The American Magazine Online | 8.7.08
By Alan W. Dowd and Amela Karabegovic

There are times when common sense is not so common. We may be in one of those times, which is why the Fraser Institute’s new study on the power of economic freedom is so important.

Common sense tells us that lower taxes, smaller government and flexible labor markets create an environment that encourages economic growth. Fraser’s 2008 Economic Freedom of North America report (EFNA)offers a striking but yet unsurprising picture of the benefits of policies that promote economic growth – and the consequences of policies that constrain it.

To develop this picture, the Fraser Institute employed an “economic freedom index,” which utilizes 10 components based on size of government, taxation and labor-market freedom. This index allowed our team to rate economic freedom at two levels: the sub-national level (state and local) and the all-government level (federal, state and local).

What we found was that economic freedom – not government planning – is one of the main drivers of prosperity and growth.

For example, Colorado, Georgia, Delaware, North Carolina, New Hampshire, Tennessee and Texas – states with consistently strong records of economic freedom – had a per capita GDP that was more than $4,300 above the American average in 2005, the most recent year with available data. Plus, their growth from 1981 to 2005 was nearly 20 percentage points higher than the US average.

What sorts of inputs produce such positive outputs?

Consider Delaware and Texas. Delaware is the top-ranked state in all of North America on the most recent EFNA index; Texas is tied for second (with the Canadian province of Alberta). And for good reason: Delaware has the smallest size of government at the sub-national level and ranks first among US states on key taxation measures. Texas sits atop the ranking for labor-market freedom at the all-government level and has a state top marginal income tax rate of zero. Both states rank in the top 10 on the report’s measure of government transfers and subsidies as a percentage of GDP at the all-government level.

By comparison, West Virginia, Hawaii, Maine, Montana, New Mexico, North Dakota and Rhode Island – states with low levels of economic freedom – had an average per-capita GDP more than $4,300 below the US average. Their total growth from 1981 to 2005 was 10 percentage points below the US average.

Again, the inputs are predictable: All of these states rank in the bottom half of the nation on taxation at the all-government level, labor-market freedom at the state/local level and size of government at the all-government level.

The benefits of policies that promote economic freedom extend far beyond good scores and bragging rights. For instance, a one-point increase in economic freedom results in an increase of $32.13 in venture capital investment per capita, an increase in the number of patents by 8.2 per 100,000 population and an increase of 4.2 percent in the growth of sole proprietorships.

Speaking of good scores, the good news is that most states have maintained a high degree of economic freedom and consistently embrace polices that nurture economic freedom. In fact, the 2008 EFNA report found that 20 states have improved their levels of economic freedom since our last report, with Louisiana experiencing the greatest increase.

Plus, success stories can be found from coast to coast.

For instance, when states are ranked according to size of government at the sub-national level, Nevada and South Dakota are close behind US leader Delaware. The fact that there are states in the Northeast, Midwest and West that rate highly on size of government serves to underscore that no region has a monopoly on smaller government.

States with the highest scores on labor-market freedom are predominantly found in the Southeast and Southwest. Arizona, South Carolina and Tennessee (tied for first at the state/local level) and North Carolina and Texas (tied for first at the all-government level) sit atop these rankings.

Nevada has the lowest percentage of overall government transfers and subsidies as a percentage of state GDP. Subsidies and transfers account for only 2.6 percent of Nevada’s GDP. Nevada also rates best on government-sector employment as a percentage of total state employment.

With a zero-percent state top marginal rate, nine states share first place in the EFNA’s tally of marginal income-tax rates. (With a 10.3 percent topmarginal income-tax rate, California ranks last.)

This year’s report also includes a regional breakdown of the United States.

Given its strong showing in the overall categories, it is no surprise that Delaware dominates the top of the rankings in the Northeast. Within this region, Delaware ranks first in every category but one (labor-market freedom). At the other end of the spectrum, West Virginia is in last or second-to-last place in every regional measure.

There is more parity in the Southeast, where North Carolina ranks best overall, Tennessee ranks best on taxation, Georgia on size of government at the all-government level, South Carolina on labor-market freedom (tied with Tennessee) and Virginia on size of government at the state/local level. In this sense, the Southeast may be the most competitive region.

Indiana and South Dakota share top billing in the Midwest region. South Dakota ranks first across three categories, while Indiana ranks in the region’s top four in every category.

Within the Southwest region, Texas claims the top position in all but one category. Also worth noting is Louisiana’s consistently solid showing across all the categories.

Finally, Colorado, Nevada and Utah – the best in the West – are separated by very narrow margins on the summary rankings.

During his trek across America in the 1830s, Alexis de Tocqueville observed that “social condition is commonly the result of circumstances, sometimes of laws, oftener still of these two causes united.”

What is true of individuals is true of states. Laws – and public policy in general – often shape the circumstances of states. The result can be economic successes or economic messes.