Corporate Tax Cuts Help Put State in the Red

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Corporate Tax Revenue Declines for First Time in a Generation

A decade of corporate tax cuts are a major reason that Pennsylvania is expected to have far fewer resources than it needs to pay for education, health care and other essential services for years to come. Unless lawmakers reverse course and come up with additional revenue, our schools, communities and families will continue to bear the brunt and our economy will suffer.

The elimination of the capital stock and franchise tax (CSFT), without a replacement, and other corporate tax changes mean that overall corporate tax revenue will decline in an expanding economy for the first time in at least a quarter century. Robust growth in sales and personal income taxes will not be enough to overcome the loss of corporate tax revenue.

While many analysts say higher pension and Medicaid costs explain the growing gap between the revenue the commonwealth is taking in and what it needs to meet its obligations — a situation known as a structural deficit — revenue losses from tax cuts are a significant factor. Corporate tax changes and reductions enacted during the Rendell and Corbett Administrations cost $3.2 billion in 2013-14 and will grow to almost $4 billion annually by 2018-19.

If, instead, corporate taxes grew at the same rate as other taxes through 2018-19, the structural deficit would be all but eliminated.

Source. Pennsylvania Budget and Policy Center calculations of Pennsylvania IFO revenues and expenditure forecasts.

The decline in corporate tax collections has made it increasingly difficult for the commonwealth to pay for critical services like schools, health care, higher education, and other public investments that bolster the economy. Since the state is required to balance its budget each year, either services will need to be cut or more costs will be shifted to local taxpayers.

Structural Deficit Identified by Independent Fiscal Office

Buried in a November release, the Pennsylvania Independent Fiscal Office (IFO) issued a stark warning about the Pennsylvania state budget in coming years. It projected a structural deficit and noted that, unlike in previous years, the state will have no surplus funds available to cover even a portion of the gap. Another recession, “would greatly exacerbate future fiscal challenges,” it added. [1]

The report predicts a deficit of $839 million for the upcoming fiscal year, growing to $2.1 billion in five years. The deficit is a result of revenue growth that lags behind expenditures, which are predicted to increase by an average of 4.1% per year. Looking deeper into the numbers, the increasing costs of corporate tax breaks will be a significant contributor to the lagging revenue growth expected during the next five years.

Source. Pennsylvania Independent Fiscal Office.

General Fund services (schools, prisons, health care) are supported by a three-legged revenue stool that includes the state’s personal income tax ($11.7 billion in 2013-14), sales tax ($9.3 billion), and corporate taxes ($5.0 billion). Miscellaneous other taxes, including inheritance, gaming, cigarette, and liquor taxes, generate an additional $3.4 billion.

While personal income and sales taxes are expected to show healthy growth in coming years, corporate taxes ̶ the third leg ̶ are projected to shrink, on average, by 1.5% a year until 2018-19.

Source. Pennsylvania Budget and Policy Center calculations using Pennsylvania IFO forecasted revenues.

A driving force in the decline of corporate tax revenue is the phase-out of the capital stock and franchise tax rate, which is set to be eliminated after 2015. The tax, a property tax on the net worth of corporations and other companies, was 26% of corporate tax revenue in 1999-00, 23% in 2003-04, and just 6% of total corporate tax revenue in 2013-14.

Source. Pennsylvania Budget and Policy Center calculations using Pennsylvania Department of Revenue actual and Pennsylvania IFO forecasted data.

Rate Reductions Yield Decline in Corporate Tax Revenue

Pennsylvania has been on a crusade to cut corporate taxes, which lawmakers have argued is necessary to increase employment, under both Republican and Democratic administrations. In 2000, the General Assembly began to phase out the capital stock and franchise tax and between 2003 and 2013 it added a host of new tax credits; created new “improvement zones” directing tax dollars to pay for private development in mid-sized cities; allowed businesses to take more prior year losses against current profits; and greatly reduced taxes for major Pennsylvania manufacturers though changes to the corporate tax formula.

The annual cost of these changes has already grown by 300% between 2003-04 and 2012-13, from $850 million to $3.0 billion, and is expected to reach $3.9 billion by 2018-19. (A detailed list of annual costs can be found in Appendix 1.)

Source. Pennsylvania Budget and Policy Center calculations using data from the Governor’s Executive Budget (various years) and the House Committee on Appropriations.

While the tax reductions may have helped improve the profitability of companies doing business here, there is little evidence of a significant increase in employment. Between 1999-00 and 2011-12, the commonwealth performed worse in job creation, dropping from 27th to 34th nationally in employment growth. [2]

Conclusion

A full understanding of the causes of Pennsylania’s structural deficit must include a critical review of both revenue and spending decisions. The steady decline of corporate tax revenue is a significant contributor to the projected imbalance.

At the same time they were approving new corporate tax cuts, state lawmakers made deep cuts to preK-12 education, colleges and universities, economic development, and human services in order to balance the state budget. These cuts came after three years of recession when lawmakers cut hundreds of programs and eliminated dozens of others.

The General Assembly has been like a homeowner who turns up the furnace, opens all the windows and then blames increasing oil prices for the increase in his heating bills. Lawmakers must say “no” to additional business tax cuts, and consider options to raise revenue. Failing that, we can expect five more years of largely self-induced crisis.

Endnotes

[1] Pennsylvania Independent Fiscal Office, Pennsylvania’s Economic & Budget Outlook: Fiscal Years 2013-14 to 2018-19, November 2013 http://www.ifo.state.pa.us/resources/PDF/Five-Year-Economic-and-Budget-O....

[2] Keystone Research Center based on Bureau of Labor Statistics data, February 2013