Are Pennsylvania businesses overtaxed?

Despite a series of incremental improvements in its tax climate over the past seven years, Pennsylvania is still, clearly, a high-business tax state.   Pennsylvania’s corporate net income (CNI) tax rate is the 3rd-highest among the 44 states that impose such a tax, and is the nation’s highest effective rate, as affected firms in Iowa and North Dakota (the only two states with higher CNI rates) can deduct a portion of their state CNI payments on their federal tax returns. 

Pennsylvania businesses will continue to pay taxes on both their income and their assets, unless the planned phase-out of the capital stock and franchise (CSF) tax is completed as scheduled.   This tax was retroactively increased in 2002, from 6.24 to 6.99 mills, and the phase-out delayed an additional year, until 2010—the final year of Gov. Rendell’s prospective second term.

The twin burden of these taxes represents a backbreaking weight on the state’s effort to draw new businesses to Pennsylvania and encourage existing companies to expand.   The result is the dubious distinction of having below-par job and population growth rates.   At the same time, increased government spending during a recession delays and weakens economic recovery by siphoning capital from where it is most needed—in the private sector where it can be invested to create economic growth.   The best way to spur investment is to cut the taxes that inhibit it, including the corporate net income, capital stock and franchise, and inheritance taxes.

Status-quo oriented opponents of tax cuts claim that governments can’t “afford” to cut taxes during a recession for fear that revenues will drop and then not be sufficient to meet government obligations.   Revenues do drop initially when taxes are cut, but a “static” view of tax cuts neglects to account for the changes in individual behavior that result in increased economic activity.   Businesses respond to lower tax rates by expanding their operations, buying more equipment, and hiring more workers—all because the lower rates provide an incentive to undertake more productive activity.   This “dynamic” economic activity creates new tax revenues that help to offset the revenues “lost” to the state due to the tax cut.

In fact, as economic activity increases over time, tax revenues actually increase in response to the cuts.   In 1995, the state CNI rate was cut from 11.99 to 9.99 percent.  CNI revenues initially dipped from $1.91 billion in 1995 to $1.63 billion in 1996, but then increased in each of the next four years (from $1.697 billion in 1997 to $1.86 billion in 2000) as businesses responded to the lower rate by increasing investment, thus generating more taxable income.

For example, immediately cutting the CNI rate to 8.5 percent would return the CNI to its level prior to 1991, move Pennsylvania into at least an average position among its nearest geographic competitors and would help to stem the tide of capital flowing from Pennsylvania to other states.   Deeper cuts would improve the situation even more. 

According to the PA-STAMP econometric model, lowering the CNI rate to 8.5 percent in 2002 would have stimulated more than $2 billion in additional capital investment in the state.   At the same time, completely eliminating the CSF tax over the next four years would have led to an additional $13 billion in new capital investment, thus giving Pennsylvania businesses even more incentive to invest and create jobs and opportunities.