Sunday, June 10, 2007

Lame Excuses for Not Cutting the Corporate Net Income Tax - Part 2

Continuing the list of lame excuses for not cutting the Pennsylvania Corporate Net Income Tax rate, even though it's clear that the high tax rate is hurting job creation in the state:

Excuse #2: "The state can't afford to reduce business taxes because it will reduce revenues for other important programs."

This is the equivalent of a company saying "even though fewer people are buying our product because it's too expensive, we can't cut prices because we'll lose revenue." In fact, if the company cuts prices and gets more customers, its total revenues will go up even more than if it refuses to change.

The same is true of state business taxes -- if Pennsylvania "cuts the price" to operate a corporation here (i.e., its uncompetitive taxes), more businesses will "buy the product" (i.e., locate and expand in the state), thereby increasing revenues.

To see evidence of this, you need look no further than Pennsylvania itself. In each of the three years between 2003 and 2006, Pennsylvania reduced the rate of the Capital Stock and Franchise Tax, for a cumulative cut of 1/3 in the rate (from 0.724% in 2003 to 0.489% in 2006). Did the revenues from the Capital Stock and Franchise Tax go down? No, the total revenues from the CSFT increased by over 20% between 2003 and 2006. Pennsylvania generated 79% more for each tenth percent of tax than it did before.

Yet in each year, the state originally projected that it was going to get less revenue from the CSFT than the year before. For example, in February 2005, the Governor's 2005-06 Budget projected revenues from the CSFT would go down by $90 million in 2005-06 compared to 2004-05 as a result of the reduction in the CSFT rate. In fact, the state collected $55 million more than in the prior year. Last year, the Governor's 2006-07 Budget projected that revenues from the CSFT would go down by $165 million. As of April, CSFT revenues were nearly $80 million ahead of estimate.

So, in similar fashion, the state (over)estimates the "cost" of cutting the Corporate Net Income Tax by assuming that nothing changes but the rate. So if you propose cutting the CNI tax from 9.99% to 8.92% (which would give Pennsylvania a lower rate than Minnesota, Massachusetts, New Hampshire, Alaska, Iowa, Rhode Island, New Jersey, West Virginia, and Maine), the state will tell you that it will reduce revenues by $265 million.

Now, $265 million is only 1% of the state's $26 billion budget. But that's the worst case scenario, because that assumes that the tax reduction doesn't stimulate economic growth. If businesses expand and add jobs, it will increase revenues under both the Corporate Net Income Tax and the Capital Stock and Franchise Tax. But it will also increase revenues under the Personal Income Tax and the Sales Tax, because when businesses hire more people, those workers will have more income, spend more money, and pay more taxes. The state's growth only needs to increase by a small amount (about 1%) to generate enough new revenues to offset the cut in the CNI rate. Since the state's job growth was 1% below the U.S. rate last year, that's not an unrealistic expectation.

Also, the state can phase in the CNI rate cut over several years, in order to reduce the short-term impact on the state's revenues while still sending a clear signal about the change in its business climate. For example, in the coming year's budget, the state could rate the rate to 9.49% effective January 1, 2008 and drop it below Massachusetts and Minnesota. That would only cost the state at most $60 million (since it only affects half of the 2007-08 budget year) -- less than 0.25% of the state budget. Then it could reduce the rate in 2009 to 8.92%, and make further reductions in subsequent years.

In other words, the state can easily afford to make the Corporate Net Income Tax rate more competitive.


Anonymous Anonymous said...

The $265 million tax cut you propose would go directly into the pockets of existing businesses. Yes, perhaps there would be long term job growth benefits; but you vastly overstate the impact of state taxes in corporate decisionmaking. I doubt you can find an economic model that shows more than a marginal impact of a 1% CNI change. It would be much more effective to direct that $265M to direct growth incentives for companies making location and expansion decisions.

12:20 AM  
Blogger Schultz said...

Anonymous - I think you are underestimating the effects a strong economy would have on the region. Those corporate tax savings would spur new commercial and retail development, more hirings, M&A activity, growth in R&D, and much more activity that would fuel growth in the state and southwestern PA.

The problem is that in order to fill that tax gap something has to give. The casino tax revenue pie is already being divided up to senior citizens, education, and real estate tax relief, so it has to come from somewhere else. I think we'll see either a sales tax increase or maybe even an inclusion of food and/or clothing in the sales tax, perhaps at a lower rate.

10:09 AM  

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