage of $8 per hour. Minimum wage laws can have only one of two effects. Either the minimum wage is below the wage that would be paid to any employee, so it is irrelevant; or, the minimum wage law raises the wage costs for employers, leading to greater unemployment. By imposing a minimum wage in excess of the federal minimum wage, California is unnecessarily increasing employer costs, thereby reducing business flexibility and overall employment in the state. These effects do not exist in Texas, providing Texas’ regulatory environment with another comparative advantage.

A final regulatory aspect to consider is a state’s treatment of unions. States are divided into two distinct categories with respect to their union organizing laws. They are either right-to-work, which means workers have the right not to join a union, or non-right-to-work, which means that workers are forced to join a union and pay dues if they work in a unionized industry. The evidence points overwhelmingly to the fact that right-to-work states have much greater growth of employment than non-right-to-work states. Texas is a “right-to-work” state; California is not.

Spending

The final policy area, spending, impacts the state economy for two reasons. First, before the government can spend revenues it must first take money away from the private sector. As governments get larger and larger, the value of the dollar taken away from the private sector is greater if it were spent in the private sector than the value of the money if the government spent it. As a consequence, government spending lowers the total potential output in the state. Second, larger government spending today oftentimes begets even greater government spending and activity tomorrow. In other words, the threat of higher tax and regulatory burdens grows as the size of the government grows.

California’s spending record is dismal in comparison with Texas. Texas’ current expenditures per capita are 44 percent smaller than California’s per capita expenditures. Furthermore, California’s expenditures have grown at a higher rate than Texas’ in recent years. Therefore, the gap in expenditure between Texas and California will only grow in the years to come. Higher future taxes, increased fiscal crises, and slower economic growth will all follow as a result of the rising government expenditures in California. In the area of spending, Texas’ prudence and restraint again give it a significant competitive advantage over California.

Conclusion

Both Texas and California have large populations, plentiful natural resources, and the allure of geography. Moreover, the economies of both states have outperformed national trends. But current policies matter for future economic performance. Texas’ superior policies over the past several years are making the Lone Star State more resilient to economic downturns and will provide powerful tailwinds for the Texas economy going forward. The opposite is true for California. The relative success of Texas gives California policy-makers a realistic goal to shoot for. If they can do it in Texas, they can do it in California, too.

Arthur B. Laffer is Chairman of Laffer Associates, Co-Author of “Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index” now in its 4th Edition, and the Laffer Center’s Distinguished Chair in Supply-Side Economics.

Mary Katherine Stout is the Executive Director of the Laffer Center for Supply-Side Economics at the Texas Public Policy Foundation.

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