How to Eat our Cake and Have It, Too

Eliminating the state corporate income tax sounds like a crazy idea when the commonwealth is facing $4.2 billion revenue shortfall in the Fiscal 2011-2012 budget. After all, the Kaine administration expects the tax to bring in $660 million, or 4.7% of all General Fund revenues.

But is it really so crazy? Only if you engage in static revenue analysis, assuming that cutting the tax — and putting $660 million back in the hands of Virginia businesses — would do nothing to stimulate economic expansion, job creation and revenues from other taxes.

A group of Richmond-area businessmen led by Bob Marcellus, a hedge-fund manager and global trader, has been working behind the scenes to get Gov.-elect Bob McDonnell on board with the idea, pushing the angle that the tax cut would stimulate job creation and, perhaps, even pay for itself. According to the Times-Dispatch, Del. Harry R. Purkey, R-Virginia Beach, has submitted legislation in the House, and Sen. Ryan T. McDougle, R-Hanover, has said he would do so in the Senate.

So far, McDonnell has been noncommital. “It’s an innovative idea and something that we are looking at,“ Eric Finkbeiner, director of policy with McDonnell’s transition team, told the T-D.

I can understand why McDonnell is cautious. He is obligated by the state constitution to balance the budget, and $4.2 billion is a big hole to patch, especially following the belt-tightening measures already instituted by Gov. Tim Kaine. Eliminating the corporate income tax would make that hole even bigger if it failed to pay for itself through extra tax revenues from accelerated economic growth. Unlike Barack Obama, McDonnell doesn’t have the luxury of borrowing money to finance the government. He has no margin for error.

Still, I think the idea warrants serious discussion. First of all, there is ample evidence that cutting the corporate tax does stimulate growth and inward investment. Marcellus’s talking points attribute much of Ireland’s stupendous economic growth since 1985 to cuts in its corporate income tax. A better example, also noted by Marcellus, may be the superior growth rate enjoyed by Swiss cantons with lower corporate income taxes. Closer to home, Marcellus cites the experience of Canadian provinces, quoting from a Fraser Institute study: “A 10 percentage point cut in a province’s corporate income tax rate is associated with a 1 to 2 percentage point increase in the annual per person GDP growth rate.”

Virginia’s corporate income tax rate is 6.0%. Let’s say, for purposes of argument, that a combination of higher corporate profitability and an influx of capital into the Old Dominion increases economic growth by 1.0% annually. To keep things simple, let’s say that 1.0% annual economic growth translates into increased General Fund revenues (not including the corporate income tax) of 1.0% annually. That would yield roughly $150 million in extra revenue from other taxes.

In the first year, the state would lose $660 million in corporate income taxes, offset by $150 million in other tax revenues, creating a net $510 million revenue shortfall. In year two, the revenue shortfall would shrink to $360 million, assuming that the economy continued to grow one percent faster annually, and so on. The budget would surpass break-even by year five. At that point, Virginia would enjoy the best of both worlds — revenues from faster economic growth would exceed the loss of corporate income tax revenues, and the state’s superior competitive position would be growing the economy, creating jobs and boosting incomes. Clearly, that’s a better place to be.

The trick is getting from year one to year five. How do you deal with that $510 million shortfall the first year? Here’s where I would look. Virginia’s income tax code is riddled with loopholes, all carved out for one special interest or another. Back when Gov. Mark Warner was looking to balance the budget, the Secretariat of Finance totaled the revenues lost from the loopholes and (to the best of my memory) came up with a figure of roughly $600 million. That number is undoubtedly higher by now. So, if we closed, say, $500 million worth of the special-interest loopholes in the personal income tax, we would offset the revenues lost from eliminating the corporate income tax.

Here’s the big difference: While eliminating the income tax would have an immensely positive effect on the economy, a grab bag of miscellaneous loopholes benefits no one but the special interests for whom they were enacted. Eliminate the loopholes, and you inflict minimal damage to the economy.

Bacon’s bottom line: Use the revenues from closing $500 million in special-interest loopholes to pay for eliminating the corporate income tax. Virginia would break even from a revenue perspective in the first year, allowing McDonnell to balance the budget. As a bonus, the state also would enjoy superior economic growth, creating jobs and growing revenues, more or less forever. If McDonnell wants to make a name as the “jobs” governor, this is one good way to do it.


Share this article



ADVERTISEMENT

(comments below)



ADVERTISEMENT

(comments below)


Comments

24 responses to “How to Eat our Cake and Have It, Too”

  1. Anonymous Avatar

    great idea on removing the special interest loopholes to complement abolishing this job killing tax. The proposal is clearly stimulating the debate as it should.

