KY Policy Blog

Income Tax Cuts No Way to Grow Small Businesses

By Anna Baumann
February 27, 2013

The claim that cutting state income taxes is an effective strategy to help small businesses create jobs is discredited in a new report released by the Center on Budget Policy and Priorities (CBPP).

The report shows that state personal income taxes have an insignificant effect on small business job creation. And by taking resources away from critical services like education, income tax cuts could harm a state’s ability to grow an entrepreneurial economy. CBPP notes that:

  • Taxable income for small businesses is typically modest enough that even a full repeal of state personal income taxes would not amount to the salary requirements for one full-time employee.
  • Nationally, only 2.7 percent of taxpayers own a small business with employees other than themselves, and the majority who have no employees have no plans to hire, either.
  • The minority of small businesses that would hire in the right conditions are far more responsive to increased demand for their products and services than to negligible tax cuts.
  • Small start-up companies creating a sizeable share of new jobs in the economy spend heavily on new equipment, product development and marketing such that they have relatively little taxable profit in their early years, and would therefore not benefit from tax cuts.

Quality-of-life and access to human capital, markets and business development resources bear much more on entrepreneur’s decisions about location than state income tax codes. In other words, “tax flight is a myth.”

The report cites a 2012 study commissioned by the U. S. Small Business Administration that found “no evidence of an economically significant effect of state tax portfolios on entrepreneurial activity.”

If more tax cuts aren’t the answer, then what can the state do to create jobs at small businesses in Kentucky?

In part, the same factors that attract and support small business drive economic development more broadly: access to quality education and healthcare for all ages, well-maintained infrastructure, an efficient court and justice system, universities producing innovative research and up-to-date communication systems.

To support job creation and economic growth, Kentucky must invest in these public goods and services.

But during the past six budget years, inadequate revenue has led to severe budget cuts: no funding for new school textbooks, childcare subsidy cuts, and the removal of health services from schools are just a few examples that directly impact Kentucky’s children and their future success. State income tax cuts would further diminish Kentucky’s inadequate revenue stream, resulting in even more cuts.

Yet arguments in favor of income tax cuts continue. The final recommendations by the governor’s tax reform commission included reducing the top income tax rate from 6 percent to 5.8 percent. While the recommended cut is small, it would result in a loss of much-needed revenue without any evidence that the cut would attract entrepreneurs or create jobs.

Income taxes do not hinder job growth, but are one of the state’s most important revenue sources. Income taxes also keep up with growth in the economy better than other taxes and are fair – taxing people based on their ability to pay.

If Kentucky addresses tax reform this year – which it should – it must do with a clear understanding of the relationship between income taxes, public investment and economic growth.

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