By A. JAMES HEINS

Helping Illinois business: Tax reform is the only game in town

Although he disagrees with several of the points made by Woods Bowman and Mark Laubacher in their May article, "Illinois business climate: Charity begins at home?" A. James Heins shares their belief that business tax incentives are not the best way to improve the state's economy. He argues strongly, however, that tax reform — lowering taxes generally — may be the best, and only real way to improve the business climate in Illinois

THE PURPOSE of this article is twofold. First, I offer a rebuttal to the article by Laubacher and Bowman published in the May issue of this magazine that describes the "futility of tax incentives," among other things. Second, I hope to set a new and more fruitful tone to the discussion of the impact of state and local policy on economic performance.

Let me begin by carping about a couple of minor points in the Laubacher and Bowman piece, hereafter called L & B. In citing studies that offer counter evidence to their thesis, L & B indicated that: "neither of these studies surveyed decision makers; instead, they were based on statistical models which are vulnerable to random error and related problems."

For shame, L & B. Are surveys of decision makers' intentions not vulnerable to random error and related problems? Do you suggest that statistical studies of past behavior are inferior to surveys of decision makers' intentions as predictors of future events? The vast majority of economists would disagree with you on that point. Carp number two has to do with L & B's use of my 1976 Illinois Economic Growth Study for the Illinos State Chamber of Commerce (ISCC) to make a selective counterpoint, without acknowledging that it also makes the main point. Specifically, L & B use results of my study to argue that the benefits of government programs (education in particular) may have a positive impact on economic growth. They fail to note that my study also turns up a negative relationship between corporate income taxes and growth, and lays some basis for linking growth of government in Illinois in the period 1967-74 to relative economic decline in that period.

Turning to the major shortcoming of the L & B thesis, they argue — as others have before them — that since taxes are a secondary consideration in industrial location decisions, it is futile to worry about tax incentives. This is clearly fallacious reasoning, and were this point to be made in the field of medicine, a malpractice suit might be in order. Let me explain.

Suppose a doctor pointed out to his patient that since the primary determinants of life span are heredity, metabolism, psychological makeup, and certain predispositions, it would be futile to worry about good hygiene. How quickly would that doctor be in court? The tax incentive argument is essentially the same. Since labor costs, location, availability of raw materials and energy are the major determinants of industrial location, "why worry about tax climate?" We might take L & B to court on this.

The fact is that taxes and programs are the only games in town — the legislature cannot enact a new location for Illinois. It cannot enact better weather. It cannot enact iron ore mines. It cannot enact longer, wider rivers. But, it does enact tax and spending legislation. The fact that tax laws are less important than good soil in making Illinois a prime agricultural state does not in any way diminish the significance of tax and programmatic legislation.

If I might be permitted to carp about L & B one final time, they say that: "From almost all recent studies, tax incentives are ineffective in altering industrial location patterns. . . ."This is a very strong statement, and one I believe not to be true. Moreover, it is unbecoming to make this kind of argument by appealing to the weight of paper. I refer L & B to State and Local Economic Development Strategy: A "Supply Side" Perspective, a staff study prepared for the Subcommittee on Monetary and Fiscal Policy of the Joint Economic Committee of the U.S. Congress, October 26, 1981. Here Richard Vedder provides a compilation of the substantial literature that argues that taxes do matter. As a point of interest, if L & B were to have weighed paper for purposes of fortifying their "almost all recent studies" statement, I wonder on which pile they would have put my Illinois Economic Growth Study?

Taxes won't make a Texas

Let me now set a new tone for the discussion of the impact of the tax structure and public expenditures on economic performance in Illinois. I begin by acknowledging that we cannot make Texas out of Illinois through a new tax structure. I continue by recognizing that the tax structure is perhaps sixth on the list of concerns raised by industrial locators, behind labor costs and availability, transportation systems, access to energy, proximity of markets, and the climate. I understand that the spending side of the government equation is as important as the tax side. Having said all of this, let us agree to try to determine the extent to which marginal changes in the amount of taxes, the structure of taxes, and the government programs those taxes finance do affect the economic performance of Illinois.