    You may be pleasantly surprised by the actual experience of Irish, Swiss, and Canadians. If you track their overall government revenue take during the years they cut their taxes, you will find no dip in the year to year numbers. Canada had one flat year of revenue growth with all others steadily increasing. Irish experienced no dips, only increases even in their first 12 months, and the Swiss actually gained +6.6 by month 12 of the cut. You have underestimated the rate of revenue "recapture" but bring up a compelling argument to simplify the tax system as this proposal hopes to do. We are optimistic that there will be minimal drawdown in revenues on a year to year basis based on both modeling and real time results.

    Your "projection" above also does not consider the bonus of the lag factor. If announced in the beginning of the year and then made effective 12 months out, there is still revenue coming in while the wow factor goes to work attracting significant migration.

    Your suggestion more than provides enough buffer to get through this, but I would suggest lower personal income taxes as well while at the same time removing the loopholes. We would attract more people to move to the state increasing the tax base just for that proposal,property values would go up…etc but that is dynamic analysis.

    In the interest of disclosure, I am familiar with, and a big supporter of the Marcellus Initiative to abolish this tax before a neighboring state does.

  2. Darrell -- Chesapeake Avatar
    Darrell — Chesapeake

    Great Idea indeed! McD taking advice from a hedge fund manager hiding in the shadows, yep that's a vote of confidence. Ask dubya how that worked out.

    And those talking points, yeah real winners there. Ireland is right in line with Greece and Iceland to go down the tubes. Canada's tax rates are only double what Virginia's are, so even a tiny reduction appears to pay off. Then there is Switzerland. They are going to have to raise those business rates because all the money that was once legally hidden away by global tax cheats is quickly being grabbed by national governments.

    Who knows maybe it will be different with Virginia. All the tax exemption bills this year's GA is considering doesn't look promising though. One thing is for sure, the hedge fund manager will cover his bets no matter which way the financial winds blow.

  3. Anonymous Avatar

    Ireland is actually a great example. Before the cut they had the lowest GDP per capita in the Eurozone. They moved to the highest per capita GDP within 10 years due to the cuts. Would you have rather gone into the greatest economic contraction and credit crunch since the depression of the 1930's with the highest or lowest per capita GDP? They are all bankrupt now over there, as are we.

  4. Darrel, regarding your comment as follows;

    "Canada's tax rates are only double what Virginia's are, so even a tiny reduction appears to pay off."

    Darrel, just combine the VA 6% and US 35% rate and that is a 41% total tax on corporations, the highest in the world currently.

    so, why exactly wouldn't this pay off?

    Let's start with VA offering this tiny reduction in trade for more jobs and the increased revenues that comes with them.

  5. R. Stanton Scott Avatar
    R. Stanton Scott

    I would want to know just what "special interest" loopholes you mean before agreeing that this would be revenue neutral. This looks like raising taxes on some groups so you can lower them on other–no less special interest–groups.

    Even if the magical GDP growth you claim would result from elimination of corporate income taxes materializes, you have not made a case that taxing these other groups more heavily wouldn't offset some of this growth.

    And it is not clear that this growth would in fact materialize. The experience of the Irish, Swiss, and Canadians may not generalize to Virginia, and in any event your characterization of it relies on the dubious and simplistic assumption that any increase in growth these states experienced derived exclusively from reductions in corporate taxes. I daresay this was not the only contributing factor.

    Reducing corporate taxes only pays for itself with respect to Virginia government revenue if the corporations invest the savings in specific ways (e.g., hiring more Virginians, buying more equipment or supplies in Virginia). It is not guaranteed, or even plausible, that Virginia corporations, especially national or multinational ones, would invest all their savings in the Commonwealth, rather than paying dividends or bonuses to out-of-state stockholders or executives, purchasing equipment from out-of-state suppliers, or using the money for expansion into other states.

    In the end, cutting corporate income taxes on Virginia companies is more likely to produce increased economic growth in India or China than in Roanoke.

  6. E M Risse Avatar

    Sorry Jim, this is another half measure that, if enacted, will only give governance practitioners an excuse to do nothing else until this proves futile.

    Yes, cut out the loop holes RIGHT NOW.

    But as to corporate tax, Reich has a much better idea:

    ELIMINATE THE MYTH THAT A CORPORATION IS A ‘PERSON.’

    Remove all corporate taxs and tax those who own the corporation.

    Make citizens responsible for everything that corporations (and all Enterprises and Institutions) do including making money. Reich spells out many the reasons this makes sense.

    The only counter arguments we have heard are that it will slow down a few from getting richer faster.

    Making citizens responsible will also slow down consumption, with is a sine qua non of attaining a sustainable trajectory for contemporary civilization – and for democracies with market economies.

