Policy Points from Iowa Fiscal Partners

Posts tagged business tax breaks

Reining in business tax breaks

Posted February 5th, 2020 to Blog

It has become a familiar story: Tax breaks and tax expenditures growing at a pace that spending on traditional state priorities cannot match. This growth continues on autopilot, year after year, with little scrutiny and often with weak justification.

The cost of business tax credits under the income tax grew from $214 million in Fiscal Year 2015 to $244 million in FY19, and is projected to be $287 million for FY20.[1] The commercial and industrial property tax cuts enacted in 2013 have added significantly more to that estimate. The business property tax credit enacted in that legislation, which will remain at $125 million every year, will bring the overall state cost of business tax credits to more than $400 million by FY20. In other words, business tax credits in total will have about doubled in six years. (See graph.)

Related business breaks would drive total spending on subsidies to business much higher.

      • Iowa in recent years has spent $152 million annually to backfill local public revenues lost when commercial and industrial property assessments were rolled back to 90 percent of actual value, a tax break to business.[2]
      • Revenue losses from the state’s failure to enact combined reporting to plug loopholes in the corporate income tax amount to an estimated $200 million.[3]
      • The state also spends nearly $60 million annually backfilling the loss of tax base to school districts as a result of city and county use of tax increment financing, much of which reduces the costs of business development.[4]

The total cost of business subsidies, in other words, approaches $800 million, even without other so-called tax expenditures, such as the state’s use of single-factor apportionment.

Tax credits have the same impact on the state’s bottom line as any other spending. Such spending comes outside the normal budget process where agencies, advocates and constituents make proposals that lawmakers vote up or down, on the record. Tax credits, with few exceptions, cause spending outside that competition.

State spending on business subsidies necessarily comes at the expense of other budgetary priorities, including education, health, and public safety. Investments in education and infrastructure, the building blocks of a strong economy, suffer when the annual budget debates start out with a billion dollars already committed to business incentives.

Real reform is needed now more than ever.

See our Roadmap for Opportunity two-pager on this topic.

[1] The following tax credits listed in the Iowa Department of Revenue Contingent Liabilities Reports are included in our analysis as business tax credits: Enterprise Zone Programs, High Quality Jobs Program, Historic Preservation, Industrial New Job Training Program (260E), Research Activities, Targeted Jobs, Venture Capital, Accelerated Career Education, Redevelopment, Renewable Chemical Production, Renewable Energy, Wind Energy Production, Biodiesel Blended Fuel, E15 Gasoline Promotion, E85 Gasoline Promotion, Ethanol Blended Gasoline, Ethanol Promotion. With the exception of Historic Preservation, this list is in line with credits classified as “business incentives” by the Iowa Department of Revenue in their most recent tax expenditure study.

[2] Legislative Services Agency, Summary of the Governor’s Budget Recommendations FY2021. Jan. 16, 2020, page 212.

[3] Iowa Department of Revenue, 2017.

[4] Legislative Services Agency, FY 2018 Annual Urban Renewal Report, February 15, 2019, p. 24. About 15 percent of TIF erxpenditure in FY18 went directly for business projects; it is not known how much of the 63 percent that went to property acquisition, roads, bridges, utilities, and water or wastewater treatment plants was associated with business development.

Peter Fisher is research director of the nonpartisan Iowa Policy Project.

Anti-taxers don’t get ‘competitiveness’

Posted January 27th, 2020 to Blog

slide_taxfoundation-cropHere we go again. Whenever Iowa legislators or lobbyists want to cut taxes for business, or for high-income individuals, they trot out the same myth about competitiveness.

The reality is pretty simple: Iowa is a low-tax state for business, and has been for some time. Late last year, the Council on State Taxation released its latest report on how much businesses pay in state and local taxes, prepared by the accounting firm Ernst and Young. Iowa was 18th lowest — only 17 states had a lower overall tax rate on business, 32 had higher taxes.[1] Another accounting firm, Anderson Economic Group, ranks Iowa’s business taxes even lower, at 14th – only 13 states have lower taxes.[2]

But why use real data when you can just cite some anti-tax, anti-government think tank that has cobbled together a “competitiveness index” that makes Iowa look bad?

So it is again in 2020. The governor cited the need to be competitive in her condition of the state address, and the Senate president repeated the theme. To support the claim, Senator Charles Schneider pointed to a bogus study by the Tax Foundation that ranked Iowa 42nd among the states in “business tax climate.” Only eight states were worse.

The Tax Foundation, it turns out, mashes together 124 components of state tax systems to produce an overall “index number” to rank the states. Their index is meaningless; it gives weight to components that cannot plausibly affect tax competitiveness, while ignoring features that have a large impact on business taxes.[3]

The last problem is particularly salient for Iowa. Iowa offers single-factor apportionment, which can drastically reduce a corporation’s Iowa tax if they export much of their production. And Iowa is one of the few states that allow corporations to deduct part of their federal income taxes on their state return. Both of these factors are completely ignored by the Tax Foundation. Instead, they focus on things like the number of tax brackets. Meanwhile, the sales taxation of food is a good thing, in their book; Iowa’s failure to tax food somehow makes us less competitive. This is nonsense.

