Policy Documents

The Potential Effect of Eliminating The State Corporate Income Tax On Economic Activity

Laura A. Wheeler –
March 6, 2006

A proposal to eliminate the state’s corporate income tax has been advanced. This report addresses the potential effect of the proposal on economic activity within the state.

At first glance, the elimination of the corporate tax on business seems an obvious method of attracting new firms to the state and promoting the expansion of existing firms. In fact, states and localities have been offering tax incentives, usually in the form of reduced property taxes or corporate income tax credits, to firms for many years. The assumption is that firms move to states that impose the lowest tax on corporate profits. By minimizing taxes, corporations can maximize profits. That creates new jobs for the state that result in additional tax revenue. Unfortunately, there is scant evidence to suggest that this is an effective economic development policy in the long run.

Economists have struggled with this issue for over 30 years. More than 100 studies have been conducted, each trying to determine what effect, if any, fiscal variables have on firm location and thus on state employment and investment levels. The results have been less than definitive. Some studies have found relatively small effects in a few industries and for a few types of fiscal variables. Others have found no effects at all under any conditions. Various measures have been used over the years, almost all yielding the same level of weak and sporadic effects. So why is the issue not put to rest? Probably because it would be the most obvious result to have fiscal variables influence firm location. Taxes are a cost of production and profit-maximizing firms are expected to choose the lowest-cost location as part of their profit-maximizing decision.