Of course taxes matter

by John Hood, John Locke Foundation and NC SPIN panelist, March 11, 2015.

If North Carolina’s tax burden has no effect on business decisions and the performance of the economy, as left-of-center politicians and editorialists have repeatedly insisted, then why are they so enamored with targeted tax breaks?

Gov. Pat McCrory and many Republicans in the North Carolina General Assembly are currently pushing legislation to expand or restore various tax credits for economic development. I don’t agree with their choice of means. I prefer uniform taxation levied as low, flat marginal rates on broad tax bases. But at least they have the right goal in mind: to reduce the costs that governments impose on businesses. At least they recognize that these costs really matter.

I can’t say the same for many of their ideological foes. For years, Democrats and liberals have denied that taxes have a significant effect on state competitiveness. They attacked the Republican-led legislature in 2011 when it refused to extend sales and income taxes first imposed by then-Gov. Bev Perdue and the previously Democratic General Assembly. Two years later, McCrory and the legislature enacted a sweeping tax-reform bill that reduced North Carolina’s tax burden by hundreds of millions of dollars a year. Again the Left cried foul.

In both cases, the Republicans argued that North Carolina’s economy would prosper by lowering the cost of government — by reducing taxes and reorienting revenue to the state’s highest priorities. They were on solid empirical ground. Over the past 25 years, academic scholars have produced hundreds of peer-reviewed studies exploring the relationship between state fiscal policies and state economic growth. Most of them found that taxes do, indeed, matter.

The latest contribution to the literature was published just last month in the journal Economics Letters. The study’s author, Clarkson University professor Bebonchu Atems, found that state taxes “have negative short- and long-run direct, spillover, and total effects on state economic growth.” That is, taxes don’t just dampen economic activity in the short run. They also discourage inflows of labor and capital over time, reducing productivity gains and the benefits they confer. Those consequences aren’t even limited to the states where taxes go up. They “spill over” into neighboring states, too.

Taxes aren’t the only element in the economic story, of course. Because modern economies require the provision of certain public services, some level of state taxation produces net economic benefits. The real debate is not between two camps of primitives grunting “government good” and “government bad” under their collective breaths. Rather, the debate is about locating the point at which the cost of government (taxes) exceeds the value of public services.

Most state governments seem already to have exceeded that point. All other things being equal, low-tax states outperform middling or high-tax states in economic growth. All other things being equal, I want my home state of North Carolina to be among those high-performing states. Don’t you?

Now to the incentives question. While some Democrats have maintained intellectual consistency about taxes, others are now arguing that while across-the-board tax cuts are useless, North Carolina can enhance its business climate and economic growth by doubling down on tax credits, “closing funds,” and other incentive programs. I suppose the idea here is that state politicians have “wasted” recent tax cuts on unworthy companies that either didn’t need or didn’t merit them, but that if they would just exercise more discretion, they could cut taxes on the “right” companies while keeping taxes higher on the “wrong” ones.

Sorry for all the quote marks here. In my defense, I am trying to speak a foreign tongue. I have a hard time articulating the position that politicians possess the relevant information and acumen to determine which industries, businesses, or business decisions (i.e. research and development vs. other expenditures) are “good bets” and which ones aren’t.

In other words, I prefer across-the-board tax reduction to targeted tax incentives not only because I have read many academic studies but also because I have met many politicians. I may respect and like them. I may think they have good intentions and impressive talents. But I don’t consider them superhuman.

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