Iowa is a slow growing state, but more tax cuts for those at the top will not help. They will further erode the state’s ability to invest in our roads and bridges, in our children and our workforce, the building blocks of a strong economy. Education, from early childhood through college, not only produces the skilled workforce businesses need, but makes it easier to attract workers from elsewhere, knowing their children will get a good education.

[1] Business taxes as a percent of GSP. Ernst & Young LLP, Total state and local business taxes, October 2019. Table 4, page 12.

[2] Business taxes as a share of business pre-tax operating surplus. Anderson Economic Group LLC, June 2018. 2018 State Business Tax Burden Rankings, Exhibit I, page 17.

[3] For a more detailed critique of the Tax Foundation’s ranking, and others, see “Grading the States: Business Climate Rankings and the Real Path to Prosperity.”

2010-PFw5464Peter Fisher is research director of the nonpartisan Iowa Policy Project in Iowa City, and professor emeritus in the School of Urban and Regional Planning at the University of Iowa. His widely cited Grading the States analysis is available at

IFP End of Session Statement

Four months we won’t get back

IOWA CITY, Iowa — The Iowa Fiscal Partnership today issued this statement on the conclusion of the 2016 session of the Iowa General Assembly:

When the 2016 session began, Iowa faced a host of critical challenges: polluted water, slow job growth, a tax system skewed to benefit those at the top and those with strong lobbyists, and a wavering commitment to investments in education and services for low- and moderate-income working families — those most vulnerable in our state. There were fresh uncertainties about health care due to plans to privatize Medicaid.

This session has done little to ease any of those concerns, and nothing to meet those challenges for the long term. Public policy stands tall when it supports long-held, long-promoted values of our state. Education and a clean environment are among those. Neither had victories of note.

Work supports and wages
• Iowa remains one of only 21 states that has refused to raise the minimum wage above the spartan $7.25 per hour. Iowa’s minimum wage has remained at $7.25 longer than any state minimum wage — over eight years — and likely is guaranteed to reach the nine-year mark before the Legislature returns to the Capitol.
More: “Iowa: Once a Leader, Now a Laggard on Minimum Wage,” updated March 2016
• Once again, lawmakers left in place Iowa’s severe eligibility limits for child care assistance, which can make it more costly for families to take a higher paying job.
More: “Reducing Cliff Effects in Iowa Child Care Assistance,” March 2014
• No action was taken to combat the problem of wage theft.
More: “Stolen Chances: Low-Wage Work and Wage Theft in Iowa,” September 2015

Education School funding remains too little and too late. Lawmakers in the House and Senate set State Supplemental Aid (SSA), which governs growth in per-pupil spending in Iowa schools, at 2.25 percent for Fiscal Year 2017 — a compromise below even the Governor’s meager proposal of 2.45 percent. With this, average per-pupil spending growth in Iowa will have been below 2 percent for seven years. School districts have already begun reducing teaching staff to cope with this low funding level, while property tax increases will be necessary in several districts that have declining enrollment. Money existed in the treasury to do much better.

In addition, the Legislature — which acted on FY2017 SSA about 13 months past the legal deadline — chose once again to violate the law by failing to set funding for the following budget year. SSA for Fiscal Year 2018 was to have been set by mid-February.
More: “Sensible context on school aid growth” blog post, March 29, 2016

Water quality and school infrastructure
Another legislative session has come and gone without agreement on a sustainable strategy to improve Iowa’s water quality, which is threatened by agricultural pollution — either with regulation, funding or a combination of both. Iowa voters gave lawmakers a roadmap to a funding solution in 2010 with a constitutional amendment designating the next 3/8-cent sales tax increase to go toward land and water protection and enhancement. Neither the Governor nor a majority of legislators has taken that step, nor have they taken it to a vote even though the amendment passed the Legislature in two consecutive general assemblies before it went to the voters. Other proposals offered during the session would have diverted funds from existing and designated uses toward water quality, but not in sufficient amounts or without damaging other services.
More: “To fund water solutions, why not the obvious? Tax pollutants,” blog post, March 7, 2016

Continued state spending for business
The Governor’s unilateral action to expand a sales tax exemption for manufacturers was left in place; though scaled back, it will still take $21 million from next year’s budget at a time when schools and universities are scrapping for every dollar. Moreover, the exemption was combined with a more costly decision to “couple” with federal tax code changes for the current budget year.  The coupling cost in the current year, $98 million, was not budgeted by the Governor and Legislature, has no value to incentivize investment, and comes at a time other identified state priorities have seen funding held down or reduced on grounds that revenue is not available. The Legislature left open the question of whether coupling will continue next year, and thus uncertainties on new unbudgeted costs. Iowa policy makers are too quick to provide tax breaks without finding ways to fund our traditional priorities.
More: “High Cost of Conformity,” IFP Policy Brief, March 2, 2016

Business tax credits have become an increasing share of state spending and are rising in cost at a faster pace than priorities in education and human services. Iowa taxpayers will see more of their dollars going to business subsidies next year, with little or no accountability for the public return on investment.

