U.S. State Marginal Tax Rates and State Capital per Worker, 1977-2017

We use a newly created measure of state-level capital per worker to test whether tax structures can explain long-standing differences in capital investment and productivity across U.S. states. A standard neoclassical growth model shows that differences in marginal tax rates on property, sales, capital gains, and corporate income will lead to persistent differences in capital per worker across states, predictions that are borne out in the data. We also show that the factors that drive state variation in capital-labor ratios are consistent with their impacts on per capita income and labor productivity, results that are also consistent with predictions from the theory. Persistent differences in capital-labor ratios across states are leading to rising income inequality between states.