    The overarching problem is that any action like this masks the reality that ALL the tactics that worked in the past to increase consumption – e.g. tax cuts for the rich – will not work in the future now that humans are bumping up against the holding capacity / consumption rate of a finite planet – peak oil, scarce metals, water and air pollution, etc.

    EMR

  7. Anonymous Avatar

    Raise the corporate tax to pluc the revenue gap, with the proviso that if corporate revenues in the state go down the opposite tack will be tried.

    Raise th ecorporate tax by 5% and if state busines investment falls then lower it by 10% and see if state business investment goes up.

    Run an experiment and end the argument.

    RH

  8. Anonymous Avatar

    To hear anonymous 10:04 tell it, if we reduce the rate to zero, revenues will go to infinity.

    RH

  9. James A. Bacon Avatar
    James A. Bacon

    Ed, I don't think anyone thinks that eliminating the corporate tax is a panacea. It's only one of many, many reforms that need to be put into place. The people behind this measure want to make transformational changes to Virginia institutions, and I think they are open to the idea of reforming transportation and human settlement patterns (among other institutions). So, enacting this measure won't give anyone an excuse to do nothing. Indeed, it will encourage them to push for even more fundamental changes.

  10. Anonymous Avatar

    "Make citizens responsible for everything that corporations (and all Enterprises and Institutions) do including making money."

    —————————-

    By all means lets make people responsible for corporations making money. Can't have that, now, can we?

    If I have to take all of my share in corporate profits, whether I want to or not, I have vey limited options for either sheltering that income or putting it to good use.

    But If I and the other shareholders pool our resources (that's what a corporation is, pooled resources), then the corporation can afford to hire professional managers who can reduce profits by investing more in long term growth.

    EMR's only answer is that we all must be poorer and consume less. I suspect that most people would rather kill someone than accept the idea of working harder for less. When the trajectory we are on slams us against the wall of global carrying capacity for human activites, history suggests we will just kill off a few million people.

    That, we know how to do. What we have no idea of how to do is make a sustainable, steady state economy.

    RH

  11. R. Stanton Scott Avatar
    R. Stanton Scott

    I think EMR's point is not that we "must be poorer and consume less." (Emphasis mine.)

    I think he's pointing out that this is about to happen whatever we do, since we are rapidly exhausting the wealth available for investment and consumption.

  12. Anonymous Avatar

    It is one thing to consume less in a constrained situation, as in a famine.

    It is something else again to try to devise government policy which creates an artificial famine, which is what I think EMR wants. government orders to consume less as in CAFE requiremnts etc.

    With a half billion people on the planet we can probably all drive Hummers, but with 20 billion, most of us will be walking.

    It is not consumption that is the problem is is population times per capita consumption. Historically, we have been a lot better at controlling population than consumption, and we don't have any idea how to operate a steady state economy.

    RH

  13. Anonymous Avatar

    "It is not consumption that is the problem is is population times per capita consumption."

    Well said.

    TMT

  14. E M Risse Avatar

    TMT:

    EMR agrees, that is well stated. It is a matter of physics.

    Here is a link to a speech given in India recently:

    http://www.cnn.com/2010/OPINION/01/12/rosling.converging.world/index.html

    There are many facinating aspects of the data and the presentation but what the speaker — esteemed as he is — misses is the fact that, as noted in our prior comment humans are running out of resouces to improve health or income (consumption).

    Citizens of the First World can start TODAY to cut consumption or civilization as we know it will COLLAPSE soon. It is a matter of physics.

    The choice is ours, for now.

    The good thing about China now being the largest Large, Private Vehicle market on the planet is that when the revolt comes, more than just the army will have vehicles — at least until they run out of gas.

    EMR

    EMR

  15. Anonymous Avatar

    "Citizens of the First World can start TODAY to cut consumption …"

    Well, we can, but I rather doubt we will. War is a lot faster and less painful, if not for our "enemies", at least for us. We've got it down to remote killing by robots.

    Where is our incentive to reduce our consumption by one third, just so the rest of the world can increase their population by two thirds?

    RH

  16. Anonymous Avatar

    the good news about china being the largest larg private vehicle market is that almost all fo those vehicles will be a lot saller than our domestic crop of large private vehicles.

    Already American manufacturors are re-designing for the Asian market.

    Maybe that means they will be better and more eliable, as well as smaller.

    What I never understood about the Domestic manufacturors is why they let their dealers drive such a wedge between the manufacturors and their customers. Delaer service will kill your brand faster than anything.

    Controlling dealer service in China is going to be a challenge – one they never mastered even closer to home.