The Iowa Fiscal Partnership is a joint public policy analysis initiative of two nonpartisan, nonprofit Iowa-based organizations, the Iowa Policy Project in Iowa City and the Child & Family Policy Center in Des Moines. Reports are at

New rule! Governor wants to make laws himself

Posted October 14th, 2015 to Blog

We all know the drill: The Legislature passes bills and the Governor signs or vetoes them, whereupon they become either laws, or nothing.

Not anymore, apparently.

The move by the Branstad administration to implement a new sales tax break worth an estimated $40 million a year — possibly more — is taking place outside the legislative session. If it succeeds, we have entered a new world of executive authority in Iowa.

Business lobbyists wanted the change, it could not pass the Legislature, and the administration thinks it has found a short cut: Change the longstanding interpretation of the existing law. Presto, tens of millions of dollars will be available for manufacturers. And those same tens of millions of dollars will not be available for schools.*

Consider a Des Moines Register guest opinion by Mike Ralston of the Iowa Association of Business and Industry, a lobbying group representing manufacturers who would benefit from the change:

Part of the change affects Iowa’s existing sales and use tax exemption for machinery and equipment used in the manufacturing process.  The change is sound policy.

If that’s the case Mr. Ralston wants to make, let him make it during the legislative session. This rules change skirts the legislative process, and Iowans are noticing. Jon Muller writes in an insightful piece on the Bleeding Heartland blog:

It’s easy to look at political discourse today and conclude everything is a battle between Democrats and Republicans, the left and the right, liberals and conservatives. But far more is going on with this issue. … A Democrat will surely be Governor again someday, and it would be a mistake to set a precedent that allows the Executive Branch to so drastically change the tax climate. If Republicans in the Legislature do not stand up against this unprecedented over-reach of power, they will almost certainly live to regret it.

James Larew, an Iowa City attorney who was general counsel to former Governor Chet Culver, served for four years as Culver’s appointee on the Administrative Rules Review Committee, a panel of legislators who have the authority to delay the rule change from taking effect. He advised the panel: “This is new territory. What is sauce for the goose eventually becomes sauce for the gander, too.” Larew went on:

The balance of political power changes from one election to the next.

The balance of constitutional power — the relationship between the Iowa General Assembly and executive departments of government — is more serious and more lasting.

Broad interpretive powers given up by the Legislature, in one moment of time, concerning one issue, are not easily, later recovered.

As the Cedar Rapids Gazette opined in an editorial, the change “breaks the rules of good government.” The Gazette wrote:

The Branstad administration should drop its rule change bid and make its case to the General Assembly, which is elected to craft a budget and write tax policy. If it’s truly a great idea that will create jobs, as the department contends, surely the sales job won’t be that difficult.

Many businesses, we often note at IPP and the Iowa Fiscal Partnership, already pay no income tax in Iowa, and they just had their property taxes slashed. The corporate appetite for tax cuts is insatiable. Guess who pays?

*  Note: The Department of Revenue estimate of the cost of this tax break to both the state and local governments is over $40 million for each of the first four full years of implementation, according to a document provided the Administrative Rules Review Committee. The Legislative Services Agency has told ARRC that it does not have enough information to determine the accuracy of that estimate. We have revised the initial version of this blog post to reflect this uncertainty, until state officials agree on an estimate.
Owen-2013-57Posted by Mike Owen, Executive Director of the Iowa Policy Project


Iowa Cannot Afford Another Wasteful Business Tax Break

Posted October 13th, 2015 to Blog

2010-PFw5464Statement by Peter Fisher, Research Director, The Iowa Policy Project, before the Administrative Rules Review Committee

October 13, 2015

The administration’s proposal to create new sales tax exemptions for Iowa businesses is unnecessary, expensive and counterproductive. The state can ill afford another tax break that will harm essential state services while producing little or no economic benefit.

Iowa business taxes are already quite competitive

  • The most recent study of state and local taxes on business as a percent of state GDP by Ernst and Young and the Council on State Taxation shows that Iowa taxes business at 4.7 percent of GDP, exactly the same as the national average. Iowa ranks right in the middle of the pack.
  • A study by Anderson Economic Group in 2015 calculated state and local taxes on business as a percent of pre-tax profits and found Iowa’s effective tax rate to be 8.7 percent, which placed it 32nd among the states, below the national average.