I have personal plans to conduct a new study of economic performance in Illinois for release within a year. I may find, as I did before, that spending for education tends to enhance the economic climate, and that welfare

August 1982 | Illinois Issues | 7

programs tend to generate economic drag. I may find that failure to spend enough for highways — as I did in Illinois Highways and Economic Growth, a 1979 study for the ISCC, has inhibited the economy of Illinois. I may find that tilting the tax scales toward business tends to retard economic growth. On the other hand, I might not.

Debt no draw for business

Two things at which I must look, and events scream for this look, are the workers' compensation and unemployment insurance programs. People in the business community have felt beleaguered ever since the 1975 legislature enacted vast increases in benefits under these programs. And there can be little doubt that Illinois' current $1.9 billion dollar debt to the federal government for unemployment compensation paid in the past creates a serious problem to those interested in attracting industry to Illinois. What firm wants to come to a state and share in taxes needed to pay for benefits long since gone?

Lest readers wonder about the significance of a $1.9 billion debt, that represents a debt approximately equal to the amount of corporate income taxes paid over a four-year period in Illinois at current rates. It represents about 1.5 percent of Illinois personal income. It is a whopping debt.

Beyond the problem of debts accumulated to pay for past unemployment benefits, there is question about the economic drag created by continuing benefits under the Illinois workers' compensation and unemployment insurance programs. One cannot be sure whether there is drag or not; after all, benefits paid under these programs ought to improve the labor pool available to Illinois business. On the other hand, the benefits are mandated by law; if workers do not value those benefits as much as the foregone wages, economic drag could result. My task is to measure these relationships as best I can.

I would be less than candid, however, if I did not say what I believe the results of my new study will show. My 1976 study showed that Illinois performed about as expected between 1947 and 1974, albeit with a modest decline after 1967. Illinois was doing about as well as the average of the snowbelt states in these years of the sunbelt phenomenon. All of the new data show, however, that Illinois has suffered a major decline since 1975, relative to our snowbelt partners, and the table shows this most vividly.

Between 1950 and 1975, Illinois' share of income generated in the Great Lakes states declined from 31.38 percent to 30.44 percent, a modest drop of .038 percent per year, and one quite in line with the U.S. economic developments. Between 1975 and 1981, however, the average annual decline of Illinois relative to its Great Lakes partners has been .168 percent per year, a fourfold increase in the rate of decline. The fact that the Great Lakes' economic income base for 1981 includes that disaster area called Michigan emphasizes Illinois' recent problems.

All of this has happened since 1975. Could it be that the screaming about that 1975 legislation was for real? The numbers I offer here do not prove that. After all, as L & B point out, Illinois has been victimized by other — and uncontrollable — economic changes. Any such cause and effect conclusions certainly must await a more sophisticated study. But, these numbers do create suspicion.

Let me add a few words about the concept of "tax incentives." I would prefer that the term be limited to describing selective and special tax relief designed to attract new firms to Illinois, or retain firms currently operating in Illinois. Included in programs called tax incentives would be such things as industrial revenue bonds, property tax abatement, free land and special provisions that would exempt new or expanding firms from sales taxes on equipment. Under this concept, the original 1978 proposal to exempt machinery and equipment purchased by new or expanding firms from the sales tax would have been appropriately titled a "tax incentive" program.

As the bill was ultimately passed, however, it provided that any purchase of machinery and equipment used in manufacturing or processing is exempt (albeit, on a phased-in schedule) from the sales tax. Since every firm qualifies, I would prefer that the program as finally passed be called tax reform. General tax changes — even though they may lower business taxes in the short run — should not be called tax incentives, but rather tax reform, or perhaps tax relief. It may, of course, be that tax reform or relief makes a state more attractive to some businesses.

Tax reform propositions

This semantic distinction is important. I believe that most "tax incentives" as so described are indeed futile, as L & B do. I do not believe that in the long run singling out new business for special breaks not available to continuing business will create a favorable economic climate in Illinois. But I do believe that tax reform that lowers taxes generally would improve the business climate. I also believe that tax reform that brings costs and benefits of government programs into line would also improve the economic climate. While I believe these propositions, they will require demonstration.

A. James Heins is professor of economics at the University of Illinois at Urbana-Champaign and director of the Office of Real Estate Research, Bureau of Economic and Business Research at the university. He also acts as economic consultant to the Illinois State Chamber of Commerce.

8 | August 1982 | Illinois Issues