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One Campaign Promise Worth Breaking

As newly elected governors confront their states’ grim fiscal reality, one promise that some of them made during the campaign should go in the trash along with the yard signs and the balloons from last night’s victory celebrations:  cutting or eliminating their state’s corporate income tax.

At least six of the new governors elected yesterday promised corporate tax cuts as a way to boost the state economy.  Governors-elect Tom Corbett of Pennsylvania, Nathan Deal of Georgia, and Terry Branstad of Iowa proposed sharp, across-the-board cuts in corporate income tax rates of between 30 percent and 50 percent.  Governors-elect Rick Scott of Florida, Nikki Haley of South Carolina, and Scott Walker of Wisconsin promised to eliminate their states’ corporate taxes — over a three-year period in Florida, immediately in South Carolina, and at an unspecified time in Wisconsin.

As a recent Center report explained, cutting state corporate income taxes is not an effective way to stimulate economic growth and in fact is likely to be counterproductive.  Briefly, here’s why:

  • The resulting budget cuts or other tax increases would cancel the short-term stimulus. Unlike the federal government, states are required to balance their budgets.  So states must fully offset the revenue loss from corporate tax cuts.  That means some combination of cuts in services and increases in other taxes.  So even if corporations boosted a state’s economy by spending their entire tax cut in-state (which is very unlikely, as noted below), there would be no net stimulus.  The economy would lose as much as it gains.
  • 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 of no value to the state that cut the taxes.  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.
  • Corporate tax cuts do little if anything to boost corporate investment over the long run. Numerous studies have found that cutting businesses’ total state and local tax bill by 10 percent would likely boost economic output and jobs by 2 percent to 3 percent.  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 2 percent to 3 percent more long-term growth.  And, even these modest positive effects assume a state wouldn’t cut public services or increase other business taxes to offset the lost revenue.  But that’s exactly what they will do, given states’ balanced-budget requirements.
  • Corporate tax cuts weaken long-term growth by causing 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 for their facilities, which need to be located in areas with good schools and recreation to attract senior managers, engineers, and other highly paid personnel.  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 will not likely materialize.

In short, the evidence overwhelmingly shows that across-the-board corporate tax cuts aren’t an effective means of creating jobs.  Ideally, new governors who have called for these tax cuts will recognize this reality and let these proposals slide down — and then finally off — their priority lists and focus instead on providing needed public services as cost-effectively as possible.  But if they don’t, their legislatures would be well advised not to go along.