State and local taxes have little effect on business location decisions

  • State and local taxes are less than two percent of total costs for the average corporation. As a result, even large cuts in state taxes are unlikely to have an effect on the investment and location decisions of businesses, which are driven by more significant factors such as labor, transportation, and energy costs, and access to markets and suppliers.

Enacting a subsidy through administrative rules guarantees complete absence of evaluation and accountability

  • While the sales tax break has been promoted as an economic development incentive, creating it by administrative rule eliminates even the minimal level of accountability established by the Legislature for the periodic review of tax credits. There will be no review, no evaluation of its effectiveness, not even an annual accounting of its cost.

Tax breaks erode support for public investments in our future

  • The proliferation of tax incentives and business tax cuts over the past two decades has resulted in several hundred million dollars each year cut from the state budget. This has undermined the state’s ability to support quality education, from pre-school through public colleges and universities, which in the long run will have serious consequences for state economic growth and prosperity.

Corporate Taxes and State Economic Growth

10-page PDF
Revised April 2013

By Peter S. Fisher

When a business contemplates a major facility expansion or relocation, they naturally ask themselves: Where is the best place for this facility to be? When evaluating alternative locations, a firm will consider a wide range of factors that affect its costs, productivity or sales: access to markets and to suppliers; transportation costs; energy costs; access to a pool of labor with appropriate education and skills; wage rates; health care costs; the quality of schools, recreation opportunities, climate and other amenities important in attracting skilled labor; the quality of state and local government services, such as public safety and infrastructure; and state and local taxes.

Proponents of business tax breaks claim that taxes are a significant factor in the location choices of businesses, and that a state can tax-cut its way to economic growth and generate tax revenue in the process. As we will see, there are good reasons to be skeptical of such a claim on the face of it, and several decades of research on the relation between state taxes and growth confirm that such claims are vastly overblown and misleading. Business tax breaks turn out to be an expensive and inefficient way to attempt to stimulate a state economy.

State Corporate Taxes are a Small Part of the Cost of Doing Business

State corporate tax breaks are alleged to have substantial influence on a corporation’s decision about where to expand or to locate a new plant. There is good reason to be skeptical of such claims at the outset, for a simple reason: Differences in state corporate income taxes from one state to another are usually trivial when stacked up against differences in other costs of doing business. Businesses take many factors into account when making an investment location decision: access to markets and to suppliers; transportation costs; access to a pool of labor with appropriate education and skills; wage rates; energy costs; land acquisition costs; access to supporting business services; the quality of local schools, recreation facilities, climate and other amenities important in attracting and keeping skilled labor; proximity to university research facilities; quality of state and local government services and fiscal stability of government.

State and local taxes on businesses (corporate income taxes, sales taxes, local property taxes) represent only about 1.8 percent of total business costs on average for all states.[1] Corporate income taxes, in turn, are only about 9.5 percent of state and local taxes on businesses, according to one estimate.[2] A large corporate tax break that reduces corporate income tax revenue by half thus represents a cost savings to the average firm of 50 percent times 9.5 percent times 1.8 percent or just .09 percent. In other words, such a sizeable corporate income tax break would reduce total business costs by just nine-hundredths of 1 percent in the average state. 

Now let us imagine a business planning the location of a new facility. After considering all the non-tax differences between State X and other states — labor skills, energy costs, access to markets, etc. — the firm determines that State X is not the best location. It is difficult to imagine that the tiny reduction in business costs produced by even a large corporate income tax break could offset all the disadvantages in such a case and tip the balance in favor of State X, in anything but a very small number of instances. Yet this is precisely what must happen, lots of times involving lots of jobs, for the tax breaks to generate significant job growth. For all those other instances where State X is already the best location, based on all other considerations, the tax breaks obviously do not change the decision but are merely a windfall.

We need not rely on this common sense presumption that tax differences can have little effect on location decisions and state growth, however. There has been a large body of research investigating precisely this question. It is to this research that we now turn.

Research Shows At Most a Small Effect of Taxes

If taxes affect business location decisions, then states with lower taxes should experience more rapid growth, other things equal. The last phrase, “other things equal,” turns out to be crucial. Anyone can make a list of states with higher tax rates, for example, and another list with lower tax rates, and then see which set of states grew faster over some time period. Many people, in fact, have done just that, but such an exercise proves absolutely nothing about causality. Such “research” is no more useful than a “study” I conducted showing that states with names of six letters or less grew faster than ones with long names.

As we pointed out above, a great many factors influence business location decisions and state economic growth rates. To discern the separate effect of tax levels, researchers must use statistical techniques to hold all these other factors constant. The question is: If two states are similar in terms of labor skills, access to markets and materials, labor and energy costs, etc., will a difference in taxes on business produce a difference in the rate at which the state grows? 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 this question.

