Comparisons are commonly made. Students compare test scores. Siblings pencil their heights on door jambs. Friends and coworkers compare careers and incomes. Investors compare firms’ sales, market share and profitability.
Churches compare attendance and membership. It is natural, therefore, to compare the vitality of local and state economies. By doing, so we gain insight into strengths, weaknesses, risks and reasons for these.
To the casual observer, Nashville has grown more than Louisville. For example, Nashville has two professional sports franchises whereas Louisville has none. But clearly this is a limited comparison of community attributes that many would view as unimportant. The following comparisons focus economic performance and population growth. We first compare Louisville-Jefferson County, Ky., and Nashville- Davidson County, Tenn. Next we compare their respective 13-county metropolitan statistical areas. We conclude with a review of some possible reasons for Louisville’s lagging economic performance.
The Bureau of Economic Analysis currently reports local-area data for the 39-year period 1969-2008. Table 1 shows total personal income, per capita personal income and population for Jefferson County, Ky., and for Davidson County, Tenn., at the beginning and at the end of this period. In 1969 Jefferson County surpassed Davidson County by a wide margin in all categories: total personal income was 62 percent higher, population was 55 percent greater, and per capita income was 5 percent higher. By 2008 Jefferson’s County’s personal income exceeded Davidson’s by only 7 percent, Jefferson’s population exceeded Davidson’s by only 14 percent, and Jefferson’s per capita income ($41,517) was about 7 percent below Davidson’s ($44,228) per capita income.
Metro data tell a similar story. Table 2 reports total personal income, per capita personal income, and population for each of the two 13-county metropolitan statistical areas. In 1969 the Louisville metro area far exceeded that of Nashville in all categories. However, by 2008 total personal income ($61.89 billion) in the Nashville area exceeded the comparable figure ($47.48 billion) for Louisville by roughly 30 percent. Also, by 2008 Nashville’s metro area population had surpassed that of Louisville by over 300,000. In addition, by 2008 the Nashville metro area had not only caught up with but had surpassed the Louisville metro area in per capita income.
Small differences in growth rates matter. Per capita income in Jefferson County grew at an average annual rate of 6.3 percent over the 39-year period whereas per capita income in Davidson County grew at 6.6 percent. The 0.3 percent difference appears trivial, but the power of compound growth is astounding when applied to long time periods. In this case a 0.3 percent difference resulted in a per person income gap of nearly $14,000. This may, in part, explain why Nashville has two professional sports franchises while Louisville has none.
The question cannot be avoided: Why has Louisville and Jefferson County grow more slowly than Nashville and Davidson County? At the most general level, economists point to labor, capital and technology as key sources of economic growth. Higher labor costs or lower-skilled workers matter. Differences in existing infrastructure and in highways matter. Climate, ports and harbors matter. A comparison of these between the Louisville and Nashville areas is not possible here, but it likely would show more similarities than differences. It seems reasonable to look toward public policies for the answer.
Public policies matter because they can reduce incentives to utilize labor and capital, and therefore can act as restraints on economic and population growth. High taxes, unless associated with improved infrastructure that makes for higher productivity, can be expected to discourage work, saving, investment and thus growth. Laws governing the employer-employee relationship such as policies that encourage collective bargaining are likely to increase wages and, unless associated with higher labor productivity, can be expected to increase production costs and result in lower expected profit, reduced business investment, and lower growth rates.
It’s not just business taxes that matter. High taxation of individuals and families can discourage location choices especially in the case of highly sought after, high-income individuals. We estimate, for example, that a hypothetical couple in Louisville with $200,000 in income pays about $11,000 more in “big three” taxes (sales, property and income) than the same couple in Nashville. The Nashville family pays more in sales and property taxes, but this is more than offset by the nearly $14,000 of state and local income tax in Louisville.
Empirical studies of the effects of business taxes have shown mixed results. An early study (Helms, 1985) found that higher taxes reduce growth when used to finance transfer payments, but do not reduce growth when used to finance infrastructure such as prudently built highways and the like. Another early study (Genetski and Ludlow, 1982) found states that decreased their tax burdens relative to the national average tend to experience above-average growth, whereas states that increase their tax burden relative to the national average tend to suffer below-average economic growth.
A more recent study (Bauer, Schweitzer and Shane, 2006) that included a measure of “knowledge stock” found that tax burden is statistically insignificant. It is not surprising that studies show different results. They frequently use different periods of time, often measure tax burden differently and, most importantly, often are unable to control fully for the impact on growth of factors other than taxes.
The tax comparisons presented here are suggestive. In a comprehensive statistical study matching similar states (such as Kentucky and Tennessee) and taking into account a variety of influences on growth, including education and physical capital, Western Kentucky University colleagues and I find that nearly half of the 10 percent growth advantage enjoyed by Tennessee from 1997 to 2006 can be attributed to Kentucky’s higher tax burden, with labor law also contributing.
Policy makers in Louisville and in Frankfort may want to reconsider the impact that public policy has on growth, for even small negative policy impacts can have large consequences for economic performance over long time periods.