Government spending occurs in the construction and maintenance of schools, transport systems, health sector, and public safety among other critical areas that are essential in sustaining human lives. The revenue is collected through the imposition of taxes by the local and national governments. The justification encouraging business tax incentives and tax cuts is crucial in the creation of employment opportunities and spurring economic growth. However, tax expenditures such as tax credit, tax abatement, and loopholes easily dwarf other allocations for national and local development initiatives. This paper discusses the arguments for and against business tax cuts as a strategy to spur both local and state economic development. The paper also examines the essence of taxes in location decisions.
Reduction of company tax burdens
Firms that pay state and local business taxes inflate their operating expenses that equally reduce their anticipated profits after tax. Tax expenditures reduce the revenues of the sole proprietorships, partnerships, and companies by increasing the cost of doing business. Due to the decline of net profits after heavy taxation, firms are unable to engage in further investment or hiring of additional staff members (Tannenwald, Shure, and Johnson par. 13). Tax cuts motivate the existing firms to invest and stimulate the development of start-ups thereby creating more jobs.
Increased savings and investment
Tax cuts for both individuals as well as businesses give incentives to work more and accumulate savings. Since the rate of investment is directly proportional to that of savings, the level of state and local development increases. Lower taxes enhance continuous investment through cost averaging. Market downturns are inevitable, and thus individual businesses and firms must ensure that the volatility of the market works in their favor (Lynch 7). The savings that result from low tax expenses aid in economic development by ensuring consistency in adding capital to business portfolios and increasing long-term earnings. Besides, the investment allows the creation and expansion of firms, thus demanding more labor to satisfy the requirements of customers and meet the overall financial goals of the company (Fisher and Wassmer 23). The savings also help businesses to avoid external borrowings from lending institutions, thus cutting expenses attributed to loan interests.
Favorable business climate
A state’s business climate is viewed from the perspective of providing proper conditions for investment purposes. The availability of quality physical and social infrastructure and increased levels of employment, profitability, and better value of life are essential building blocks, which are required to prosper economies (Fisher and Wassmer 12). A healthy business atmosphere must consider the fiscal and tax initiatives that coincide with ensuring responsiveness to the customers’ needs. By initiating tax cuts, the government demonstrates its commitment to support the growth of businesses for economic advancement and job creation.
The cutting of costs will ensure that the United States becomes a highly attractive destination for conducting business (Lynch 12). For the realization of the economic development agenda, both the state and the local governments have to encourage healthy business competition. When the tax incentives focus on areas that inhibit high unemployment rates, more investments will eventually be relocated to such areas due to small tax expenses. Therefore, more employment will be created thereby addressing the concerns of distressed communities. Further, better competition among the government will breed efficient provision of services and condense the enterprise taxes in all the jurisdictions (Lynch 12). Businesses will thus receive benefits of equal value regarding public utilities that meet the taxes remitted to the authorities.
Disadvantages of tax cuts
Poor provision of public services
When achieving the initiative of economic development and job creation, the government ought to provide essential services to existing and starting enterprises. The financing of services is done from the collections that the government makes from levying taxes to businesses. Reducing the rate of taxation would consequently lead to a drastic decline in state revenues due to budget deficits (Klemm and Parys 396). Accordingly, tax incentive deters the government from the provision of the required infrastructure, which is deemed necessary when undertaking business. Good bridges, roads, coastal ports, airports, and other transportation facilities aid in carrying out business operations. Other public services such as the maintenance of the sewerage system, disaster response facilities, the judicial system, and the education services are essential in catering to the workforce involved in any business. In this regard, cutting taxes would prevent the government from achieving its mandate of availing quality services and satisfying appropriate business climate needs.
Reduction in government spending
When taxes are reduced, the incomes of both individuals and companies increase thus encouraging more demand for goods and services. Inflated spending supports huge volumes of sales because the firms will produce more and hire additional workers (Johnson and Man 55). As the rate of spending increases among individuals and businesses due to tax cuts, the revenue received by state and local governments reduces. Through offsetting the revenue lost from the tax cuts, the government indulges in external borrowing to meet the public service needs. Local governments bear the constitutional mandate of balancing their budgets. Consequently, they are restricted from foreign sourcing of funds thereby making the reductions of spending to emerge as the only alternative. As the general rates of spending lower, most of the businesses will be coerced to produce less, thus creating the urge to lay off a considerable number of employees.
