Thursday, August 12, 2010

Art Rolnick is Correct: Why Business Taxes are not that Important to Location Decisions

Today Art Rolnick questioned the evidence behind Tom Emmer’s claims that taxes in Minnesota are driving businesses to Minnesota. Rolnick is correct.

In a January 29, 2009 op-ed I discussed the impact that business taxes have on job relocation. There is little evidence that taxes are a major determinate in terms of affecting business location decisions.

I am linking to the original op-ed.

Why business tax cuts don't make sense now

Hope is great when it comes to miracles. Belief is terrific when it comes to the Tooth Fairy. But neither hope nor belief should guide the making of economic policy, especially during a recession. The making of public policy should be driven by social science evidence regarding what does work, otherwise taxpayer dollars may be wasted.

Gov. Tim Pawlenty's call in his State of the State Address to cut business taxes to spur economic development begs two important questions: Do tax cuts encourage economic development? If so, is this the time and place to cut taxes? Social science research is clear: Tax cuts will do little to help the state economy now and will probably hurt it as Minnesota confronts this recession.

The economic literature is clear — tax breaks to encourage economic relocation or investment are generally economically inefficient and wasteful. Hundreds of studies overwhelmingly reach this conclusion. When businesses are surveyed regarding factors important to their economic (re)location, taxes often come in way behind proximity to markets, suppliers and the quality of the labor force.

These other factors occupy a larger percentage of a business's budget than do taxes, and all of them are far more critical to long-term success than are taxes. Businesses occasionally admit this. Nearly 62 percent of those interviewed in a California study on hiring tax credits indicated that they had never or rarely affected their decision to employ individuals.

In the same study, nearly half stated that tax incentives for relocation did not affect their decisions. Tax incentives reward businesses for decisions they were already going to make.

A variant of the "taxes are important factors affecting location decisions" is the claim that high taxes are deterrents to economic growth and that cutting them will lead to investment decisions that produce jobs and new employment. For all of the same reasons that taxes are not a major factor in economic relocation decisions, the same is true in terms of the impact of taxes on business or individual activity. While taxes may have some minor impact alone in terms of marginal decisions to produce, the broader claim that they impede serious economic growth is vastly overblown.

Public investments in education, infrastructure and worker productivity rank significantly higher in terms of encouraging economic development and higher workers' wages than do tax subsidies and incentives. Adam Smith, writing in his 1776 "Wealth of Nations," first pointed that out, and this remains true more than 230 years later.

Overall, tax cuts and incentives are usually a dreadful way to encourage business development. Yes, some do point to tax cuts under President John F. Kennedy as an example of how they helped the economy. That was one of the rare circumstances where they worked. The country then was not in a severe recession and the cuts went mainly to consumers to encourage consumption, not investment.

Pawlenty's call for tax cuts is not that type of consumer relief. His cuts do little to help the economy. Instead, they may exacerbate the recession in Minnesota. During the early days of the 1930s Depression, many states cut state consumption and spending as a way to address their economic problems. The cuts only made matters worse as they left more workers unemployed and depressed economic output even more. Pawlenty's tax cuts for business, if accompanied by additional decreases in state spending, will repeat this foolish path and only damage the state economy in the short and long term.

Under some circumstances, taxes and cutting them do matter, but not now. Pawlenty has it exactly wrong in his call for tax cuts, and this policy should be rejected because it is based on hope and myth, not facts.

(Note at end of original op-ed: David Schultz is a Hamline University School of Business professor who teaches classes in economic development, planning and policy analysis. He is a former housing and economic planner and is working on a book tentatively entitled "Stupid Public Policies and Other Political Myths," which examines bad laws and why they are made).

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