Two summaries of the research, in 1988 (by Newman and Sullivan) and 1991 (by Bartik), produced something of a consensus on the independent effect of state taxes on state growth. The research conclusions were expressed in terms of an “elasticity,” a measure of how sensitive growth is to taxes. The elasticity of state GDP with respect to state taxes, for example, is the percentage change in GDP divided by the percentage change in taxes. Bartik’s review of 59 studies completed prior to 1991, including 34 studies that attempted to measure the effects of business taxes on state output, led him to conclude that the bulk of the credible research indicated an elasticity somewhere between -.1 and -.6, and probably about -.3. What does this mean? It means that a 10 percent reduction in taxes will lead eventually to an increase in the state GDP of 3 percent (+3 percent divided by -10 percent is -.3).

Not everyone agreed with this consensus position. Economists Therese McGuire (1992) and Dick Netzer (1997), in particular, pointed out the inconsistencies among the studies and remained skeptical that taxes had any significant effect. Since that time, additional studies have been conducted and several summaries and reviews of those studies have been published. Phillips and Goss (1995), running a meta-regression study on Bartik’s literature, seemed to confirm the reasons for Bartik’s findings. Later in the 1990s the Federal Reserve Bank of Boston commissioned a series of reviews of the economic development literature. Wasylenko (1997), looking at the most recent tax studies as well as those reviewed by Bartik, concluded that the likely impact of taxes is somewhat smaller, an elasticity of -.2 being his best estimate. Other reviews of the literature since then indicate that the research continues to produce mixed results.[3]

One of the problems with the vast majority of studies is that they have relied on rather inadequate measures of state taxes on business, usually some measure of the average rate on all businesses. One of the most sophisticated and recent studies was based on a set of effective tax rates for 15 different manufacturing sectors, the tax rates measuring the net effect of the state and local system of business taxes and incentives on a firm’s rate of return on a new plant investment in that state (Funderburg et al, 2013). This is important, because a firm is presumably concerned about the effect of alternative locations on the firm’s bottom line, and this depends not on some overall “business tax rate” but on the taxes and tax incentives that apply to a new facility.

The data for this study covered five periods (1990, 1992, 1994, 1996 and 1998) with industry-specific and time-specific tax rates and growth rates for each of 20 states. The large number of observations allowed the researchers to effectively control for the unmeasured characteristics of each state — its climate, its location relative to markets and suppliers, energy costs, the quality of education and other public services, the regulatory system — through state “fixed effects” variables. The model measured the extent to which a state’s effective tax rate on new investment for typical firms in a particular manufacturing industry, such as transportation equipment, was a significant predictor of a state’s growth in value added in that industry. The model, in other words, was designed to detect the maximum effect of a state’s system of taxes and incentives, at the state and local level combined, on that state’s manufacturing growth.

The conclusion of this research was that the elasticity of state manufacturing growth with respect to state and local taxes and incentives was between -.35 and -.53. In other words, a 10 percent cut in total state and local business taxes on manufacturers could be expected to produce about a 3.5 to 5.3 percent increase in state manufacturing activity. This elasticity is within the range that Bartik posed in 1991. The researchers also found incentives alone had a much lower elasticity, -.12, that was not even statistically significant. This suggests that businesses discount the value of incentives heavily and pay more attention to the overall level of taxation. 

It appears that the preponderance of the evidence from many dozens of studies over a period of 30 years or more is that business tax cuts, if they could be enacted without cutting public spending or raising taxes on other sectors, have some positive effect on state economic growth, but that this effect is small. Not every study has come to this conclusion, to be sure, and some economists, such as Therese McGuire (2003), remain skeptical. She points out that many of the studies that have been relied upon the most cannot be replicated in other time periods.[4] Furthermore, no one has yet produced a plausible explanation for another consistent finding: Labor costs are many times state and local taxes, yet the elasticities found for wages are only two or three times the tax elasticities.[5] If the labor elasticities are correct, the tax elasticities should be much smaller than -.2.

What the Research Does Not Show

It is important to understand the limitations and correct interpretation of these research results. For example, an elasticity of .3 does not mean that a 10 percent cut in the corporate income tax would produce a 3 percent increase in economic activity. The corporate income tax is only about 9.5 percent of total state and local taxes on business, so a 10 percent cut in corporate income taxes is equivalent to a 0.95 percent cut in overall business taxation, which would lead to just a 0.3 percent increase in the economy (a .95 percent tax cut times the elasticity of 3 percent).

The results also do not imply that a 10 percent cut in total business taxes falling on manufacturing will lead to a 3 percent increase in overall state economic activity. They may lead to a 3 percent increase in manufacturing activity (subject to all the other caveats discussed above) but manufacturing is typically a small share of the state economy. And tax cuts for other sectors of the economy that are not “footloose” but are dependent upon serving local markets, are unlikely to produce any measurable effect on state economic activity.

Most important, the research does not imply that a 10 percent cut in taxes on business that is paid for by cutting 10 percent of the state budget would produce 3 percent growth. Such a balanced budget policy (and states of course must balance their budgets) might produce no growth at all, especially in the long run, depending on the nature of the budget cuts and their importance to economic activity.

