Tax Cuts Widening Wisconsin’s Budget Hole

While much of the national attention on Wisconsin in recent days concerns Governor Walker’s proposal to strip many public workers of collective bargaining rights, the role of the tax cuts in widening the state’s budgets problems also merits a close look:

• Wisconsin’s budget problems, like those in other states, stem largely from the record drop in revenues due to the recession. The state has a $137 million shortfall in the current fiscal year (which ends June 30) and a $3.6 billion shortfall in the upcoming 2011-13 biennium.  Those shortfalls represent the gap between projected revenues under current law and the projected cost of continuing current services, and must be resolved in order for the state to meet its legal requirement of a balanced budget.It’s doable, though.  Wisconsin’s $3.6 billion shortfall represents 13 percent of state revenues, well below the average shortfall among all states of 20 percent.  While state revenues around the country have generally stabilized after plunging in the recession, they remain 11 percent below their level in 2007, before the recession hit.

• Wisconsin enacted tax cuts earlier this year that have widened its shortfall for 2011-13. In January, lawmakers expanded the tax deduction for people with health savings accounts.  They also enacted two other tax cuts the governor has said he will sign, which would benefit businesses that relocate to the state or increase employment in the state.  These tax cuts don’t affect the current year’s budget, but Wisconsin’s nonpartisan fiscal office estimates that they will expand the budget gap for the 2011-13 biennium by $117 million.

• Governor Walker is expected to propose additional tax cuts in the budget he’ll announce March 1. For example, he may propose taking the first steps towards accomplishing his campaign promise of repealing the state’s corporate income tax.

• The evidence shows that cutting state business taxes isn’t an effective way to stimulate the economy and will likely do more harm than good. In brief:

1. Tax cuts require larger cutbacks in public services. 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.
2. Corporate tax cuts could even reduce total 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.
3. 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.
4. 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 past years, Wisconsin has addressed its budget problems in a more responsible fashion — with a combination of spending cuts and tax increases to restore some of the taxes lost due to the recession.  Wisconsin was among more than 30 states that raised taxes in 2009.  Even though the state laid off workers that year, froze hiring, and implemented eight days of furloughs, among other budget cuts, the additional revenues helped avert very deep reductions in education, health care, and other services that would have harmed the state’s economy further.

Such a more balanced approach to closing the state’s existing budget gap would help to preserve the services required to foster the well-educated, healthy, and mobile workforce that will drive Wisconsin’s future prosperity.