    RH

  17. E M Risse Avatar

    Jim Bacon said:

    “Ed,

    “I don't think anyone thinks that eliminating the corporate tax is a panacea. It's only one of many, many reforms that need to be put into place. The people behind this measure want to make transformational changes to Virginia institutions, and I think they are open to the idea of reforming transportation and human settlement patterns (among other institutions). So, enacting this measure won't give anyone an excuse to do nothing. Indeed, it will encourage them to push for even more fundamental changes.”

    Good to hear, BUT, EMR was NOT casting aspersions on those making the suggestion. What he said was:

    “Sorry Jim, this is another half measure that, if enacted, will only give governance practitioners an excuse to do nothing else until this proves futile.”

    Perhaps I was not clear. It is the GOVERNANCE PRACTITIONERS (that is the elected and appointed persons who populate the Agencies) who enact and enforce this measure who will see it as an excuse to do nothing else.

    Until the leadership of Agencies, Enterprises and Institutions (with a Capital “I”) ALL join hands and say we understand the best interest of all citizens and we understand that we must make Fundamental Transformations from the current trajectory, then all the partial good ideas will only postpone the Tipping Point.

    That must be the message of the AntiPartisan movement.

    In the meantime, just starting another war – and / of using other means – to kill off a few million “enemies” will seem like a good strategy to those at and near the top of the Ziggurat.

    There are six plus BILLION humans on the planet and expecting someone else to go without so those at the top of Ziggurat in the First World can enjoy the remaining bounty of the planet is not a strategy that will avoid COLLAPSE.

    EMR

  18. Gooze Views Avatar
    Gooze Views

    Jim "No Tax" Bacon
    Let me see the logic here.
    We have a $4 billion plus revenue shortfall, so you want to cut a tax.
    It would take five years to make up the $600 million that the corporate income tax would no longer provide, assuming that we have at least a 1 percent growth rate.
    What is to assume that if there were no corporate tax rate that the bosses would really add jobs? What's to keep them from simply passing the savings along to their shareholders (if they have any) or to themselves? If you want a great exampl,e look at what Big Banking chiefs are doing with OUR bailout money? They are giving it to themselves!
    Five years is a long time to make up the revenue difference. I dpn't follo how this is not a problem.
    Who's to say that there will be economic growth that is essential to replace the $600 million?
    Six percent ain't that much of a corporate tax rate. Virginia is already rated as being the most if not one of the most business friendly states in the U.S. How much more business friendly should the state be?
    I love you libertarian-conservatives. The s–t hits the revenue fan and you guys still get dreamy over tax cuts.
    Earht to Bacon!

    Peter Galuszka

  19. Anonymous Avatar

    There are six plus BILLION humans on the planet and expecting those at the top of the ziggurat to do with out so someone else (or ten persons) in the Third World can enjoy the remaining bounty of the planet is not a strategy that will avoid COLLAPSE.

    RH

  20. Anonymous Avatar

    If we cut the population from six billion to one billion, the one billion remaining would expect ten times as much.

    We are not going to uninvent the automobile or airplanes, or bulldozers, or power plants.

    EMR thinks we are doomed, and I think he is probably more right than he thinks.

    I'm not too worried about it.

    RH

  21. Anonymous Avatar

    "Five years is a long time to make up the revenue difference. I don't follow how this is not a problem.
    Who's to say that there will be economic growth that is essential to replace the $600 million?"

    ————————

    I'm with you Peter.

    If you need money you have to take it from where it is.

    Kepp raising the corporate tax until revenues actually go down. Thn admit the libertarians were right and back off half a percent.

    Everybody is happy.

    RH

  22. Anonymous Avatar

    Ariz. to close 13 parks due to budget woes.

    You want a good environment, you had better plan on a good economy.

    RH

  23. Anonymous Avatar

    Department of Political Correctness:

    I've concluded that the Redskins should not hve to change their name.

    Instead, change the logo from an Indian to a sack of potatoes.

    RH

  24. Anonymous Avatar

    I've been reading many of the various opinions, expressed in a variety of locations, where people can express their thoughts regarding the Pros and Cons of the State Corporate Income Tax, especially as it relates to the sections that would be repealed under the current HB 119. I also reviewed the sections of code that would be repealed under this bill.

    After sifting through the arguments using quotes from text books, economic facts from distant states and lands, various foundations, opinions of businessmen, economists, politicians, and citizens, suggestions to the removal of the "personal income tax exemptions" to externalize the cost of the corporate tax repeal, and all the other smoke and mirrors used to champion this agenda, a thought came to me.

    Hedge funds don't hire thousands of of unskilled and semi-skilled workers. But, between $650 and $700 million dollars that would no longer paid to the state in tax after 2012 will find its way into salary increases and bonuses, etc. for the Principals of the businesses who benefit from HB 119. Those guys will be looking for a way to invest their new found loot. Will Bob Marcellus be there to remind them who championed HB 119?

Leave a Reply