Legislative Analyst's Office: The Impact of the Governor's Proposed Corporate Tax Cut

This analysis of Governor Pete Wilson's proposed reduction of the bank and corporation tax rate is from 1997-98 Budget: Perspectives and Issues, by the Office of Legislative Analyst Elizabeth G. Hill.

Editor's Note: Governor Wilson, in his 1997-98 state budget, has proposed a 10 percent reduction in the bank and corporation tax rate. It would be phased in with 5 percent effective January 1, 1998 and 5 percent effective January 1, 1999. It comes on the heels of a 5 percent rate reduction enacted in 1996 that took effect January 1, 1997. The governor had originally proposed a 15 percent reduction, phased in over three years. The current rate is 8.84 percent, which ranks 14th highest among the states. The proposal would lower the rate to 7.96 percent over two years

With this background, here are the analyst's summary comments:

The basic rationale for the proposal is to further improve California's business climate relative to competing states, thereby fostering continued corporate investment, job creation, and overall economic expansion. The proposal's net state revenue impact would be $90 million in 1997-98 (a partial-year effect), rising to $608 million in 2000-01 (when fully implemented).

The tax reduction's benefits to corporations would be roughly proportional to their current-law share of tax liabilities. About 15 percent of businesses in California would have their taxes reduced in any given year.

Relative corporate tax burden comparisons between states are difficult to make. However, at present, California's corporate tax burden seems to be relatively high, although when all taxes affecting businesses are considered, its burden ranks in the middle and is not significantly out of line with comparable states. The state's relative tax rate ranking among western and industrial states would not change significantly if the Legislature adopted the proposal, although its position in terms of overall tax burden on businesses would improve somewhat.

The proposal would have a variety of offsetting effects which would have to be weighed against each other. It would tend to stimulate the private economy by decreasing the cost of "doing business" in California, thereby leading to increased investment and job creation. The magnitude of these impacts, however, would depend on a variety of difficult-to-predict behavioral and "dynamic feedback" effects. Offsetting factors would include out-of-state "leakages" of a portion of the tax reduction and the effects of reduced public-sector spending on the economy.

In examining the proposal, the Legislature will need to decide what its tax-policy and expenditure objectives are, and evaluate the proposal's fiscal and economic effects on taxpayers and the state generally.

The Role of State Taxes In Business Decision Making

Before going further, it first is useful to briefly consider an important underlying question relating to the Governor's proposal- namely, to what extent do state taxes "matter" to businesses?

Many Factors Affect Business Decisions ...

A state's tax structure is one of a number of key elements influencing the business climate. In fact, many studies have ranked other factors higher in terms of their influence on business locational and investment decisions (although taxes certainly appear on the list). The specific ranking of factors (including taxes) can vary depending upon the particular industry and business involved. Some of these other factors that businesses typically rank as important include access to markets, availability and costs of labor and other inputs, geographic characteristics, climate, infrastructure (such as transportation facilities), regulatory environment, quality of public services for employees and their families (such as schools), and housing prices.

... However, Taxes Do Matter

Despite the above, there is evidence that state tax policies can play an important role in business-related locational and investment decisions "at the margin"- that is, once a business' "highest priority" factors have been taken into account and it still finds itself trying to choose between competing locations. It also is important to note that state tax policy is an element of a state's business climate that can be changed in the near term, because it is under the direct control of policy makers. Sometimes, this can be especially important for businesses already located in a state but considering moving elsewhere.

Thus, the "bottom line" is that although various other factors are frequently more important than state taxes per se in business locational and investment decisions, state taxes can and do "matter."

Editor's Note: Cal-Tax supports the governor's tax-cut proposal. See commentary on Page 2 and the Guest Commentary by state Finance Director Craig Brown in the February issue of Cal-Tax Digest.

The tax reduction's benefits to corporations would be roughly proportional to their current-law share of tax liabilities.

... the "bottom line" is that although various other factors are frequently more important than state taxes per se in business locational and investment decisions, state taxes can and do "matter."