Tax breaks for all firms needed

David G. Tuerck

November 1995

Heedless of the consequences and with hardly a whimper from the recognized guardians of sound government, the Massachusetts Legislature is about to perform another exercise in good intentions gone awry. This it will do, in the name of tax reduction and job creation, by passing a bill that will probably lead to higher taxes and job destruction.

How can this happen? Earlier this year, Gov. Weld proposed taxing Massachusetts corporations according to their in-state sales, payroll and property. This was in response to demand for tax breaks from manufacturers with mainly out-of-state sales, particularly Lexington-based Raytheon Co.

Although the Weld proposal is arguably less desirable than an outright cut in the state corporate-tax rate, it does offer tax relief for all sectors of the Massachusetts economy, and it does create jobs. The trouble now is that the Legislature wants to limit the proposal to manufacturers.

The reason given for limiting the tax in this way is that the original proposal extending tax cuts to all sectors of the economy would cost too much in tax revenue. The "static" revenue loss (the one obtained by assuming away any change in economic activity that might be induced by the tax cut) would be about $227 million. Limiting the tax cut to manufacturers reduces the revenue loss to $162 million. The trouble with limiting the tax cut to manufacturers, however, is that it won't create jobs and it won't save revenue.

There is strong evidence that broad, across-the-board state tax cuts stimulate both capital spending and job creation. As originally crafted, the so-called "single sales factor" proposal would create as many as 10,400 new jobs and up to $615 million in increased wages for Massachusetts.

Now some legislators are arguing that, because manufacturing is in decline, the state should cut taxes for manufacturers, even if it can't "afford" to do so for other sectors. But why cut taxes only for a sector that is in decline? Over the period 1984-94, manufacturing jobs in Massachusetts fell by about 33 percent. Over the same period, jobs in finance, insurance and real estate rose by about 11 percent. If Massachusetts wants to stimulate capital spending and create jobs, why not aim a tax cut at sectors like financial services that are on the rise, rather than a sector like manufacturing that is on the decline?

A tax cut limited to manufacturers can, in fact, be expected to accelerate the loss of jobs. The evidence shows that, because of their high capital intensity, Massachusetts manufacturers substitute capital for labor and thus cut jobs when the cost of capital falls. Because a corporate tax cut reduces the cost of capital, it leads manufacturers to trim their work forces even as it leads them to add plant and equipment.

Because of the additional loss of tax revenue brought about by lost jobs, the current proposal will be only about $13 million less costly to the state Treasury than Weld's original proposal.

The only sure way to stimulate job creation as well as capital spending, therefore, is to cut taxes for all businesses, manufacturers and nonmanufacturers alike. Job losses in manufacturing will then be more than offset by job gains in other sectors. More important, the market will be allowed to decide which sectors should expand and which should contract, and more particularly, which should shed jobs and which should create them.

Why won't the Massachusetts Legislature see any of this? The answer lies in the political payoff that comes from currying favor with a few big corporations and their unions rather than just creating a climate in which individual businesses, large and small, can lead the way to economic growth and job creation. The squeaking wheel gets greased while the horses pulling the wagon get ignored.

David G. Tuerck is executive director of the Beacon Hill Institute and chairman and professor of economics at Suffolk University. This article first appeared in The Boston Globe on November 7, 1995.

Format revised on 18 August, 2004