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The Path to Prosperity

Thursday, August 7, 2008

A new report confirms that low taxes, limited government, and flexible labor markets help to spur economic growth.

There are times when common sense is not so common. We may be in one of those times, which is why a new report on the power of economic freedom is so important.

Common sense tells us that low taxes, limited government, and flexible labor markets will help to spur economic growth. The Fraser Institute’s 2008 Economic Freedom of North America (EFNA) report offers a striking, yet unsurprising, picture of the benefits that flow from such policies.

In 2005, the most recent year for which data are available, Colorado, Georgia, Delaware, North Carolina, New Hampshire, Tennessee, and Texas—states with consistently strong records of promoting economic freedom—had an average per capita GDP that was more than $4,300 above the U.S. average. Their total growth from 1981 to 2005 was nearly 20 percentage points higher than the U.S. average.

In the latest EFNA index, Delaware is the top-ranked state or province in all of North America while Texas is tied for second with the Canadian province of Alberta. And for good reason: Delaware has the smallest size of government at the subnational level and ranks first among U.S. states on key taxation measures; Texas ranks first in labor-market freedom at the all-government level and has a state top marginal income tax rate of zero. Delaware and Texas also rank high in the categories of government transfers and subsidies as a percentage of GDP at the all-government level.

In 2005, Colorado, Georgia, Delaware, North Carolina, New Hampshire, Tennessee, and Texas—states with consistently strong records of promoting economic freedom—had an average per capita GDP that was more than $4,300 above the U.S. average.

By comparison, West Virginia, Hawaii, Maine, Montana, New Mexico, North Dakota, and Rhode Island—states with low levels of economic freedom—had an average per capita GDP that was more than $4,300 below the U.S. average. Their total growth from 1981 to 2005 was 10 percentage points below the U.S. average.

Again, this is predictable: all of these states rank in the bottom half of the nation on taxation at the all-government level, labor-market freedom at the state/local level, and size of government at the all-government level.

The benefits of policies that promote economic freedom extend far beyond good scores and bragging rights. For instance, a one-point increase in economic freedom results in an increase of $32.13 in venture capital investment per capita; an increase in the number of patents by 8.2 per 100,000 population; and an increase of 4.2 percent in the growth of sole proprietorships.

The encouraging news is that most states have maintained a high degree of economic freedom and embraced polices that nurture economic freedom. In fact, the 2008 EFNA report found that 20 states have improved their level of economic freedom since the last report, with Louisiana experiencing the greatest increase.

Success stories can be found from coast to coast. For instance, when states are ranked according to size of government at the subnational level, Nevada and South Dakota are close behind U.S. leader Delaware. The fact that there are states in the Northeast, Midwest, and West that rate highly on size of government indicates that no particular region has a monopoly on limited government.

States with the highest scores on labor-market freedom are predominantly found in the Southeast and Southwest. Arizona, South Carolina, and Tennessee (tied for first at the state/local level) and North Carolina and Texas (tied for first at the all-government level) sit atop these rankings.

Nevada has the lowest percentage of overall government transfers and subsidies as a percentage of state GDP. Government subsidies and transfers account for only 2.6 percent of Nevada’s GDP. Nevada also rates best on government-sector employment as a percentage of total state employment.

Nine states boast a zero-percent state top marginal income tax rate, and thus share first place in that category. With a 10.3 percent state top marginal income tax rate, California ranks last.

This year’s EFNA report also includes a regional breakdown of the United States.

Given its strong showing in the overall categories, it is no surprise that Delaware dominates the top of the rankings in the Northeast. Within this region, Delaware ranks first in every category but one (labor-market freedom). At the other end of the spectrum, West Virginia is in last or second-to-last place in every category.

There is more parity in the Southeast. North Carolina ranks best overall; Tennessee ranks best on taxation; Georgia on size of government at the all-government level; South Carolina on labor-market freedom (tied with Tennessee); and Virginia on size of government at the state/local level. In this sense, the Southeast may be the most competitive region.

Indiana and South Dakota share top billing in the Midwest region. South Dakota ranks first in three categories, while Indiana ranks in the region’s top four in every category.

Within the Southwest region, Texas claims the top position in all but one category. Also worth noting is Louisiana’s consistently solid showing in all categories.

Finally, Colorado, Nevada, and Utah—the best in the West—are separated by very narrow margins on the summary rankings.

During his trek across America in the 1830s, Alexis de Tocqueville observed that “social condition is commonly the result of circumstances, sometimes of laws, oftener still of these two causes united.”

What is true of individuals is true of states. Laws—and public policy in general—often shape the circumstances of states. The result can be economic successes or economic messes.

Amela Karabegovic is associate director of globalization studies at the Fraser Institute and a co-author of its 2008 Economic Freedom of North America report. Alan W. Dowd is a senior fellow at the Fraser Institute and a contributor to the report, which is available at Fraser am.eri.ca.

Image by The Bergman Group/ Darren Wamboldt.

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