The U.S. economy has recently been in the midst of the slowest growth recovery since World War II. That slow growth has coincided with a steady decline in economic freedom (freedom from government meddling in the economy), as taxes, spending, and regulation have all been on the rise. In fact, a recent report ranked the U.S. 16th in the world for economic freedom, down from 3rd in 2000. This is concerning because numerous studies show that economic freedom is associated with prosperity.
The pattern across the states, however, is quite varied and shows promise. According to this year’s newly released Economic Freedom of North America report, which ranks states on how free their economies are, the average level of freedom at the state and local level has risen slightly in recent years. This is driven in part by the fact that in recessionary times the growth of both revenue and spending tend to fall at the state level since states must balance their budgets. The federal government, on the other hand, can just keep on spending by running up larger and larger budget deficits.
States that have seen the fastest growth, like Texas and Florida, tend to have a policy strategy that differs from the national trend: maximize economic freedom. They attract new businesses and residents by keeping the burden of taxes, spending, and regulations low. In contrast, states like New York and California that take the opposite approach have seen much less economic prosperity.
Residents and businesses have been voting with their feet in favor of economic freedom. Over the last three years, population in Texas and Florida has grown more than two-and-a-half times faster than it has in New York and California. Employment and income have also grown faster in those two states.
Not surprisingly, Texas and Florida were at the top of EFNA’s list for economic freedom among the largest states, while New York and California were at the bottom, ranked 50th and 49th respectively. Colorado also ranks near the top, at 13th, and its economic growth has been comparable recently to that in Texas and Florida.
What’s going on in states like Colorado should give us hope. There have been over 400 scholarly articles by independent researchers examining economic freedom at the national level, and over 200 at the state level (using the EFNA). Most of that literature finds that areas with economic freedom tend to have more prosperous economies, as well as a variety of other positive outcomes. One of the reasons for that is the fact that high levels of taxes, spending, and regulations make it harder for entrepreneurs to be successful. When entrepreneurs cannot expand their businesses and hire new workers, it hurts everyone.
Although Colorado is ranked relatively high in this year’s report (13th), there is always room for improvement. Given the importance of economic freedom for prosperity, it is troublesome that its ranking has actually fallen recently, down from 9th last year and 4th in 1998. Coloradans should remain vigilant and pursue policy changes that will move it back closer to the top.
For example, Colorado is to be applauded for having a flat rate income tax, but there are nine states that have no tax at all on wage and salary income. Colorado’s rate of 4.6% puts it at a competitive disadvantage to those states, including Texas and Florida. Also, Colorado scored particularly low on the burden of the sales tax, ranking only 23rd.
Furthermore, Colorado’s state and local government bureaucracy is particularly large, representing nearly 11% of the total workforce. Colorado ranks only 21st on this measure. That excessive bureaucracy is one of the reasons for those higher taxes Coloradans must face.
Finally, Colorado has 30 different targeted business incentives programs. In addition to squandering scarce tax dollars, such cronyism creates an uneven playing field that makes it harder for entrepreneurs and small businesses – the backbone of our economy – to be successful. Eliminating these corporate welfare programs would make it easier for entrepreneurs to expand their businesses and hire new workers, which would be beneficial to all, not just those companies with political influence.
Politicians in Denver and at the local level should reduce corporate welfare spending that puts small businesses at a disadvantage, cut taxes and regulations, and shrink their government bureaucracies. Doing so would help Colorado move closer to the top of the list for both economic freedom and economic prosperity.
Dean Stansel is an economist at the O’Neil Center for Global Markets and Freedom in Southern Methodist University’s Cox School of Business and the primary author of the annual Economic Freedom of North America report (available at www.freetheworld.com).