|
Relationship between taxes and economic growth is tenuous at best
It has become virtually a given truth that state and local tax cuts create jobs and that tax hikes cost jobs. The conservative Manhattan Institute even uses a special econometric model, STAMP (State Tax Analysis Modeling Program), to quantify a direct link between cutting taxes and creating jobs. In a recent Manhattan Institute study, STAMP was applied to conclude that State tax cuts enacted since 1995 created more than 117,000 private-sector jobs, at least one-fifth of total job growth over the period. Another recent Manhattan Institute concluded that the number of New York City jobs rises by 1.87% for every percentage point reduction in the average marginal tax rate. Similar conclusions were reached by Andrew Houghwout, et.al in their report, “Local Revenue Hills: A General Equilibrium Specification With Evidence from Four U.S. Cities,” covering the period 1970 to 1997. The authors correlated New York City employment declines from 1969 to 1977 and from 1989 to 1993 to increases in taxes during these
periods.
These analyses are flawed because they confuse correlation and causation; increases in unemployment are correlated with increases in taxes and the conclusion is made that it was the lower taxes that caused the higher employment and higher taxes that increased unemployment.
A critical examination of the Houghwout study by Moshe Adler, Oliver Cooke and James Parrott for the Fiscal Policy Institute found that, during the two study periods, many factors other than taxes led to employment declines. During the 1969-1977 period, there was the post-World War II process of suburbanization experienced across the nation and the shift in employment from the Northeast and Midwest to the South and West. Federal highway construction spending and the federal tax code encouraged suburban development. Lower wages and the absence of unions in the South were major draws away from the Northeast. The shift of manufacturing from older urban areas was hastened by the changes in manufacturing that required large, horizontally laid-out facilities on one floor that could not easily be built in crowded urban centers. One of the responses by New York City when budget deficits grew as a consequence of these economic dislocations was to raise taxes.
During the 1989 to 1993 period, New York City experienced large employment losses from restructuring in the securities and banking industries, especially after the stock market crash in 1987. Mergers and consolidations in commercial banking were major contributors to employment losses in the FIRE (finance-insurance-real estate) sector.
The Houghwout and Manhattan Institute reports also ignore how sharp increases in urban crime and the decline of urban schools prompted many individuals and businesses to relocate to the suburbs during the 1970s. The abysmal condition of New York City’s subway system before billions of dollars were invested in renovations in the 1980s was another factor. Finally, the Houghwout and Manhattan Institute studies are flawed because they consider only taxes in New York and not the taxes imposed in other jurisdictions.
Contrary to the conclusions reached by the Manhattan Institute and Houghwout, et al., every other serious study published on the subject of taxes and business location decision-making during the past three decades concludes that the relationship between state and local taxes and economic growth is tenuous, at best. There is little evidence that a modest increase in taxes will cost jobs, particularly not when the alternative is cuts in government services on which businesses rely.
In 1997, Michael Wasylenko’s review of studies conducted on this issue concluded, “[T]axes do not appear to have a substantial effect on economic activity among the states.” While some of the studies he reviewed found a very small effect, most found no statistically significant relationship between state business tax levels and private-sector employment. In 1996, Robert G. Lynch, reviewed several hundred studies on the effectiveness of state and local business tax incentives published since the 1950s, including surveys where business decision-makers were asked about the factors affecting their location decisions and statistical or econometric analysis. Lynch’s conclusion: “There is little evidence that the level of state and local taxation figures prominently in business-location decisions.”
In 1985 the New York State Legislative Commission on the Modernization and Simplification of the Tax Law drew a similar conclusion from its exhaustive review of the efficacy of business tax incentives in New York State. According to the Commission’s executive director Richard D. Pomp, the Commission found that “changes in business taxes are not an effective means of influencing business decisions to locate a plant in a particular area.”
Among the reasons for the tenuous relationship between taxes and jobs cited by the Tax Study Commission, Lynch, and others are:
• Taxes are one of many costs of doing business; the magnitude of these other costs can easily swamp the amount of state and local taxes involved. Cost factors that typically play a primary role in corporate location decision-making include operating expenses such as occupancy cost (e.g. office rent), labor, utilities, transportation and telecommunications. For many businesses, workers compensation and unemployment insurance expenses figure prominently.
