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.
