Chicago Policy Review: Tax Breaks Do Not Spur Economic Growth and City Finance Director Interview

Existing literature claims that businesses are sensitive to changes in tax rates enforced through state fiscal policy. These claims rely heavily on assumptions: 1) all businesses are operating in a perfect market in which they rationally choose to locate where they are able to maximize their profits, and 2) lower tax rates reduce the marginal cost of doing business so that, all else equal, businesses are able to increase their profitability and spend more on job growth and/or higher wages. These assumptions, however, do not hold under two conditions: 1) if taxes are passed on to consumers through higher prices or lower wages, or 2) the tax expenditure is immaterial relative to the company’s total revenue and does not affect their location decisions.

Importantly, existing literature is largely silent on the response of businesses to national tax policy as opposed to state policy.

Additionally, large estimates of the magnitude of a corporation’s sensitivity to taxes may not account for other factors that impact business location decisions such as the quality of public service provision, the price of capital, the quality of human capital, and transportation costs. Importantly, existing literature is largely silent on the response of businesses to national tax policy as opposed to state policy.

The authors use panel data from 1977 to 2005 for all 50 states to explore each state economy’s response to a reduction in the tax incidence for businesses. Tax incidence is measured using a host of variables that are summed as a percentage of gross state product (GSP), including corporate net income taxes, property taxes, corporate licensing taxes, and occupational and business licensing taxes. To account for an imperfect market in which taxes are passed on to consumers rather than absorbed by the business, the authors measure the impact of non-business (personal) taxes in all 50 states as a percentage of GSP.

The data is analyzed using the Arellano-Bond GMM estimator, which proves beneficial in measuring complex impacts that arise between policy actions and state economic outcomes. The state economic variables include: 1) the real growth rate of GSP; 2) the change in the employment rate; 3) the change in the net job-creation rate; 4) the growth rate of per capita real income; and 5) the rate of entrance and exit for business.

The study reveals that business taxes are positively associated with the growth rate of GSP, meaning that decreasing the tax rate may prove harmful to the state economy.

The study reveals that business taxes are positively associated with the growth rate of GSP, meaning that decreasing the tax rate may prove harmful to the state economy. Furthermore, employment is only modestly affected by state policy. Major responses to the employment rate are driven by national policy, as opposed to state policy. One implication of this result is that states should focus on increasing the requisite human capital through investments targeted to educational attainment rather than trying to increase employment rates through business growth.

Additionally, an increase in business taxes of 10 percent is associated with an increase in business exit of 0.04 percent. Even though this number is positive, it is relatively small and economically insignificant when considered with other factors tied to investment decisions for businesses.

The non-business effects, though mixed, were more closely aligned with existing theory. A one percentage point decrease in the GSP of non-business tax receipts is associated with an increase in the growth rate of GSP by 4.55 percent. However, the magnitude of the increase in growth is small in comparison to the reduction required in GSP to attain this growth.

States must consider other factors that are valued more highly by businesses than their tax incidence.

Overall, this study unravels the theory that tax cuts benefit state economies by attracting businesses. States must consider other factors that are valued more highly by businesses than their tax incidence. Factors such as human capital and capital investment costs are popular drivers behind location and investment decisions for businesses that states may be able to address. Furthermore, states suffer a loss in corporate tax revenue by offering tax cuts as an incentive that may result in a reduction in the provision of public services such as education and public health. US policymakers must stop the rhetoric that tax breaks from the state appeal to businesses and instead divert more time to exploring other interventions that are actually effective in improving the state’s economy.

Brian Collins, Director of Finance for the City of Memphis, talks about his city’s determination in the face of financial and socio-economic adversity.

Brian Collins, Director of Finance, City of Memphis

Brian Collins serves as the Director of Finance for the City of Memphis, a position he has held since 2012. After years as a Chicago trial attorney, Collins made a home and career in Memphis, working for First Horizon and teaching in the University of Memphis MBA program. He earned his bachelor’s degree from DePaul University, JD from Loyola University, and MBA from Ohio State.

The beginning of 2014 saw the opening of an Electrolux manufacturing plant, a major new employer in Memphis. From an economic development standpoint, what is Memphis doing to distinguish itself from other cities in the region?

I have a lot of faith in EDGE (Economic Development Growth Engine). EDGE President and CEO Reid Dulberger and our EDGE board do an excellent job of screening, trying to attract, and putting really terrific deals on the table. But the competition is pretty ferocious and we find ourselves in a tough spot. We are at the southwest corner of our state with Mississippi to our south and Arkansas across [the Mississippi River]. Those communities in North Mississippi in particular have a whole different mechanism for attracting business because they can use income tax revenues. Of course Tennessee is one of the few states that does not have an income tax. And based on the vote we had last week, it doesn’t seem like we will in our lifetime.

