Corporate Taxes and State Economic Growth

When businesses are considering expanding or relocating, they weigh various factors that affect costs, productivity, and sales. These factors include access to markets and suppliers, transportation and energy costs, wage rates, healthcare costs, land acquisition costs, access to business services, quality of schools, proximity to university research facilities, and state and local taxes. While advocates of business tax breaks argue that taxes are a significant factor in location decisions, research spanning several decades has shown that claims of tax breaks generating economic growth and tax revenue are often overblown and sometimes misleading.

Corporate taxes represent only a small part of the cost of doing business, with state and local taxes on businesses, including corporate income taxes, sales taxes, and local property taxes, representing an average of only 1.8 percent of total business costs for all states. Corporate income taxes make up about 9.5 percent of state and local taxes on businesses. Therefore, a large corporate tax break reduces income tax revenue by 50% which is only a mere 0.09 percent in cost savings, or nine-hundredths of 1 percent, for the average firm in the average state.

While some people believe that differences in state corporate income taxes have a significant impact on corporations’ decisions about where to expand or locate a new plant, such claims are questionable. Differences in state corporate income taxes are typically insignificant when compared to differences in other costs of doing business, such as labor skills, energy costs, and access to markets. Even if a large corporate income tax break produced a tiny reduction in business costs, it is unlikely to offset all the disadvantages associated with the location, such as labor skills or energy costs.

Although tax breaks could generate significant job growth, tax differences may not have much effect on location decisions, and states with lower taxes do not necessarily experience more rapid growth if other factors are not considered. Several factors influence business location decisions and state economic growth rates, and researchers must use statistical techniques to discern the separate effect of tax levels. The difference in taxes on business produces a difference in the rate at which a state grows only if two states are similar in terms of labor skills, access to markets and materials, labor and energy costs, and other determinants of location.

Statistical techniques have become increasingly sophisticated over the past 25 years, allowing for better ways of controlling for other location determinants and more reliable answers to the question of whether taxes affect business location decisions. Therefore, policymakers should carefully consider the cost-effectiveness of tax breaks when implementing them. They should weigh the costs of tax breaks against the benefits that they generate in terms of job creation, economic growth, and revenue generation. It is essential to take a comprehensive approach that considers all of the factors that affect location decisions and economic growth to ensure that policies are based on solid evidence rather than misconceptions.

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