Public Services Matter

It is important to understand exactly what the research on the sensitivity of growth to taxes implies for state policy. States must balance their budgets. Since tax breaks are costly, these costs must be offset, either by increased revenues elsewhere or by cuts in state services. Cuts in state services can increase business costs and negatively affect state growth in a variety of ways.

Researchers have studied the relation between public services and state economic growth. Ronald Fisher reviewed 43 such studies in 1997 and reported that 27 of the studies found that increased public spending had a positive effect on state economic growth. Helms (1985), for example, found that increases in taxes that financed more spending on health, highways, education or other public services contributed positively and significantly to state economic growth. Bartik (1989) found positive effects on the rate of small-business formation from additional education and fire protection spending financed by tax increases. Among all the studies Fisher reviewed, spending on transportation, education, and public safety were the services most likely to produce measurable effects on growth. The results varied widely, however, and he could not discern a consensus on the magnitude of these effects, which in some studies were smaller and in others larger than the magnitude of tax effects.

While the exact effect of public expenditure on the state economy has been difficult to pin down, it is clear that much of what state and local governments do is to provide the foundations for economic growth in the long run. There would not be a functioning economic system without the infrastructure to support it, and much of that infrastructure is provided and maintained by state and local governments: streets and highways, water and sewer systems, port facilities, airports, reservoirs. And an economic system cannot function without a healthy and educated labor force; the increasing skill requirements in the private sector cannot be met without significant commitments of resources to public education. In fact, a recent study found that the education level of the workforce in a state was the primary determinant, along with the rate of patents, of which states experienced more rapid growth in incomes from 1939 to 2004.[6] Furthermore, the ability to attract workers to new jobs, particularly for higher skill jobs in technology sectors, depends in no small measure on the quality of life, which includes the quality of the schools those workers will send their children to, and the quality of public services and public recreation facilities available.

It is important to point out, therefore, that the positive effects of tax cuts identified in the research show up for the most part only when studies control for the level of public services. This means that tax cuts promote growth holding everything else constant, including state spending on education, health, infrastructure, and public safety. Since states must balance their budgets, in practice spending cannot be held constant. As Bartik wrote in 1991: “[A]n economic development policy of business tax cuts may fail to increase jobs in a state or metropolitan area if it leads to a deterioration of public services to business. An economic development policy of tax increases may succeed in increasing jobs if it significantly improves public services to business.”[7]

Thus any estimates of the employment effects of tax breaks, even if based on an elasticity of -.3, are undoubtedly overstated. They fail to account for the negative effects of state spending cuts on the economy. And they fail to account for the very likely reduction in public sector jobs necessitated to pay for the tax breaks. These job losses would be immediate. The result is that the tax breaks would very likely produce a net loss in total jobs for several years. And this accounts only for the direct loss in public sector jobs; a long-term decline in public services would have additional negative effects on state private sector growth.

Large jobs effects are not credible for another reason: State economic growth has been shown to be more affected by the rate of new firm formation than by any other factor.[8] Most tax breaks do nothing to enhance the prospects for a new firm.

Tax Breaks Are Costly

Corporate tax breaks are a very inefficient means of promoting state economic growth. Most of the lost revenue simply flows to corporations who are doing nothing different, nothing that they wouldn’t have done anyway.[9] And this accords with common sense. As we saw, a corporate tax cut is a tiny share of a business’s costs, so that the vast majority of location or investment decisions will hinge on factors other than taxes.

Much of the benefit of corporate tax breaks will go to economic sectors that are tied to local markets: retail trade, utilities, transportation, and services.[10] These are industries that have to be where their market is. If the market grows, they will grow; state taxes have nothing to do with it, and the tax breaks are simply a windfall, with no effect on growth. In fact, the loss of public sector employment and purchasing power brought about by the tax breaks will have a detrimental effect on sectors dependent on local consumer purchases. The tax breaks to corporations do not stimulate consumer spending, and it is not clear how retailers can collect more sales tax if consumers are not spending any more money. The tiny reduction in the costs of doing business cannot be expected to translate into retail price reductions, which is the only way sales could increase in the absence of a shift in the consumer demand curve.

Yet some will claim that tax breaks more than pay for themselves. Such conclusions may follow from analyses that include personal income tax revenues from new employees in addition to the direct business taxes from the firms creating the jobs. But research shows that in the long run a large majority of new jobs are filled by in-migrants.[11] Those workers bring with them families, with children that need to be educated, and they bring cars that help to create the need for new streets and highways. If these secondary fiscal effects were fully accounted for it is likely that the additional public costs associated with increased population would eat up all of the additional tax revenue they would bring. After all, state and local governments must balance their budgets, and they do so by using the additional taxes brought by growth to pay for the additional services necessitated. In fact, it could well be that the direct fiscal effect — the change in business tax revenue associated with a tax break — is even more negative than described above, as the business activity itself may necessitate some additional investment in public infrastructure. It is clear, at any rate, that to treat new workers as if they contributed only to the revenue side of the public budget and not the expenditure side is plainly wrong and misleading.

