End and Means: Reports Say Tax Cuts Won't Spur Economic Development

Apr 1, 2014

Charles N. Wheeler III
Credit WUIS/Illinois Issues
  Guess what? 

State tax cuts don’t improve economic growth.

No, that’s not an April Fool’s Day zinger.

Rather, it’s the conclusion of a report issued last month by the Fiscal Policy Center at Voices for Illinois Children, a nonpartisan advocacy organization for the state’s youngsters (Poor Finances, Uncertainty about Looming Revenue Collapse Threaten State Economy).

“Despite frequent assertions that reducing taxes will create jobs and improve economic growth, states around the country have found this not to be the case,” wrote David Lloyd, senior policy analyst at the center.

“If anything, a state economy is hurt by reducing support for schools, health care, transportation, public safety, and other building blocks of job creation and widespread prosperity,” Lloyd argued.

While the conclusion runs against conventional wisdom and the campaign talking points of many a politician, Lloyd’s analysis offers solid evidence to buttress the claim.

For starters, academic research and the experience of other states show at best only a negligible link between tax cuts and economic growth; many studies found no correlation. For example, nine states with high income tax rates experienced faster per capita economic growth from 2002 to 2011 than nine states that don’t have income taxes, according to research published a year ago by the Institute on Taxation and Economic Policy.

Moreover, other research suggests, tax cuts actually may slow economic growth by reducing revenue needed for essential public services, like education and infrastructure improvement, that are important to business expansion.

“CEOs repeatedly cite an educated workforce and high-quality infrastructure as two of the most important factors in deciding where to locate,” the report noted. “Given these considerations, it is not surprising that states can best promote economic growth through investments in education and infrastructure.”

Nor could corporations be expected to use their tax savings to expand their operations or hire more workers in Illinois, according to the report, unless there’s an accompanying increase in demand for their products and services. “Businesses make investments when they think those investments will lead to profitable sales; they do not invest simply because they have more cash.”

But were those tax dollars used instead to shore up state programs and pay down the state’s bill backlog, most would flow back into the economy through salaries and contracts, thus generating greater demand for what businesses hope to sell, the report predicted.

The Voices analysis comes as Gov. Pat Quinn and the General Assembly struggle to craft a FY 2015 budget with a billion less dollars than the current year, thanks to the January 1, midyear rollback of current income tax rates, and another billion or so of unavoidable spending increases for health care, pensions and similar obligations.

Facing that scenario, the report reinforced Voices’ long-standing position that the current tax rates remain in place. “If Illinois’ income tax rates decline as scheduled at the end of this year, the resulting revenue collapse will threaten the state’s economic recovery, curtail the ability to support vital investments, and create more uncertainty over how the state will meet its many obligations,” the report said. “Rather than dig a much deeper hole that would undermine business and investor confidence in the state, the better way to put Illinois back on track is to maintain stable and sustainable revenue so that the state can invest in what really matters for job creation and economic growth.”

While flinty-eyed fiscal conservatives might dismiss the Voices report as just the pleadings of soft-hearted do-gooders, the organization’s message closely matched similar recommendations from the Civic Federation, a Chicago-based, nonpartisan government research organization with strong ties to business leaders.

In a State of Illinois FY 2015 Budget Roadmap report issued by its Institute for Illinois’ Fiscal Sustainability, the federation called for extending the current income tax rates for an additional year, then rolling them back gradually over the next three years, to 4 percent for individuals and 5.6 percent for corporations on January 1, 2018.

The federation plan also would broaden the income tax base to include federally taxed retirement income. Of the 41 states that impose an income tax, Illinois is one of only three that exempt all pension income and one of 27 that exclude all federally taxed Social Security income, costing the state some $2 billion, the federation said.

On the spending side, the federation proposed limiting annual growth in operations spending to 2 percent, rather than the current 2.9 percent projected by Quinn’s budget staff, and using the savings to pay off old bills and to create a Rainy Day fund for future fiscal emergencies.

In addition, the federation called for the state to publish a five-year financial plan, then update it annually, to highlight long-range financial issues and help policymakers look beyond budget gap-bridging measures, such as one-time or temporary revenue sources, toward remedying structural problems.

Explaining the rationale for its recommendations, the federation noted “the steep rollback in income tax rates would dramatically destabilize Illinois’ already weak financial condition” to the tune of $4.4 billion less in income tax revenue in FY 2016 than the current fiscal year. “This kind of fiscal cliff is unsustainable for a government that still has not been able to pay off a mountain of unpaid bills left over from the recession.”

Even without paying old bills, the revenue loss would require spending cuts of some $2.7 billion by 2016, which would “necessarily be concentrated in the areas of education and human services because so many other State costs are determined by law, court order and legally binding contracts,” the federation noted. Agency spending excluding pensions and health care already has declined by an estimated $992 million in the past five years, according to the federation, including an $800 million cut for elementary and secondary education.

In contrast to that bleak picture, “the Civic Federation’s proposal provides a roadmap for a sustainable fiscal future,” the document concluded. “The five-year plan would restrain spending to pay down the backlog of bills and gradually reduce income tax rates by 20 percent while broadening the tax base and building a reserve fund as a cushion against future economic downturns.”

Voices and the Civic Federation make compelling arguments for extending the current income tax rates, at least for a while, but don’t expect anything to happen before the November election. Indeed, if you listened closely to the primary campaign rhetoric from most candidates, you’d come away convinced the state’s financial woes can be cured through belt-tightening, running the state like a business, eliminating waste, fraud and abuse, and similar empty slogans that thoughtful citizens should find demeaning.

Once the votes are tallied in November, though, one hopes the winners will address seriously the issue, perhaps taking to heart the advice from Laurence Msall, the Civic Federation’s president (who is also an Illinois Issues advisory board member):

“Politically attractive efforts are no longer enough to address the enormous financial challenges we’ve created for ourselves. All Illinoisans will need to share the burden of fixing the State’s problems.” 

Charles N. Wheeler III is director of the Public Affairs Reporting program at the University of Illinois Springfield. 

Illinois Issues, April 2014