Podcast: States Can’t Stimulate Their Economies By Cutting Taxes
March 23, 2010
In this podcast, we will discuss the myth that cutting taxes can stimulate a state's economy. I'm Shannon Spillane and I'm joined by Senior Advisor Iris Lav.
1. Iris, with so many states facing fiscal crisis, policymakers in a number of states are eager to find ways to boost their economies. Many of them have called for tax cuts they claim will provide economic stimulus. Your recent report, The Zero-Sum Game, finds that claim is false.
That's exactly right: States cannot stimulate their economies by cutting taxes.
Let me explain why. Almost every state is required to balance its budget. That means that a tax cut usually would have to be offset by a cut to a program or service to keep the budget balanced. When states cut spending, they lay off public employees, cancel contracts with private-sector vendors, and eliminate or lower payments to nonprofit organizations that provide direct services. This is likely to reduce demand in the state just as much as the reduction in taxes may stimulate demand. It is at best a zero-sum game, where the gains in one area are offset by the losses in another.
In addition, there is no guarantee that a cut in corporate tax rates or a similar broad tax cut would result in investment or hiring in the state providing the cut. The company may save the value of the tax cut for a later date, or it may invest it in another state.
2. What about so-called job creation tax credits? Would they boost employment?
A number of states already have these kinds of credits in place and there is no evidence that these states' economies are doing better than any other states' economies.
Research has shown that many companies receive these credits for hiring employees that they would have hired anyway. And the history of credits suggests that employers can game the system to appear that they are expanding employment when they are not. In addition, the federal government captures a lot of the value of state credits because state taxes are deductible from federal tax liability, so states end up subsidizing the federal government rather than local employers. For all these reasons and others, the amount a state spends to create a new job through tax credit is actually much higher than the value of the credit. It is a very costly, inefficient way to try to create jobs.
3. Congress is also considering job creation tax credits. Do the same problems apply on the federal level?
Well, the federal government is not required to make offsetting budget cuts or tax increases to pay for a tax cut. In a recession like this one, that's a good thing.
Unlike the states, the federal government can run a deficit during bad economic times. Federal spending helps make up for the fact that spending by people and businesses has slowed dramatically. The additional federal spending plays an important role in getting the economy back on its feet.
So the costs and benefits are very different for a federal credit. While a federal credit might do some good for the national economy, a state credit is unlikely to benefit a state economy.
Thanks for joining me, Iris.