North Carolina’s state legislators are, yet again, mistaken in their assessment of a certain tax proposal’s economic implications.
The Tax Simplification and Reduction Act, which reduces the state’s corporate income tax rate from 6.9 percent to 6 percent this year, 5 percent next year and, if General Fund revenue goals are met in subsequent years, as low as 3 percent two years later, has been hailed by Gov. Pat McCrory as “critically important to growing North Carolina’s economy.” Its sponsors, Reps. Lewis, Setzer, Moffitt and Szoka, proclaimed the act “the next step in a bold economic revitalization program.”
Nonetheless, a number of studies have ascertained a modest, if any, positive impact due to the reduction of corporate income tax rates. “There is little evidence that state and local tax cuts stimulate economic activity or create jobs,” concludes Robert Lynch of The Economic Policy Institute. The Institute’s Michael Mazerov arrived at a similar conclusion. “Cutting corporate tax rates may be politically appealing,” he concludes, “but neither logic nor evidence suggests that doing so will stimulate significant economic growth.”
The evidence is clear: Reducing the state’s corporate income tax rate is not the best decision state legislators could have made in order to stimulate the economy.
This is due to a variety of reasons, namely that it is more efficient to fund public investments, only a relatively small share of corporations will benefit from these tax rate reductions, corporate income taxes account for a minute share of corporate expenditures and are not an impediment to intrastate investments and reductions in the corporate income tax are unlikely to increase intrastate investments.
Firstly, many economists have argued that it is more effective to fund public investments rather than corporate income tax reductions in an effort to stimulate the economy.
Cedric Johnson, a policy analyst at the North Carolina Budget and Tax Center, recently found that the reductions in the corporate income tax will decrease the state’s annual revenue by nearly $650 million. Since a constitutional provision prevents the state from spending more than its revenue allows, such reductions are financed by a substantial decrease in, or complete withdrawal of, funding for public investments including, but not limited to, the earned income tax credit, unemployment insurance and higher education.
Michigan State University’s Ronald Fisher found that increased funding for such public investments yields a considerably positive impact on the state’s economy. Peter Orszag, of the Brookings Institution, and Joseph Stiglitz, of Columbia University, argue that, in the short term, public investments stimulate economic growth. In the long term, argues the Political Economy Research Institute’s Jeffrey Thompson, public investments in infrastructure, education, health and safety—all of which have experienced significant budget reductions in North Carolina—produce more stable economies.
This is because such investments often directly reduce corporate expenditures, perhaps, by allowing for the attraction and retention of high-skilled employees at low costs and improvements in employee productivity. Caterpillar Inc. recently alluded to training programs offered at Forsyth Technical Community College as the primary reason the corporation decided to construct a $426 million manufacturing plant in Forsyth County. Corporations in Research Triangle Park, such as Quintiles Inc. and Red Hat Inc., frequently cite similar relationships with local universities as necessary components for efforts to increase employees’ abilities and productivity.
It is for this reason that decreased funding for public investments, according to The Center on Budget and Policy Priorities’ Iris Lav and Robert Tannenwald, “is likely to reduce demand in the state just as much as the reduction in taxes may stimulate demand.” Indeed, Peter S. Fisher, the Research Director of the Iowa Policy Project in Iowa City, discovered that a 10 percent reduction in corporate income taxes results in only 2 percent economic growth when funding for public investments is kept constant. When funding for public investments is reduced, as the state’s legislators have decided, there was found to be “no growth at all, especially in the long run.”
Since legislators are required to balance tax reductions with reductions in public investments that are essential for economic development, public investments are more efficient than corporate income tax reductions in stimulating the state’s economy.
Secondly, very few corporations will benefit from the corporate income tax reductions.
According to the North Carolina Budget and Tax Center, only 7 percent of the state’s corporations are subject to the corporate income tax. In 2009, for example, nearly 54 percent of the state’s corporate income tax revenue was raised from less than 3 percent of all corporations that filed income taxes.
Thus, reducing this tax will not affect the overwhelming majority of the state’s corporations.
Thirdly, corporate income taxes account for a diminutive share of corporate expenditures and are not an impediment to a corporation’s ability to invest in the state’s economy.
Since all taxes levied on corporations by the state represent approximately 1.8 percent of total corporate expenditures, on average, and since corporate income taxes account for 6 percent of these taxes, a 50 percent reduction in the corporate income tax would reduce total corporate expenditures by a mere .05 percent.
Such a miniscule reduction in expenditures, argues Peter Fisher, will not effectively reduce any impediment to a corporation’s ability to invest in a certain state. Michael Mazerov similarly argues that the potential effect of corporate income tax rates on a corporation’s decision to invest in a certain state, instead of another, is “simply overwhelmed in most cases by interstate differences in labor, energy and transportation costs,” which account for a more significant share of corporate expenditures than corporate income taxes and often vary more among the states than corporate income tax rates.
Even if interstate differences are not substantial, the National Federation of Independent Businesses’ survey of corporations suggests that a lack of demand for certain goods and services, not inhibitive corporate income tax rates, is the most significant impediment to corporate investments in the state’s economy.
Given that reductions in corporate income taxes are highly unlikely to influence a corporation’s decision to invest in a state’s economy, any effort to reduce these taxes is equally unlikely to stimulate economic growth.
Finally, reducing corporate income taxes in an effort to provide corporations financial flexibility is not an effective means to increase intrastate investments.
“In the absence of increased demand for output now or in the future,” explains Mazerov, “corporations will simply pocket a tax cut as a windfall increase in their retained earnings rather than spend it.” According to the North Carolina Tax and Budget Center’s Edwin McLenaghan, any additional capital a corporation may generate due to corporate income tax reductions is likely to result in higher executive salaries or higher dividends to shareholders, most of whom happen to be residing outside of the state, rather than investments in the state’s economy.
Even if that may not the case, such tax reductions may be offset by an increase in federal taxation, since corporations are able to deduct their state corporate income tax payments from their federal corporate income tax payments.
In a sense, any substantial capital a corporation may accumulate due to income tax reductions is likely to be redirected to the federal treasury, in the form of a higher federal corporate income tax rate, executives, in the form of higher salaries, or out-of-state shareholders, in the form of higher dividends.
Accordingly, the Tax Simplification and Reduction Act, inappropriately acclaimed by its sponsors as an effort to “free up capital and spur job creation,” will affect the state’s economy much differently than was originally intended.
It will result in the diversion of funding from essential public investments, as has already been seen, the assistance of a trifling number of corporations, the evasion of addressing the actual impediments to a corporation’s ability to invest in the state’s economy and the expenditures of what was once state revenue on federal taxation, executive salaries or dividends.
Unfortunately, this Act, like others passed by the state legislature last year, will carelessly ruin an economy that has been acclaimed, for far too long, as a prime example for the rest of the South.
Mousa Alshanteer is a Trinity sophomore and the editorial page managing editor. His biweekly column is part of the weekly Editor’s Note feature and runs on alternate Fridays. Send Mousa a message on Twitter @MousaAlshanteer.