What about the Counterarguments?

The unilateral disarmament argument: We have to do it because everyone else does.

Disarming unilaterally is easy once you recognize that the states are shooting at each other with very expensive popguns. If incentives are costly and inefficient, let your competitor states continue to squander their money on them, and pursue instead a smarter and more cost-effective approach to economic development that focuses on long-run fundamentals: quality education, job training and infrastructure.

Taxes may be a small share of costs, but they are a big share of profits so they matter a lot.

This is a complete non-issue. Certainly what matters to business is the bottom line, but the bottom line, or profit, is simply total sales minus total costs. The way states attempt to affect the bottom line is to reduce a firm’s costs, since states can do little or nothing to affect sales. Of course taxes are a higher percentage of profits than they are of costs; every component of cost is a higher percentage of profit than it is of costs. Labor costs are many times net profit. The point remains: A firm with a given level of sales seeking to maximize profit will do so by seeking to minimize total costs, and most other components of cost are far more important than state and local taxes. Thus even large changes in state and local taxes are unlikely to offset small changes in other more important costs in most instances.

We know they work, because we deal with corporations every day and they say taxes matter.

Businesses engaging in tax incentive competition recognize that it is in their interest to argue publicly, before and after receiving incentives, that taxes matter. This provides essential cover for the politicians who have provided them with the incentives that do so much for their bottom line, and for the economic development officials trying to justify their jobs and expense accounts. No one this close to the situation is in a position to assess objectively whether any given location or investment decision hinged on tax breaks. That’s why we look to academic research to see if tax breaks have actually affected state economic growth.

Economist X’s brand new study of our state’s tax breaks showed very large job effects. Generalizations based on outdated studies are meaningless.

A tax break may be supported by new research specific to the particular state and incentive in question and it will be argued that this is the only research of any relevance. In response, it can be pointed out that a business cares about another dollar flowing to profits, but not which path it took through the tax code to get there. A dollar gained is a dollar gained. There is no rationale for an assertion that a dollar of profit resulting from single sales factor, for example, is more important to a firm than a dollar of profit flowing from a reduction in the top tax rate, or some other tax code change.

Furthermore, to present one study as the definitive answer to the question about the effects of tax policy on business location decisions is to adopt a completely indefensible position on how social science research in this area should be used for policy purposes. A responsible researcher looks at the entire body of research over many years to determine which results have stood the test of time and have been replicated by different researchers looking at different places and time periods, and which studies are outliers that should be written off. Many studies have shown no effect of taxes, others have shown very large effects. But the preponderance of the evidence is that the effects are there but are small. For someone to pick one study out of the many dozens that have been conducted, a study whose results clearly put it in the category of outliers, and then to base policy recommendations on that one study is irresponsible and shows cavalier disregard for the careful use of social science in this area. To assert that all prior research is outdated is disingenuous at best. Being new is less important than being done well and being corroborated by others. That is how real science proceeds.

The unspoken political argument: Cutting incentives, or even voting against an increase, is risky because our opponents will tag us as “job destroyers” the next time a plant goes somewhere else, while increasing incentives appears costless (it’s a tax cut that creates revenue!) and we can happily take credit for all future job creation.

This is the most difficult argument of all to counter. Other than the point about tax cuts paying for themselves, the arguments are pretty much immune to fact-based criticism.


Business tax breaks are an expensive and inefficient way to attempt to stimulate a state economy. Because of the small effect of tax breaks on business costs, and the much larger importance of other production costs and location considerations, tax breaks will have little if any positive effect on private sector employment. In fact, the revenue losses may well produce immediate public sector job losses. Furthermore, the private sector employment effects of such tax cuts could be reduced or even eliminated by a long-term deterioration in the quality of public services, which themselves have been shown to be important to businesses making location decisions, and which provide an important part of the foundation for the state economy.


Bartik, Timothy. 1989. “Small Business Start-ups in the United States: Estimates of the effects of Characteristics of States.” Southern Economic Journal 55, April: 1004-18.

Bartik, Timothy. 1991. Who Benefits from State and Local Economic Development Policy? Kalamazoo, MI: W.E. Upjohn Institute for Employment Research.

Bartik, Timothy. 1993. “Who Benefits from Local Job Growth: Migrants or Original Residents?” Regional Studies 27, 4: 297-311.

Bartik, Timothy. 1994. “Jobs, Productivity, and Local Economic Development: What Implications Does Economic Research Have for the Role of Government?” National Tax Journal 47, 4: 847-62.

Bauer, Paul W., Mark E. Schweitzer and Scott Shane. 2006. “State Growth Empirics: The Long-Run Determinants of State Income Growth.” Federal Reserve Bank of Cleveland Working Paper. May. 

