===================================================================== Center for Community Economic Development University of Wisconsin-Extension Community Economics Newsletter No. 304 February 2002 ===================================================================== A Newsletter from the Center for Community Economic Development; Community,Natural Resource and Economic Development Programs, and University of Wisconsin-Extension, Cooperative Extension Service ===================================================================== Do Taxes Influence Business Growth By Steven Deller* Can changes in business taxes at the state or local level be viewed as an effective means of influencing business location and expansion decisions? For decades this question has been at the core of economic development policy debates. Business location theory has maintained that firms will seek out locations that have the lowest cost of operation, given certain criteria such as access to appropriately skilled labor are satisfied. Attempts by elected officials to influence the cost of operation of particular locations have ranged from investments in transportation infrastructure to lower transportation costs to structuring environmental policies to minimize the costs of compliance. The most common policy approach, however, has centered on tax policies. The widely held perception is that for strong business growth, business taxes must be minimized at every opportunity. Given the misperception that Wisconsin is a high tax state, the argument to lower business taxes to enhance economic vitality is particularly attractive in states like Wisconsin. The logic of the policy seems inescapably direct and intuitive: reducing business taxes in a particular locale, such as the state of Wisconsin, lowers the cost of operation making the locale more attractive to businesses. Seldom, however, is life so direct or simple. In this issue of Community Economics nine counter arguments to the conventional wisdom of business tax cuts to spur business growth are presented and discussed. Innumerable factors are important to businesses in their location and expansion decisions and taxes are often low on the list of priorities. Access to suppliers and customers, labor skills, and increasingly the nebulous notion of quality of life, are often identified by businesses as vastly more important than taxes in location and expansion decisions. Taxes are one of many costs of doing business and the magnitude of these other costs may easily swamp the amount of state and local taxes. Labor costs and the cost of benefits packages, such as health insurance, and investments in rapidly changing technologies greatly outweigh aggregate business tax burdens and any marginal changes taxes proposed in the name of business development. State and local taxes are deductible for the purposes of federal business income taxes, hence sharply lowering the impact of business tax differentials across state and local governments. State and local taxes are often capitalized or reflected in local land prices, again lowing the impact of business tax differentials. Most businesses that relocate or expand in a given area are likely to remain in that locale for a number of years. Business location and expansion decisions are costly and something that firms do not undertake frequently. Therefore, special concessions or tax breaks in the short term may be discounted when businesses make long-term investment decisions. The number of footloose firms that are likely to be affected by small changes in taxes is relatively low. These types of firms are more likely to relocate rapidly and react to small incentives. These firms seldom stay in one location for an extended period and are not viewed as the type of businesses that long-term sustainable economic development policies should be based. Because of the popularity of the conventional wisdom of state and local tax competitiveness, if one state significantly and permanently alters its business tax policies to the extent that affects business location and expansion decisions, neighboring states are likely to quickly follow suit negating any sustainable benefits. Businesses are consumers of the public services that tax dollars pay for. Businesses require, indeed demand, adequate police and fire protection, safe and reliable modes of transportation, waste collection and disposal, and a skilled and educated workforce. Most businesses realize and accept that as users of these public services they must pay their fair share of taxes. The cost of reducing public services available to businesses may outweigh any gain in tax reduction. Reducing business taxes in the name of economic development without a corresponding decrease in the level and quality of public services offered simply shifts the tax burden to households. If the goal of economic development policy is to enhance the standard of living for local residents, shifting tax burdens away from businesses to local residents is counter productive. Much of the current thinking on business location and expansion decisions greatly diminishes the role of aggregate business taxes levels. Rather, businesses pay close attention to the balance between taxes paid and services delivered. If public service levels, and correspondingly taxes, are too high then a problem may exist. Businesses may relocated or expand into regions with a more appropriate level of services and taxes. Unfortunately, seldom does the policy debate focus on service delivery levels. Seldom does one hear a policy maker ask the question "are our roads, police and fire departments, or public schools too good?" This is a difficult question to ask and answer, at what point is our state parks system, for example, too good? Perhaps less confrontationally, the question might be "can we afford the level and quality of services we now have?" A second way in which businesses view the taxing and public service level mix is in terms of effectiveness and/or efficiency. Business owners often ask the question in terms of whether or not they are getting what they pay for. Here the notion of government inefficiency and waste becomes very important. If businesses view that their tax dollars are being wasted on non-essential services or through government inefficiency, then serious problems exist and must be addressed. This is the common charge levied at large urban governments where for political reasons four persons are hired to do the job of one. In the end, businesses select a location to move or expand into based on a wide range of issues. One important issue is the balance between public services offered and the taxes levied to pay for those services. Business owners ask two basic questions: 1) are the mix of public goods and services in a given locale right for my business; and 2) am I getting what I pay for with my tax dollar? If the answer to both questions is yes, then a sustainable taxation policy is in place. If the answer is no, then blindly cutting business taxes will not have the desired result. Further Reading Timothy Bartik, Who Benefits from State and Local Economic Development Policies? The Upjohn Institute: Kalamazoo, MI. 1991. Helen Ladd, Local Government Tax and Land Use Policies in the United States. Edward Elgar Publishing: Northhampton, MA. 1998. * Steve Deller is a Professor, Department of Agricultural and Applied Economics, University of Wisconsin-Madison/Extension. Steven C. Deller Community Development Economist Issued in furtherance of Cooperative Extension work, Acts of May 8, and June 30, 1914, in cooperation with the U.S. Department of Agriculture. Carl O'Connor, Cooperative Extension, University of Wisconsin-Extension. University of Wisconsin-Extension, U.S. Department of Agriculture and Wisconsin counties cooperating. UW-Extension provides equal opportunities in employment and programming, including Title IX and ADA.