Tennessee will never live up to its full potential of freedom and prosperity until the Hall tax is eradicated. We are currently the fifth most economically free state in America, according to the Economic Freedom of North America 2015 report put out by the Fraser Institute. While this puts Tennessee in an elite category, the Beacon Center’s goal is to make Tennessee the freest state in the country. One area in need of improvement is the tax code. In the 2016 State Business Tax Climate Index published by the Tax Foundation, Tennessee’s tax code ranks a dismal 16th.
Tennessee is one of nine states that does not tax ordinary income. However, unlike most of the other states on this list, residents of Tennessee are taxed on investment income, such as interest, dividends and capital gains, at a rate of 6%. This tax on investment income is known as the Hall tax. There are a number of reasons that the Hall tax is especially crippling.
Perhaps the greatest threat to the American people today is their general lack of savings and an increasing dependence on federal entitlements at a time when the federal government is quite literally going broke. In 2015, the household savings rate in the US was an estimated 4.87%. This is the percentage of a household’s income that is not immediately spent on consumption, but is instead set aside. Because most families don’t horde their savings in a mattress, this money is typically invested back into the economy either directly, or indirectly through a bank. The savings rate in America is shockingly low when compared to other wealthy countries such as Switzerland and Sweden, who are currently saving at 17.8% and 15.8% respectively. It is absolutely essential that public policy not discourage savings, investment, and ultimately, financial independence; this is exactly what the Hall tax does. The most basic principle in economics is that humans respond to incentives. People will invest less of their income when the government confiscates a portion of the income derived from that investment.
Taxing investment is extremely destructive to the health of an economy. My former policy scholar at the Cato Institute, Dan Mitchell, often explains this concept through the analogy of a fruit tree. When governments raise revenue through sales or income taxes, they are siphoning off a portion of the economic output for themselves. This is comparable to plucking apples or bananas off the branch of a tree. On the other hand, taxing investment is like cutting off whole branches of the tree. Investment is what allows the economy to grow and increase its productive capacity. Taxing investment hinders the economy’s ability to produce more “fruit” in the future. It “kills the goose that lays the golden egg”, to use a common idiom.
Repealing the Hall Tax would encourage a higher rate of investment in Tennessee. This would allow more Tennesseans to achieve financial independence throughout retirement, as well as provide the capital necessary to grow our economy and raise the standard of living for all.