At a high level North and South Dakota appear to be two states that look nearly identical. Both were admitted to the union on November 2nd 1889. Both share a similar immigration history with the majority of current residents tracing their ancestry back to German and Norwegian roots. Both have comparable GDP, household incomes and unemployment rates. Agriculture and tourism are among the top three industries for each state. Both maintain budget surpluses and significant emergency reserve accounts. Politically, nearly every elected office in the Dakotas are held by Republicans. There are no statewide elected offices held by Democrats in either state. The Congressional delegation of each state has one Democrat and one Republican Senator. Each house seat is held by a Republican.
With all the similarities there is a striking divergence on how each state approaches taxation and state spending.
According to WalletHub, South Dakota taxes per residents are on average $3,766 per year compared to $5,588 in North Dakota. The North Dakota tax burden is almost 50% greater than South Dakota. South Dakota is ranked as the #5 lowest overall tax state behind Wyoming, Alaska, Nevada and Florida. None of the top five lowest tax states have a personal income tax. Since 1943, South Dakota has had no income tax. North Dakota, by comparison, ranks #9 on the lowest tax states behind Delaware, the only other state in the top nine with an income tax. The income tax is the most significant difference between South and North Dakota tax structures. North Dakota collected $758 million in personal and corporate income tax in 2013 or $1,048 per resident. In addition, South Dakota only has a state sales tax rate of 4% vs. 5% in North Dakota.
Even more dramatic is the difference in state spending between the two neighbors. The South Dakota state budget for 2014 and 2015 is $8.3 Billion. By comparison the North Dakota state budget is a whopping $13.7 Billion, or 65% greater than that of South Dakota during the current biennium. This translates into $9,824 of state spending per resident in South Dakota. North Dakota is spending $18,993 per residen,t or 93% more per resident than South Dakota.
According to the US Census Bureau in June of 2013, North Dakota had 25,177 full and part time state employees. By contrast, South Dakota only had 19,350 full and part time employees during the same period. This represents a difference of 5,827 employees, a 30% larger state workforce. South Dakota had 844,877 residents in 2013 compared to 723,000 in North Dakota. The additional 121,877 residents in South Dakota would represent a city as large as Fargo, which is North Dakota’s largest. In other words, South Dakota has only one state employee for each 44 residents while North Dakota has one state employee for each 29 residents. With two states so similar why does North Dakota need so many additional resources to maintain the state?
Historically South Dakota has maintained a highly conservative culture of limiting the growth of state government and a philosophy of “low taxes for all” that has been used to sell the state as a haven for corporate and personal investment. In the 1990’s Sioux Falls became a significant banking center as a result of the decision by South Dakota to deregulate the banking laws and attract the banking industry to the state. No corporate income tax was a key contributor to the development of this industry in South Dakota.
Unlike North Dakota, South Dakota has benefited from a strong tourism industry (Mt. Rushmore and the Black Hills) that has historically allowed the state to shift the tax burden to sales and gambling taxes much like Nevada. Recently North Dakota has developed an energy industry that is now the largest economic driver in the economy and presents a similar yet different opportunity.
Before 2006, North Dakota struggled with an economy that relied heavily on agriculture and revenues received from the Federal Government. Over a period of 70 years North Dakota’s population declined from 680,000 residents in 1930 to 640,000 in 2000. Per capita incomes were some of the lowest in the country. North Dakota was the only state in the union to lose population during this period. Between 1990 and the year 2000, only two out of fifty three counties in North Dakota had net population gains. As a result, North Dakota struggled to attract investment to all but a few counties in the state. In contrast, South Dakota’s population grew from 693,000 to 755,000 between the same period. Since South Dakota has most of its population concentrated in the two metropolitan areas surrounding Sioux Falls and Rapid City, the result was a critical mass of economic development in these communities. That contributed to a stable and growing tax base for the entire state. By contrast, North Dakota’s population centers around four metropolitan areas: Fargo, Bismarck, Grand Forks and Minot.
As a result of the macro trend of depopulation and an eroding tax base coupled with low incomes, North Dakota tax policy evolved differently than that of South Dakota. South Dakota chose to embrace the idea of no personal or corporate income taxes as a successful marketing strategy. In addition to low regulations (as referenced by the banking industry) the state is perceived differently from that of its neighbor to the North. South Dakota successfully attracted larger corporations, like Citicorp, to set up headquarters and move workers to attractive larger metropolitan communities. The South Dakota philosophy was based on a broad based policy allowing any business or individual to benefit from low taxes vs. a select set of industries and to let the free markets do their work.
By contrast, North Dakota adopted a “top down” strategy of targeted investments and economic development strategies tied to specific primary sector industries and political legislative agendas. Since North Dakota was experiencing significant depopulation and an erosion of the tax base, policy makers were reluctant to reduce or eliminate any revenue source for fear of voter backlash if taxes needed to be raised to cover future deficits or economic downturns. The cornerstone of tax policy in North Dakota is a balanced approach based on a diversified set of revenues described as a “three legged stool” of income, sales and property taxes. The belief was that having a low tax rate on multiple sources of revenues was fair and reasonable. Slow and steady was the motto. Unlike South Dakota, who used no income taxes as a promotional opportunity to attract companies, North Dakota had no such marketing hook and was lost in the noise.
When North Dakota’s energy and agricultural booms took off in 2006, the states diversified tax structure started to fire on all cylinders. Unlike states with one or two primary sources of revenue, North Dakota’s diversified revenue sources started to compound exponentially. The net result has been an astonishing influx of income into the coffers. It is estimated that oil related tax collections alone will exceed $5 Billion in the 2013-2015 biennium. Of this only $300 Million will be allocated to the general fund. The remainder will be placed into a variety of state managed trust funds. The North Dakota Legislature has been reluctant to reduce taxes based on a concern that the current energy boom will bust and the state will be required to step in and pick up the pieces. These beliefs are based on the energy downturn in the 1980’s that still effects fiscal policy.
Clearly South Dakota has received a much larger return on their state spending investments than North Dakota. South Dakota has starved its government by maintaining low tax rates and a nominal surplus by restraining state spending. The North Dakota approach is minimal tax relief and an increase in state spending that has resulted in a 300% increase since 2001. At the same time the state is allocating billions in annual surplus revenues into constitutionally protected trust funds that all but guarantee the money cannot be accessed or used without legislative approval or a change to the North Dakota constitution.
North and South Dakota have both achieved a quality of life ranked by Forbes Magazine as some of the top in the nation. However, North Dakotan’s pay significantly more in taxes and effectively receive less for their investment when key factors such as increased cost of living expenses are factored in. If North Dakota did not collect personal or corporate income tax, the overall tax burden would be $4,540 per resident and would increase North Dakota’s low tax rank to #6 directly behind South Dakota. The big question for North Dakota policy makers is how can they justify spending 93% more per resident and still maintain an equivalent standard of living to South Dakota which invests so much less.
All North Dakotans deserve to participate in the economic accomplishments of their state. The top down legislatively driven programs such as targeted tax credits for specific pet projects or select industries have reached a point of diminishing returns. It would seem logical for North Dakota policy makers to look not only at South Dakota, but perhaps the other six states that do not have state income tax as a way to benefit North Dakota tax payers. Implementing a bottom up strategy such as eliminating the personal income tax would all but guarantee the state will continue to growth and expand for the foreseeable future. North Dakota’s legislators should recognize that the “three legged stool” now has another leg called oil tax revenue. Fairness would dictate that the 450,000 people who earn wages and pay income taxes in North Dakota would be best served served by eliminating the personal income tax in the state.