I think we have issues with trying to compete with our neighbors for economic development. I think eventually there is going to be a lot of congestion and growth in North Mississippi. The land that is available is going to be further and further from the Memphis core, which is the main attractor for the region. North Mississippi would have nothing if it wasn’t for Memphis, which of course is the problem: Memphis is providing the infrastructure, the airport, the city, the urban environment, the basketball teams. When you read the websites of our suburban ring of competitors, half of what they sell themselves on is our assets: “Come to North Mississippi and enjoy all that Memphis has to offer.” All without being in Memphis, without paying a nickel for it.

I think that vis a vis other big cities around the country, we still have the lowest overall tax burden of most big cities. We rely heavily on the most regressive types of tax streams. We have a high poverty level, we have regressive taxes, and these things tend to feed on one another. We’ve just got to overcome that. We’re not going to give up. Memphis is a great place. It’s got a great heart, a great soul. Unfortunately we lag behind the state and the nation in terms of unemployment. It’s part of the underlying issues of poverty and literacy that we have to solve.

On that note, Memphis has its own agenda, but faces the particular challenge of being situated in a decidedly conservative state. How are you working with or even against the state to accomplish what needs to be done?

I believe we have a very good relationship with Nashville. The Treasurer, the Comptroller, all of the financial folks in Nashville, have been very supportive of Mayor Wharton and the policies and things we’re trying to do. For instance, they have watched with great interest and I think have been approving of the strides that we’ve made to reform our retiree healthcare. We have proposals on the table to reform our pension system. I think both of those reform pushes have been on the leading edge of the type of reforms that they are looking for.

So despite the fact that Nashville and the state government is decidedly Republican while Memphis is a Democratic town, I think that the belief that your financial house must be in order before you can succeed is a shared value. Over the last five to six years the Mayor has been in office, the size of government has shrunk. I think if you took the labels off and looked at the last five or six Comprehensive Annual Finance Reports (CAFR), you would think, “Wow, the Republicans have taken control of Memphis.”

What we’re trying to do is take a holistic approach and say “everything is connected, everything is circular.”

At the same time, we have a very different demographic than the rest of the state. Our biggest issues are overwhelmingly poverty and literacy. What we’re trying to do is take a holistic approach and say “everything is connected, everything is circular.” We have to win on the economic front, we have to create jobs in Memphis. You can’t just legislate away poverty. You can train people, you can educate them, but you’ve got to give them a job too.

Pensions were a big part of the news cycle this year. How is the city handling the so-called pension crisis?

We are working very hard to get our unfunded liabilities under control. We are managing our debt as well as we possibly can. When you look at some of the pension numbers, we are doing better than average, but we’re still going after it with a passion because that’s not good enough. Last fiscal year to this fiscal year we are more than doubling the amount that we are paying to get that unfunded liability under control.

It’s not popular to do the kind of things the administration is doing. To Mayor Wharton’s credit, he is doing things you wouldn’t expect and that won’t make him as popular as he might otherwise have been. These are tough decisions to make. I am convinced that in the years ahead as we see these problems receding in the rearview mirror and we see that we have an unrestricted fund balance that gives us flexibility to deal with these issues, we can finally stop talking about finances and be more proactive about attacking the real problems in our city.

It’s all about trying as hard as we can to build a better future for the young people of Memphis. We’ve got to make our streets safer, we’ve got to create hope for these kids. We have to support the Shelby County school system and make sure that all of our children get a high quality education. But at the end of the day when they get out of high school, we also have to make sure they have a junior college system and colleges. And there have to be jobs.

One of the saddest things is when a young person, especially young African American men and women, do fabulously well and then they end up in Atlanta, Chicago, and New York. Not only are we not providing middle class jobs for so many of our young people, we’re also losing our best and our brightest. Memphis needs to home grow their next Finance Director. We’ve got to create opportunities.

I’d love to hear your perspective on the Unified School District.

I think it’s off to a good start. I am a fan of [Shelby County Schools Superintendent] Dorsey Hopson. It is hard to be in the same room with him and not come away feeling that we have someone there who is going to refuse to let those kids down. So I am very excited and have a lot of respect for him.

Memphis has an opportunity to be a laboratory and a leader. The [bad news] is we have so many under-performing schools. The good news is we’re doing something about it. The special school district that’s run by the state is coming in with some very talented and very dedicated people. I have met some of those folks and have been so impressed by their dedication and fervent belief in their mission.

The education system here was stagnant but the pot has been considerably stirred up. I believe that good things will come of that. I’m optimistic about our future.