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posted: 5/26/2014 6:46 AM

Business case for state tax cuts isn't very good

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  • The idea that states do better when they cut income taxes and attract businesses and people is fundamental to conservative economic thinking. It's an appealing notion -- even if the supporting evidence is scant -- and goes a long way toward explaining why states such as Ohio, Michigan and Kansas are pushing to reduce or even eliminate local income taxes.

      The idea that states do better when they cut income taxes and attract businesses and people is fundamental to conservative economic thinking. It's an appealing notion -- even if the supporting evidence is scant -- and goes a long way toward explaining why states such as Ohio, Michigan and Kansas are pushing to reduce or even eliminate local income taxes.
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By James Greiff, Bloomberg View

The idea that states do better when they cut income taxes and attract businesses and people is fundamental to conservative economic thinking. It's an appealing notion -- even if the supporting evidence is scant -- and goes a long way toward explaining why states such as Ohio, Michigan and Kansas are pushing to reduce or even eliminate local income taxes.

Among the most vocal advocates of this theory is Arthur Laffer, the economist whose work in the 1970s and 1980s popularized one of the bedrock principles of supply-side economics: Tax cuts pay for themselves by stimulating the economy, leading to higher government revenue.

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Except that, according to the historical studies, they don't. Indeed, the recent record suggests those states that cut taxes find themselves with bigger deficits and none of the economic revival that might stop the population loss plaguing the Rust and Farm belts.

Consider Ohio, where Republican Governor John Kasich is pushing to cut the top marginal tax rate to 5 percent or less from the current 5.92 percent. This might save the average taxpayer a few hundred dollars a year. It's always nice to have a little more change in one's pocket, though you should ask yourself: For this amount of money, would you pick up hearth and home and move to Ohio or cancel plans to move out of state?

But if people don't relocate because of tax rates, why do they move? The answer is as basic as it gets. The biggest group of cross-border movers is people relocating for jobs or looking for work, according to a new study by the Center on Budget and Policy Priorities. Adding in people who move for cheaper housing and milder weather -- mostly retirees leaving colder climates for the South and Florida -- accounts for a majority of the people who leave.

Nor is there much evidence that people with the highest incomes, and purportedly those most sensitive to tax rates, are the ones most likely to move to low-tax states, according to the study. Yes, there are some like Laffer, who operates an independent consulting firm and can leave high-tax California for a state such as Tennessee with no income tax. But for every Laffer, there are many other well-off folks who stay put because that's where their work is.

Indeed, people lower on the earnings scale are almost as likely to move as the well-off. This stands to reason: Less prosperous people cross states lines just like everyone else in search of work. And when those who are less well-off move, they are more likely to go to states with low or no income taxes than to those with higher incomes. Again, this suggests that high earners, supposedly those most sensitive to tax rates, aren't that responsive to them as an incentive. (There are other reasons people cross states lines, of course, cheaper housing being chief among them, particularly for the elderly.)

Perhaps one of the biggest empirical problems with the low-tax thesis is that many people move to states with higher tax rates from low tax states. For example, Georgia and North Carolina (states with income taxes) were destinations for more households from Florida (a state without an income tax) than vice versa. So it's unclear how much of a role tax rates play in determining where people move -- if any at all.

Whether businesses move because of lower tax rates also is open to question. Yes, Toyota Motor Corp. said last month it will move its North America headquarters and 3,000 employees from Southern California to suburban Dallas, shifting from a state with high income taxes to one with low taxes. But just a few days earlier, Boeing Co. said it would shift another 1,000 engineering jobs from Washington state, with no income tax, to California, where it has already moved several hundred other jobs.

There's also evidence that cutting corporate taxes is of little use in stimulating business. First, many entrepreneurs aren't that mobile; second, they tend to want to be in cities with large talent pools. Taxes don't often figure among the reasons entrepreneurs cite for where to start a business. And once a company is up and running, marginal tax rates are rarely something that leads a company to move.

There's nothing wrong with cutting taxes -- provided it doesn't damage a government's fiscal health, as they have in Kansas. And no one would complain about having a few extra dollars to spend. But tax cuts should never be sold to the public as a cure-all for a state's economic travails.

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