December 3, 2012
By Robert Lawson and Richard Alm
Want a simple number to explain why Texas has been growing faster and creating more jobs than other states? Try this one — 7.5. That’s the state’s score on the Economic Freedom of North America annual report, just released by Canada’s Fraser Institute.
On the basis of this wonkish number, Texas beats out 46 other states in economic freedom, coming in a whisker behind U.S. leaders Tennessee, South Dakota and Delaware. Economic freedom creates prosperity by giving companies and individuals the breathing room they need to start, expand, manage, staff and restructure businesses relatively free of unnecessary burdens imposed by government. It pays off, too. A one-point increase in the economic freedom score raises a state’s per-capita income by $7,679 a year.
Some outsiders attribute Texas’ prosperity to sheer luck — for example, the oil and gas under our soil. However, the economic freedom index reminds us that state policies shape the business climate — for good and, mostly, for ill. States that score best on economic freedom typically have the lowest government spending, least distortionary taxes and smallest regulatory burdens.
Using data from 2010, Texas rates a 7.5 out of 10, making it stand out among the nation’s largest states. California, New York, Ohio and Michigan are all at 5.7 or below, ranking in the bottom six in economic freedom.
Texas’ relatively high score is mostly attributed to its relatively limited welfare spending, low overall tax burden and lack of an income tax. On the other hand, relatively high sales taxes and the impact of the minimum wage bring the score down somewhat.
Despite its high ranking, Texas has reasons to worry. First, its economic freedom has been falling in absolute terms — like that of most states and the U.S. as a whole. Texas’ score fell dramatically from 8.5 in 1981 to 8.0 in 2007, then slipped further to 7.5 in 2010. Texas’ decline in economic freedom is almost entirely the result of increased government spending and taxation over the three decades.
The second problem — to put it bluntly — is that Texas is part of the United States. The policies coming out of Washington — most notably, the rapid run-up in federal spending and an erosion of property rights — are increasingly hostile to economic freedom, and Texas citizens and businesses must bear this burden as well.
The companion Economic Freedom of the World annual report tracks 144 countries (Lawson is one of its co-authors). Over time, this report found that U.S. economic freedom rose steadily from the early 1970s to the early 1990s. It leveled off in the 1990s, but the country ranked second in the world in 2000. Since then, the U.S. economic freedom has faltered, with the nation’s rank tumbling to 18th in the world, far below the leaders Hong, Kong, Singapore, New Zealand and Switzerland.
Being an island of relative economic freedom in a nation drifting toward higher taxes, regulation and spending is one reason that Texas has become a magnet for migrants from other states. Between 2004 and 2010, Texas led the nation in net migration from other states, gaining a total of 682,362 residents, according to Internal Revenue Service data. Take a look at California, another large state, but on the opposite end of the economic freedom rankings. It had a net loss to other states of 865,444 residents. The lesson is clear. People vote with their feet for economic freedom.
A high ranking among states in economic freedom suggests that Texas’ growth and job creation will remain strong in the immediate future. However, the state can’t ignore the long-term challenge implied by the ebbing of economic freedom in both the state and nation. Reversing these trends is critical if Texas is to remain an engine of economic growth.
Robert Lawson holds the Jerome M. Fullinwider Chair in Economic Freedom and Richard Alm is Writer-in-Residence in the O’Neil Center for Global Markets and Freedom in SMU’s Cox School of Business.