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4 Reasons Why States Shouldn’t Cut Corporate Income Taxes

As my colleague Elizabeth McNichol explained last week, policymakers in Louisiana, Nebraska, and North Carolina have proposed eliminating their states’ income tax and raising the sales tax to make up the lost revenue.  Those plans won’t produce fairer tax systems or more “business friendly” environments, but that hasn’t stopped advocates in those states from pushing to eliminate the corporate income tax on top of repealing the personal income tax.  Now, officials in Florida, New Mexico, and Missouri have offered their own proposals to cut corporate income taxes.

Proponents of the plans say they’ll stimulate the economy and create jobs.  This idea isn’t new — but it still won’t work.  As I wrote a few years ago when some policymakers made similar proposals, the plans won’t likely deliver on those promises, and they’ll also drain state budgets of revenues needed to fund public services, including services essential to long-term economic growth like education, infrastructure, health care, and public safety.

Here are four reasons why the plans won’t work:

  1. The budget cuts or other tax increases needed to offset the revenue loss would cancel any short-term stimulus. Corporate tax cut advocates often argue that they encourage job creation by “letting businesses keep more of their money” to invest in local economies.  But, states must balance their budgets, so they must fully offset the revenue loss from corporate tax cuts through some combination of cuts in services and increases in other taxes.  Those steps would cancel out whatever boost to the state’s economy that corporations might provide by spending their entire tax cut in-state (which is very unlikely, as noted below).  The economy would lose as much as it gains.
  2. Corporate tax cuts could even reduce the total amount of economic activity in the state. Some of corporations’ tax savings would likely go to their out-of-state shareholders in the form of higher dividends, which is good for the shareholders but worthless to the state.  And some of the savings would go toward paying more federal income tax.  That’s because businesses can deduct their state corporate tax payments when calculating their federal corporate income taxes; a cut in state taxes means less to deduct, so higher federal taxes.  Meanwhile, the state revenue loss from the tax cut would likely mean lower public-sector spending on goods and services, nearly all of which is in-state.
  3. Corporate tax cuts do little, if anything, to boost corporate investment over the long run. Numerous studies show that even if states somehow managed to avoid budget-balancing cuts in services to pay for them, cutting businesses’ total state and local tax bill by 10 percent would likely boost economic output and jobs by about 2 to 3 percent above where it otherwise would be in the long run (10 to 20 years).  But, since corporate income taxes account for less than 10 percent of total state and local business taxes in the vast majority of states, eliminating the corporate tax wouldn’t generate even 2 to 3 percent more long-term growth.
  4. Corporate tax cuts weaken long-term growth by leading to cuts in public services. Businesses need and demand high-quality education systems to produce skilled workers. They need well-functioning infrastructure to get their employees and supplies to their plants and their products to customers.  They need police and fire protection.  If states help pay for corporate tax cuts in ways that impair the quality of these services, even the tax cuts’ modest positive potential impacts likely won’t materialize.