The Tricky Game of Tax Cuts

By Katherine Barrett and Richard Greene, CSG Senior Fellows
At least a dozen states—including Arizona, Florida, New York, Ohio and Wisconsin—have plans to cut taxes in the coming year. There are lots of perfectly valid reasons to cut taxes, and we’re not claiming we have some kind of magic formula available for states to set the most equitable, and economically sensible, rates possible.
That said, we worry about the oft-cited theory that cutting taxes is an immutable route to economic dynamism. This idea reminds us of the turn-of-the-century immigrants who came to the United States confident that they would find the streets paved with gold. In fact, they mostly found cobblestone.
We know this is a controversial topic and includes a number of powerful and intelligent public officials who have ridden to office on a steed made of tax cuts. As The Washington Times warranted around the beginning of the year, “tax cuts … will not only make life easier for the taxpayers, lowering their burdens in the struggle to survive and prosper, but the states will see stronger economies, with more employed workers to pay more taxes.”
But let’s take a look at some fascinating state-specific statistics. First we looked at the Tax Foundation’s list of state-local tax burdens as a percentage of state income for 2011, the most recent available ranking. Then we went through the 2014 State New Economy Index, which looks at 25 indicators representing variables that make it most likely that a state will enjoy economic health in years to come. The New Economy Index is assembled by the Information Technology and Innovation Foundation.
Of the 20 states with the highest state-local tax burdens, six of them are in the top 10 of the New Economy Index. The three states that did best in the Index—Massachusetts, Delaware and California—all were among those with the highest tax burdens. At the greatest extreme, California, which had the fourth highest tax burden in the country, ranked number three in the New Economy Index.
One case in point: Kansas enacted some of the largest state tax cuts in history in 2012, with abundant promises that they would inspire an economic boom. But Kansas’ job growth has been a little slower than the national average and incomes of residents of that state also have performed lower than the average. 
Just to be abundantly clear, it’s not that we think lower tax rates never have an impact on economic vitality. When a company is making a choice about a state for a new facility or to keep or expand an old one—and it comes down to a close decision—it would be silly not to acknowledge that lower taxes are certainly a factor that it likely will consider. What’s more, if taxes can be trimmed without any diminishment of services, then it’s entirely possible this may have a somewhat better chance of fostering economic activity. 
But, this is a tricky game. Just take a look at many of the commissions set up to reduce waste in government and we’re confident you’ll see this is far easier said than done.
In fact, based on scores of conversations about this topic over the last 15 years or so, we’ve more commonly heard that consistency of taxes is more likely to win the day, particularly when it comes to startups or new facilities. When corporate accountants do the math to help choose a location, they want to be sure that choice will lead to profitability. As long as taxes stay relatively stable in a state, that calculus is more likely to be reliable. But states that are forced to raise taxes one year—even temporarily—in order to make up for tax cuts in prior years make planning extremely difficult.
We had a firsthand taste of this some years back when we were rating the states in terms of their management capacity. At the time, a Fortune 50 company made a decision to settle in Virginia. We heard from reliable sources that a deciding factor was that our work had demonstrated the consistency of management in place in the commonwealth at the time, which, it was presumed, would forestall any major fiscal surprises. (As it happens, the Virginia project never came off, but it was huge and we felt very proud of ourselves for a little while.)
What’s more, as we reflect on the reasons we have heard for corporate decisions to grow in or move to a state, several come up that are more significant than tax rates. Underfunded infrastructure—notably roads, bridges and water systems—can be a potent impediment for companies concerned about finding a good place for its employees to live and, sometimes, a good place from which to ship goods or deliver services. And yet, when a state’s taxes aren’t sufficient to pay for regular maintenance of infrastructure, potholes will blossom like dandelions in the suburbs.
Even more important is the existence of an adequately trained workforce. 
Growing in a state isn’t just the function of putting up offices or factories. It requires filling those buildings with men and women who can do the necessary jobs without tons of expensive training and retraining. The kind of educational system that builds such a workforce isn’t cheap. And it’s primarily paid for by tax dollars. So, the moment that tax cuts require reducing the quality of K-12 or higher ed, the less competitive a state becomes. 
One small caveat: We’re not equating more money spent with better education. We’re just saying that when cuts in education result in fewer folks skilled in technology, or health care, or engineering, or teaching and so on, the less attractive a state will be for business.
By the way, we live in New York, which has the highest state-local tax burden of the 50 states. This doesn’t make us happy, at all. There are lots of ways we could enjoy spending that cash. But our state still ranks 12th highest in the New Economy Index. We can’t complain about that. 
CSG Senior Fellows Katherine Barrett and Richard Greene founded the Government Performance Project, a 10-year effort by Pew Charitable Trusts to improve state government management. As CSG senior fellows, Barrett and Greene will serve as advisers on state government policy and programming and will assist in identifying emerging trends affecting states.