Even though tax cuts increase savings within a given business, cases of income disparities and disincentives to work are attributed to tax incentives. The income inequalities undermine the capability to work by widening the gap that exists between the low and high-income earners. Tax incentives are highly correlated with the level of income, but not the work efforts that different employees contribute to the advancement of the business. Growing disparities in income play a pivotal role in initiating psychological disincentives and impediments to working (Golladay and Haveman 64). Business employees who earn less have rare chances of accessing credit for investment reasons, thus frustrating the agenda of economic prosperity.
Effects of taxes on location decisions
Surveys conducted in the early 1980s in multiple firms in North and South Carolina and Virginia depicted that business tax incentives do not influence business location decisions (Lynch 21). However, recent studies have revealed the significant contribution that taxes make when designing investment decisions like prioritization and appraisal. Business people exaggerate the positive outcomes associated with tax initiatives when formulating investment decisions because their reactions influence prospective pubic policies. In instances where the companies experience high-profit margins that are precipitated by reduction of tax expenses, several location decisions arise. The company may opt to invest additional profits out of the confines of the state or redistribute earning to owners (Johnson and Man 73).
The imposition of low taxes by a given state determines the location decisions of businesses. The implementation and sustainability of high-quality public services are mandatory necessities that potential business migrants value. Since all the services are financed via the tax dollars, levying minimum taxes will consequently result in declining amenities such as cultural, physical, and recreational facilities that define an efficient business environment (Klemm and Parys 402). The absence of appropriate public services will deter potential investors from relocating their business to states that experience challenges in the provision of public services.
The location decisions are not often influenced by taxes because the tax rates of most industries are relatively equal across multiple states. Due to negligible fluctuations in the after-tax rates of different states, the location of the company does not influence its profitability margin. Other alterations emanating from the cost of doing business are responsible for differences in profit rates between industries located in various states (Golladay and Haveman 66). The location decisions are not dependent on the tax rates because the deductibility of local and state taxable incomes undergoes a vast leveling effect that diminishes tax differentials between the states.
The local tax burdens are small and cannot outweigh other costs of doing business amongst different states. The expenses associated with quality and cost of labor, accessibility of raw materials, proximity to market for service-based industries, transportation infrastructure, and health services among other factors influence investment decisions, but not taxes. Additionally, factors such as cheaper housing, better jobs, age, education, and a better climate are evident factors that influence migration. Therefore, the claim that taxes are responsible for location decisions is extraneous.
The imposition of taxes by the state is essential in availing finances for meeting various public expenditures. The tax cut is a strategy to spur state and local development by reducing the tax burden for businesses, increasing savings, and creating a favorable business environment. However, the tax cuts breed income inequalities, inefficiencies in the delivery of public services, and a reduction in government spending. Taxes affect location decisions insignificantly, but other factors that comprise the level of infrastructural development, proximity to market, and housing amongst others critically determine potential locations within and without the states.
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Golladay, Fredrick, and Robert Haveman. The Economic Impacts of Tax—Transfer Policy: Regional and Distributional effects, Atlanta: Elsevier, 2013. Print.
Johnson, Craig, and Joyce Man. Tax Increment Financing and Economic Development: Uses, Structures, and Impact, Albany: State University of New York Press, 2008. Print.
Klemm, Alexander, and Stefan Parys. “Empirical evidence on the effects of tax incentives.” International Tax and Public Finance 19.3 (2012): 393-423. Print.
Lynch, Robert. Rethinking Growth Strategies: How State and Local Taxes and Services Affect Economic Development, Washington, D.C.: Economic Policy Institute, 2004. Print.
Tannenwald, Robert, Jon Shure, and Nicholas Johnson. Tax Flight is a Myth. 2011. Web.