Lynch found that the $20 billion that corporations paid in income taxes to state and local governments in 1991 equaled about 0.5% of their total costs of doing business, a “small cost that is further reduced by the federal deductibility of state taxes” and that after federal deductibility, “all state and local taxes paid by the average business typically represent less than 2-3% of costs.” Pomp reported that the tax study commission’s staff analysis of larger corporations “indicated that labor costs in New York are 53 times as large as their state corporate tax payments” and “a two percent wage differential is equivalent in its effects on profits to a 106 percent corporate tax differential.”
In 1996, the Federal Reserve Bank of Boston convened a symposium to “examine and critique existing theoretical and empirical evidence concerning the effectiveness of state and local tax, spending and regulatory practices as instruments of economic development,” according to a symposium summary published in the New England Economic Review. The participants generally agreed that the conditions under which state policies can significantly influence business location and economic growth “are largely beyond the control of state and local governments – for example, labor costs, the availability of appropriately skilled labor, energy costs, climate and the availability of natural resources.”
In his symposium presentation, Michael Wasylenko looked specifically at the impact of state and local taxation and public services on economic growth. He noted that while most analysts and policymakers start with a strong prior belief that “tax policy influences economic behavior,” researchers “have had difficulty determining the degree to which employment, investment, or business location responds to differences in state and local taxes. Interstate or interregional studies typically find small effects.” Business location decision consultant Robert Ady told the symposium, “[W]hen considering locations across broad geographic areas, other cost variations are almost certain to swamp the effects of tax differentials.”
State and local tax burden differentials can play a more prominent role in intra-regional business location competitions such as between Manhattan and northern New Jersey. In such cases, many of the non-tax decisional factors such as the quality of the labor pool may be similar among competing locations. Still, the existence of a substantial cost differential in just a few of the major non-tax cost factors, such as commercial rents and utilities, can overwhelm any differences in tax bills. With rent constituting one of the largest cost factors for most businesses and Manhattan’s commercial rent market sizzling in the late 1990s, a prime motivation for business to relocate offices to northern New Jersey was to realize a very substantial savings on rent – as well on as utilities, workers compensation, unemployment insurance, and other non-tax expenses.
Business location decision advisors say that the level of state and local taxation is more likely to be a location decision factor for cash-poor businesses with small profit margins that can readily relocate, such as manufacturers. Yet even among manufacturers, taxes are not necessarily the top location decision factor. In urban centers like New York, manufacturing is increasingly niche-oriented, high value-added and relies on workforces with specialized skills. Many urban manufacturers need to be centrally located to serve local markets. Tax savings would surely be appreciated, but their greatest expressed need increasingly is for affordable space, not tax relief.
This was borne out in a telephone survey of small businesses that had recently left New York City conducted in 2000 by the New York City Public Advocate Office. Most of the 29 responding businesses were manufacturers that had moved to northern New Jersey. Executives were asked the main reasons why their companies moved. Virtually every respondent said the main factor was rent: they would have preferred to stay in New York but faced lease renewals at triple or quadruple their current rents or they needed to expand and could not locate affordable, appropriate space in New York City. No doubt they welcomed New Jersey’s lower taxes, but none of the respondents mentioned high City and State taxes as a factor.
The role of tax local burdens in location decision-making also depends on the type of taxes being levied. Some taxes like property taxes and workers compensation premiums have a greater potential to impact the bottom line than broader-based taxes. Multi-state and multinational companies are less sensitive to state and local corporate income taxes than other taxes because they can shift income to lower-tax jurisdictions and because comparatively high state and local taxes in one or two operating locations have a limited effect on the overall profitability of the corporation.
• State and local tax payments are deductible for purposes of the federal income tax. Deductibility mutes any impact on net income and rate of return on investment. According to the Fiscal Policy Institute, as much a third of the value of the New York State income ax breaks enacted in the 1995 benefited the federal government and not New York taxpayers because of deductibility.
