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Corporations Won’t Flee Illinois’ Corporate Tax Hike

Yesterday, Illinois Governor Pat Quinn signed legislation that will increase the state’s personal and corporate income taxes to close a portion of the state’s budget gap (the rest will be closed with spending cuts).  Governors Mitch Daniels of Indiana, Scott Walker of Wisconsin, Chris Christie of New Jersey, and Rick Perry of Texas lost no time in chiding the state for the corporate tax increase in particular, claiming that it would make it easier for them to steal Illinois corporations away.  Walker and Christie vowed to step up their efforts to do just that.

They might want to hold off booking their flights to Chicago, though.  There is very little evidence that state corporate income taxes have a significant impact on where corporations choose to locate.  All state and local taxes combined make up only 2-3 percent of corporate expenses, on average, and the corporate income tax represents less than 10 percent of that already small amount.  In the vast majority of cases, issues like labor, energy, land, and transportation play a much larger role in corporations’ location decisions.

Moreover, due to how the Illinois corporate tax works, corporations cannot cut their tax liability by moving facilities out of state.  In Illinois, a corporation’s tax liability is based on the profits it derives from its Illinois sales — not its physical location.  As long as a corporation keeps making sales in Illinois, it will owe exactly the same tax whether its facilities are located in Illinois, Wisconsin, or anywhere else.

Claims that Illinois’ increase in its personal income tax rate will drive away small businesses (many of which pay tax at the personal rather than corporate rate) are also off the mark.  There is little evidence that personal income tax rates affect the location decisions of small businesses, most of which are tied to a local market and need to be close to their customers.

In any case, Illinois has little to worry about on that score; even after the increase, Illinois’ top personal income tax rate will be below that of all its neighbors except Indiana.  Moreover, until the Illinois increase, Indiana’s top rate was 0.4 percentage points higher than the Illinois rate, yet Governor Daniels hasn’t been sounding the alarm that this disadvantage has been driving small businesses to Illinois.  Now that Indiana’s disadvantage is about to turn into a 1.6 percentage point advantage, it’s hardly credible for him to claim that many small businesses will flee across the border.

Finally, all this bravado conveniently ignores the fact that New Jersey and Wisconsin— like many other states — raised taxes in 2009 to help balance their budgets, and they may need to do so again.  Illinois is just playing catch-up.