The U.S. Bureau of Economic Analysis released second-quarter GDP figures Thursday morning that showed negative economic growth for the second straight quarter. This means that a technical recession has already started in the United States. Colorado can isolate itself by reducing state income tax.
To understand why an income tax cut would help ease the pains of the recession, we must first understand how we got here.
Attempting to stop the spread of the COVID-19 pandemic in early 2020, governments imposed economic shutdowns and induced recession. To revive the economy, Congress issued $5 trillion in federal aid. Because the US Treasury didn’t have that much money, the US Federal Reserve actually printed it. To encourage the creation of additional money in the economy through borrowing, the Fed also lowered interest rates to near zero.
The policies boosted the total money supply of the United States from about $15.5 trillion to $21.75 trillion, a 40% increase in just two years. Economists argued that creating money would increase consumer demand, raise asset prices and bail out the economy. It worked, but they got more than they bargained for.
At the start of 2021, all the new money in the economy started driving prices up at alarming rates. As inflation persisted and rose throughout the year, the Fed began talking about reversing its “easy money” policy.
In March of this year, the Fed began raising interest rates to curb inflation. In doing so, they aim to reduce the amount of new money entering the economy, thereby reducing demand for goods and services and lowering prices. This approach risks plunging the economy back into recession, as economic indicators are already showing.
The US Bureau of Labor Statistics reported earlier this month that the consumer price index hit a new 40-year high of 9.1% in June. The market reacted by inverting what is known as the yield curve — long-term interest rates fell below short-term rates. This reflects investors’ belief that there is more risk in the near term than over the next decade.
Yield curve inversions have successfully predicted 75% of recessions over the next six months, according to research by Red.
Other economic indicators echo the yield curve. The price of oil has been on a downward trend for more than a month, the housing market is slowing and consumer confidence is at its lowest since February. Even economists sympathetic to the current administration have sounded the recession alarm.
Fortunately, Colorado can take preventative measures to cushion the blow of a coming recession.
Initiative 31, which will appear on the Colorado state ballot in November, would reduce the state income tax rate from 4.55% to 4.40%. If adopted by voters, the measure would reduce the tax burden on the private economy by $382 million, or an average of $120 per taxpayer per year. Additionally, the Independence Institute, a Denver-based think tank where the authors of this column work, has developed a plan to put Colorado on the path to zero income tax.
Income tax cuts have several advantages, especially in times of recession.
First, tax savings provide individuals, families and businesses with additional income — a good cushion during tough times. Tax cuts also encourage spending and investment without increasing the total money supply. This means they can stimulate the economy without the baggage of inflation.
A political adage illustrates precisely the rationale for an income tax cut: “If you want less of something, tax it”. People generate income by working and being productive. If you want less than that, income tax. But if you need more productivity to pull the economy out of recession, cut income taxes.
Cutting taxes at the state level can also spur investment and jobs from other states to ours. Individuals vote with their feet and prefer low-tax states. A comparison of the 2022 state business tax climate index and state emigration data shows that high-tax states such as California and New York have seen exodus while states with low taxes such as Florida or Tennessee experienced population growth during the recent pandemic-related recession.
Skeptics may dismiss the idea that a reduction in the tax rate could lead to significant behavioral changes. But tax rates change behavior at the margin. A small tax cut can go a long way.
The recession is staring us in the face. The income tax cut would reduce the direct hardship of inflation and recession while improving Colorado’s economic competitiveness and long-term economic health.
Ben Murrey is director of the Fiscal Policy Center at the Independence Institute, a free-market think tank in Denver. Stepan Mysko holds a BA in Economics from the University of California, Davis and is currently part of the Independence Institute’s Future Leaders Program.