Bruce, Donald, John Deskins, Brian Hill, and Jonothan Rork. 2007. “Small Business and State Growth: An Econometric Investigation.” U.S. Small Business Admininstration, Office of Advocacy, Small Business Research Summary No. 292, February.

Carroll, Robert and Michael Wasylenko. 1994. “Do State Business Climates Still Matter? Evidence of a Structural Change.” National Tax Journal 47, 1: 19-38.

Fisher, Peter, and Alan Peters. 1997. “Tax and Spending Incentives and Enterprise Zones.” New England Economic Review, March/April, 109-30.

Fisher, Peter, and Alan Peters. 1998. Industrial incentives: Competition among American States and Cities. Kalamazoo, MI: W.E. Upjohn Institute for Employment Research.

Fisher, Peter and Alan Peters. 2010. “How Taxes and Economic Development Incentives Affect Returns on New Manufacturing Investment in Pennsylvania and Surrounding States.” In Greg LeRoy et al. Growing Pennsylvania’s High-Tech Economy: Choosing Effective Investments. Washington, D.C.: Good Jobs First.

Fisher, Ronald. 1997. The Effects of State and Local Public Services on Economic Development. New England Economic Review March/April: 53-67.

Funderburg, Richard; Timothy J. Bartik, Alan H. Peters, and Peter S. Fisher. 2013. “The Impact of Marginal Business Taxes on State Manufacturing.” Forthcoming in the Journal of Regional Science, 2013

Helms, L. Jay. 1985. “The Effect of State and Local Taxes on Economic Growth: A Time Series-Cross Section Approach.” Review of Economics and Statistics 67, 4: 574-82.

Lynch, Robert G. 2004. Rethinking Growth Strategies: How State and Local Taxes and Services Affect Economic Development. Washington, D.C.: Economic Policy Institute.

McGuire, Therese J. 1992. “Review of Who Benefits from State and Local Economic Development Policy.” National Tax Journal 45 (4): 457-59.

McGuire, Therese J. 2003. “Do Taxes Matter? Yes, No, Maybe So,” State Tax Notes, June 9: 885-890.

Netzer, Dick. 1997. “Discussion of ‘Tax and Spending Incentives and Enterprise Zones.’” New England Economic Review (May/June): 131-35.

Newman, Robert and Dennis Sullivan. 1988. “Econometric Analysis of Business Tax Impacts on Industrial Location: What Do We Know, and How Do We Know It?” Journal of Urban Economics 23: 215-34.

Peters, Alan, and Peter Fisher. 2002. State Enterprise Zone Programs: Have They Worked? Kalamazoo, MI: W.E. Upjohn Institute for Employment Research.

Peters, Alan, and Peter Fisher. 2004. “The Failures of Economic Development Incentives.” Journal of the American Planning Association, 70, 1: 27-38.

Phillips, Joseph, and Ernest Goss. 1995. “The Effects of State and Local Taxes on Economic Development: A Meta-Analysis.” Southern Economic Journal 62: 297-316.

Tannenwald, Robert. 1996. “State Business Tax Climate: How Should it be Measured and How Important Is It?” New England Economic Review, Jan/Feb.: 23-38.

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Weiner, Jennifer. 2010.  State Business Tax Incentives: Examining Evidence of their Effectiveness. Boston, MA: Federal Reserve Bank.


[1] This is based on data averaged over three years 2005-2007 from two sources: U.S. Internal Revenue Service, Statistics of Income, Integrated Business Data for all U.S. Corporations, partnerships, and non-farm proprietorships, showing total deductions for business costs on tax returns, at,,id=152029,00.html ; and a 2009 report by the Council on State Taxation, which estimates total state and local taxes paid by businesses, available at .
[2] Council on State Taxation (see note 1). This is the average proportion over the three years 2005 to 2007; the fraction is lower in recession years.
[3] See Peters and Fisher (2004); Weiner (2010); Funderburg et al (2010).
[4] See, for example, Tannenwald (1996); Carroll and Wasylenko (1994).
[5] Lynch (2004).
[6] Bauer et al (2006).
[7] Page 8.
[8] Bruce et al (2007).
[9] The negative fiscal effects of business tax breaks and incentives at the state level have been shown in Bartik (1994); Fisher and Peters (2001); and Peters and Fisher (2002), chapter 5.
[10] According to analyses by the Franchise Tax Board, 34 percent of the benefits of the largest of the three tax breaks, SSF, would flow to utilities, retail and wholesale trade, transportation, real estate, and services. SSF was estimated to account for $1.1 billion of the $1.27 billion total cost of the three tax breaks.
[11] Bartik (1991), p. 95; Bartik (1993).


 Peter Fisher

Peter S. Fisher is research director of the nonpartisan Iowa Policy Project. He is co-director of the Iowa Fiscal Partnership and is professor emeritus of Urban and Regional Planning at the University of Iowa.