• Many other factors, besides taxes, influence where to locate. If state and local tax burdens really are of paramount importance in business location decisions, then the Route 128 high-tech corridor around Boston would not have grown up at a time when Massachusetts was widely derided as “Taxachusetts” and Silicon Valley’s development would have been stymied by the area’s high costs, including high taxes. New York City’s economy boomed in the mid-1990s even though both the 12.5% “Safe Cities, Safe Streets” personal income tax surcharge instituted in 1990 and a 14% personal income tax surcharge instituted in 1991 were in effect. So clearly, many other factors play an equal, if not more important, role.
The key role of quality public services on corporate location decision-making was emphasized in a 1996 Federal Reserve Bank of Boston study that concluded that while “business tax climate exerts only small, highly uncertain effect on capital spending… [s]tates may be more likely to stimulate their economy by enhancing public services valued by businesses.” It has been said with much justification that a city’s two most important economic development agencies are its board of education and police department.
Because the quality of local schools directly affects the quality of the workforce, schools are among the most important of these services. Whether a potential business location offers high-quality worker training and skills upgrading programs, typically offered through community colleges, can be an important location decision factor. As Robert Ady told the Boston Federal Reserve Bank symposium, “T]the quality of the available workforce is the single most important factor in site selection today.” An extensive analysis of the impact of education spending on economic development by Carl Rist, including a review of studies of business location decisions, “indicate that an educated workforce is one of the most important site selection factors.”
Many conservative analysts see the level of education spending as only tenuously relevant to economic growth. Rist examined the argument that schools need only spend the money they already receive more effectively. He found that research clearly notes that “simply investing more in education -- without changes in the way education dollars are spent -- will not alone lead to greater student outcomes,” but, he adds, “…recent research cautions against a simplistic conclusion that money doesn’t matter.” Rather, “scholarly research has demonstrated a significant relationship between education spending and both future earnings (at the individual level) and overall economic growth (at the aggregate level).” Rist recommends a “middle way” between “these two extremes” – education spending “must be increased” and education investments “must be made wisely.”
The crime rate is another important factor influencing decision locations. New York City’s stunning and continuing success in reducing its crime rate clearly gave the City a major economic boost. And it’s not just the rate of major felony crimes that’s important. Squeegee men returning to street corners, overflowing litter baskets, and graffiti on subway cars would signal to many investors that New York City is sliding back to its old ways. In many parts of New York City real estate interests are in fact calling for higher taxes – in the form of “assessments” -- to pay for services such as litter removal and security patrols provided through the Business Improvement Districts.
For businesses looking to build or renovate a facility, a locality’s reputation for responding to businesses – how quickly permits are approved, zoning amended, and the amount of government “red tape” businesses face -- are key concerns. In the Public Advocate survey of small business that left New York City, several of the responding executives criticized New York City responsiveness while lauding government officials at their new locations for their help in finding sites and expediting the approvals they needed to build or renovate their new facilities.
The capacity and condition of the physical infrastructure is a key location determinant. The important role of infrastructure in determining competitiveness was recognized in the Citizens Budget Commission’s New York Competitiveness Scorecard issued in July 2001. The Citizens Budget Commission compared the New York metropolitan area with 12 other major metropolitan areas in 36 indicators. Seven of these were public infrastructure indicators such as electric generation capacity shortages and highway congestion. Airline service is an important consideration for many businesses; the CBC scorecard ranked New York first in numbers of departing airline passengers although New York lagged in passenger growth .
Intangibles like “quality of life” are difficult to measure but are important location considerations, especially for the knowledge-based industries on which today’s urban economies are increasingly based; for most creative industries, from publishing to apparel design, cultural opportunities -- from jazz clubs to art museums – are essential and this is one of the areas where New York City is unparalleled.
The New Economy Index, a comparison of the 50 largest metropolitan areas in the nation issued in 2001 and of all 50 states issued in 2002, illustrated the factors that are increasingly important in the more complex, dynamic and dispersed information-based economy that continues to replace the traditional industrial economy, notwithstanding the recent “dot com” meltdown and economic slowdown. The Index covered “industrial and occupational mix, globalization, entrepreneurial dynamism and competition,” in 16 specific indicators ranging from “workforce education” and “computer use in schools” to “commercial internet domains” and “academic R & D.” The New York City region ranked 14th in the metropolitan index and New York State ranked 10th in the state index. New York State ranked especially high in “workforce education” (8th), “digital government” (8th), “broadband telecommunications” (8th) and “scientists and engineers,” (12th), but poorly in “technology in the schools” (43rd).
