Flying in the face of the often heard rhetoric that tax cuts are the cure for all ills, a new study finds that cuts to business taxes are at best ineffective, and at worst harmful to state economic growth and development. A better strategy for growth is to increase investment in education and infrastructure.
State economic development is related to many factors, but few of these are controllable by state policymakers. One often used lever is to cut taxes—particularly for businesses. Traditional economic theory would have you believe that if a state makes it more profitable for businesses to operate by cutting taxes, that state would have more business activity.
The problem is that this strategy doesn’t work, according to the study. This is because business taxes are not the only factor that influences business behavior. Being close to customers, availability of a well-educated workforce, access to raw materials, and energy costs are much larger factors in a business’s profitability than state taxes. For instance, in Alabama state taxes cost corporations only 1.89% of their revenue. Varying this small factor has a limited effect on the actions of businesses.
Using data from all 50 states spanning the years 1977 to 2005, the study’s authors (Soledad Artiz of Harvard University and Kenneth Meier of Texas A&M) found that state policies seeking to spur business investment had no demonstrative positive effect on state economic development. The authors take a broad perspective on economic development. They measure the changes in gross state product, employment, personal income, net job creation, poverty, and the creation of new establishments.
The biggest factor found to influence the growth of state economies was the health of the national economy. State economies are tightly tied together, making it difficult for individual state actions to make much of a positive difference.
When state lawmakers cut taxes, the net effect may be slower economic growth. This is because the loss of business tax revenue means less funding for government services that often pump money back into a state’s economy.
So, when politicians talk about cutting taxes as a way to grow our state’s economy, know that the opposite could occur.