“Strike the Root” of Pennsylvania’s Competitive Disadvantage

Henry David Thoreau once wrote that “For every thousand hacking at the leaves of evil, there is one striking at the root”–meaning that when confronted with a problem, most people are content to tinker around its fringes, rather than attacking it at its source and solving it outright.

Thoreau couldn’t have known it at the time, but his statement perfectly summarizes the recently released final report of Gov. Ed Rendell’s Pennsylvania Business Tax Reform Commission. For while the Commission’s report is admittedly wide-ranging and heavily detailed, it represents nothing so much as a furious pruning of the overgrown mess that is Pennsylvania’s current business tax system. What is needed instead is a mighty chop at its deeply entrenched root–the size and scope of the commonwealth’s insatiable appetite for more tax revenues.

In fairness to the Commission, its work was doomed from the start by three fatal flaws enshrined in its mandate from Gov. Rendell. First, it could only propose changes to Pennsylvania’s business taxes that would be “revenue neutral”–meaning that a cut in one tax must be offset by an equivalent increase in another, and that some businesses will benefit at the expense of others.

It turns out that this is exactly what happened. The Commission recommended a 30 percent decrease in the corporate net income tax rate (CNI), but also recommended several changes that will increase the tax burden faced by small businesses–the types of businesses which create the majority of new jobs in Pennsylvania. It also enshrines the assumption that the amount of tax revenue that state government currently takes from private sector job creators is the correct–or even the minimum–amount.

Second, the Commission did not incorporate “dynamic” economic modeling into its calculations. Dynamic modeling is critical to estimating the impact of shifts in tax policy, because such shifts affect, among other things, the level of business investment and consumer spending in the state’s economy. Failing to account for the fact that changes in tax rates impact such behavior can lead to inaccurate estimates of the revenue resulting from those changes.

But the most glaring omission from the Commission’s charge was a serious examination of state government spending policy. Pennsylvania cannot “reform” taxes of any kind until it first addresses the fact that state government has grown beyond its proper limits and spends too much of our money. Year after year of massive budget increases makes clear that Pennsylvania’s overall tax system is not designed to promote optimal economic growth and prosperity, but to simply generate the maximum possible amount of revenue for government to spend.

It is state government’s ever-increasing desire for more tax revenue that has placed our business tax climate in particular in such an uncompetitive position. It does not take training in economics to understand that when larger and larger amounts of capital are annually removed from the private sector by state and local governments, families are left with fewer dollars to spend on their needs, and businesses have fewer resources for investment and job creation.

This situation did not develop overnight, of course, but it has been the result of decades of misplaced priorities and consistent encroachment of state government into areas that do not represent its core responsibilities. Indeed, for more than 30 years, the taxing and spending habits of Pennsylvania state and local governments have far out-paced citizens’ ability to pay. With average annual increases that far exceed the cost of living increases in the incomes of families and businesses, the lack of fiscal discipline over the years has severely hindered the commonwealth’s economic growth and harmed its quality of life.

A look at recent Pennsylvania fiscal history illustrates the scope of the problem. Total state spending grew faster than inflation in 10 of the last 13 budget years. From FY 1991-92 to FY 2004-05, total Pennsylvania state government spending grew 98.3 percent, from approximately $26.2 billion to nearly $52 billion–a rate 165 percent above the concurrent 37.1 inflation rate. In fact, during the 1990s, Pennsylvania’s real per capita spending growth rate ranked second in the nation, trailing only Mississippi.

In this context, simply shifting taxes will only serve to prolong the commonwealth’s fiscal agony. In order to become more competitive, Pennsylvania must first reduce taxes of all types, and state government must also reduce its spending by paring back its scope to encompass only “core functions.” This effort must then be strengthened by a “tax and expenditure limitation” and a “super-majority” vote required for any future tax increases.

This is the formula for success that enabled many states to experience dramatic growth while Pennsylvania stagnated. These strict limits on government growth also enabled state governments utilizing them to better weather the economic downturn that took place at the beginning of this decade.

The Business Tax Reform Commission’s report is the clearest indication yet that the time for attacking Pennsylvania’s tax and fiscal problems with the proverbial pruning shears has passed. It’s time to get out the axe.

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Grant R. Gulibon is senior policy analyst with the Commonwealth Foundation (CommonwealthFoundation.org), an independent public policy research and educational institute based in Harrisburg, PA. Permission is hereby granted to reprint in whole or in part, provided the author and his affiliation are cited.