In 2000, Fortune named New York City the best place in the nation to do business. The magazine’s considerations sum up what counts most in creating a competitive business climate: the caliber of the local workforce, diversity of businesses, access to capital, the quality of life, the costs of doing business, and the overall business environment. New York City’s comparatively high taxes didn’t prevent it from coming out on top because taxes were only one part of the business cost factor. The ranking also included the opinions “of more than 1,700 top-level executives worldwide about where they like to do business.” San Francisco came in second even though it, too, is a high-cost location.
New York’s taxes are higher than elsewhere – but how much higher, really?
Opponents of raising taxes point to the high New York City and State tax burden relative to other states and cities. Here, too, some widely held assumptions must be closely examined.
A study by the New York City Independent Budget Office at first glance bears out the belief that the City’s tax burden is much heavier than in competing jurisdictions. According to the IBO, in 1997 New York City taxes absorbed $7.99 of every $100 in taxable City resources, 79% more than the $4.47 average for local taxes in the next nine largest cities. However, the study noted that New York City is unique because it pays $5.2 billion in welfare and Medicaid expenses that other major cities don’t pay because their state governments cover it. If the State relieved the City of these costs and the City proportionately reduced taxes, the gap between New York and the other cities would be cut by more than half. It must also be noted that, as “the capital of the world,” New York City proportionately has greater numbers of business visitors and tourists than the other cities in the survey, which means that a larger portion of the City’s tax burden is borne by non-residents who pay sales, hotel occupancy and other taxes and fees. Non-residents also paid over $400 million in commuter taxes when this analysis was conducted.
In 1997, a study of New York City’s fiscal outlook by New York City Independent Budget Office found “a striking decline in overall [New York City] tax burdens over the past twenty years” because of the mix of taxes, “which innately grow much more slowly than incomes in New York City.” The IBO’s historical overview found that total City taxes totaled $10.46 per $100 in personal income in 1976, $8.84 per $100 in 1986, $8.31 in 1996 and projected $7.75 per $100 in personal income in 2001. The report concluded that these findings “raise[s] serious concerns about the ability of the City’s current tax structure to reliably generate sufficient income to meet ever increasing spending needs.”
New York State’s tax burden remains moderate compared to other states. In 2000, New York State taxes amounted to $67.68 per $1,000 in personal income, slightly less than the national average of $69.52 and ranking 29th in the nation, down from 14th place in 1987. While New York’s effective personal income tax rate of 3.76% remained significantly above the national average of 2.51%, in recent years the differential has shrunk considerably from a high of 2.10% in 1988 to 1.25% in 2000.
Those who fervently oppose higher taxes do not necessarily consider the ability of residents and businesses to pay taxes. In 1998, state and local taxes in New York came to $141.92 per $1,000 of personal income, or 21.1% more than the U.S. average of $111.70, 19% more than New Jersey and 12% more than Connecticut. New York State’s burden is clearly higher, but these figures suggest not so much higher that people and businesses are compelled to leave just to save on taxes.
But raise taxes now?
Many state and local government policy makers believe, in the words of Florida Governor Jeb Bush, that raising taxes “would only exacerbate economic woes by damping consumer and business spending.” With weak New York City and State economies, now may seem an inopportune time to raise more revenue.
But an analysis by Peter Orszag of the Brookings Institution and 2001 Nobel Prize winner Joseph Stiglitz of Columbia University suggests that “tax increases would not in general be more harmful to the economy than spending reductions” that would result from government having insufficient revenue. They explain: “In the short run (which is the period of concern during a downturn), the adverse impact of a tax increase on the economy may, if anything, be smaller than the adverse impact of a spending reduction, because some of the tax increase would result in reduced saving rather than reduced consumption.”
They conclude, “…if anything, tax increases on higher-income families are the least damaging mechanism for closing state fiscal deficits in the short run,” and, “[R]eductions in government spending on goods and services, or reductions in transfer payments to lower-income families, are likely to be more damaging to the economy than tax increases focused on higher-income families.”
|
