The Red vs. Blue state divide has driven national politics since the realignment of Southern states from Democratic to Republican. Because Republicans generally favor lower taxes and less regulation, the performance of Republican-dominated Red states offers evidence on whether smaller government is better for the economy. The results are surprising, but ultimately illuminating.
To approach this, one first must classify states as Red or Blue. This is typically done based on voting in recent presidential elections. I like to use the average vote percentage of the Democratic candidate in the past four elections (back to 2000). This measure yields no real surprises: states like Alabama and Mississippi are Red, while California and New York are Blue.
Possibly the best single economic performance measure is median household income, tabulated by the Census Bureau. When we compare states, the results are clear: Blue states outperform Red states. Income averaged across states was $62,000 in 2014 in the 13 “bluest” states, versus $53,000 in the 13 “reddest” states (including Alabama). Liberal bloggers claim such numbers prove low taxes do not grow the economy.
These numbers clearly question the economic benefits of limited government which I often promote here. But I emphasize economic freedom, not party labels. Democrats and Republicans have made policy changes increasing (and decreasing) economic freedom. For example, President Carter deregulated trucking, railroads, and the airlines; while President Ronald Reagan lowered the top Federal income tax rate from 70 percent to 28 percent. Divided government under Presidents Bill Clinton and Barack Obama helped to hold federal spending in check.
In addition, both current and past economic freedom — good and bad policies from 10, 20, or even 50 years ago — affect performance today. Businesses face significant costs to move their operations and will not move immediately if taxes rise. Many industries also cluster geographically, with financial institutions in New York, automobiles in Detroit, and high tech in Silicon Valley. Industry clusters often persist even if government policies become quite unfriendly for business, and do not spring up immediately upon adoption of better policies.
Furthermore, economic freedom is not the only thing that people (and consequently firms) value. Economist Richard Florida, who has extensively studied regional economies, once noted the large number of four-star restaurants in California’s Napa Valley, in the heart of wine country. This concentration was driven by the desire of superstar chefs to live in northern California, not economics, since the competition hurts the profitability of each restaurant. People decide where to live and work based on things like climate, outdoor recreation (beaches and mountains), and the vitality and diversity of mega-cities, not just taxes and the ease of starting a business.
So Blue states could readily have higher incomes today even if limited government is better for business. A more revealing analysis asks if Blue states with the most economic freedom are more prosperous, and similarly for Red states. The freest states among both groups, based on Economic Freedom of North America scores today and back to 1981, are indeed more prosperous. Median incomes are 15 percent higher in the most-free versus the least-free Blue states, and 6 percent higher in the freest Red states (25 percent if you don’t include Alaska).
Indeed, I think politicians sometimes exploit local amenities to impose otherwise unacceptable tax and regulatory burdens. Lawmakers recognize people will pay high taxes to live in New York, Los Angeles, or San Francisco. But decades of poor policy — California and New York have the least economic freedom today — have taken their toll. Income in New York is only 10 percent above the national average.
Economic freedom contributes to prosperity, but is not the only thing that matters in life. Freedom becomes more important because it is what policymakers can change today. We cannot undo bad policies of yesterday or duplicate California’s Pacific coast or the dynamism of New York City. We should focus on what we can control that matters, namely economic freedom.
Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. The opinions expressed in this column are the author’s alone and do not necessarily reflect the views of Troy University.