State-Local Business Taxation and the Benefits Principle

Abstract

In recent years, interest in state and local taxation of business has been fueled by concerns over the possible deleterious effects such taxes may have on economic development and, in particular, on the ability of a jurisdiction to provide jobs for its residents. Much ink has been spilled over whether or not fiscal factors have a significant effect on firm location decisions. However, without analyzing why business taxes are on the books in the first place, it may be impossible to properly evaluate the impact of such taxes on business location. In this article, we advance the proposition that general business taxation should be structured so as to recover the costs of public services rendered to the business community. Economic development may be but one objective of tax policy. Other objectives, such as fairness, economic efficiency, and sound expenditure policy, are also important. For example, a local community may want to structure its taxes to discourage business activities which produce noxious side effects; state government may wish to restrict business activity in such a way as to promote monopoly power of home enterprise(s) serving an out-of-state clientele. Even in the absence of such motives for growth controls, business taxation may be desirable to recover the cost of government services provided to businesses within a jurisdiction. Not only does this promote fairness, by recouping the costs of such services from those who ultimately benefit from them, it also enhances economic efficiency by causing the prices of goods and services to reflect their full costs of production. Such prices enable people to make appropriate choices among consumer goods. Business benefits taxes similarly promote appropriate choices between private and public goods. Without recovery of the costs of business services, voters may not support otherwise worthy public services provided to business. Alternatively, the voting public and their representatives may believe that business taxes can be ratcheted skyward as a way to subsidize those public services provided to households. One objective of this article is to develop a comprehensive framework for evaluating the efficacy of state-local business tax structures. This framework will then be applied to existing practices within the U.S., with specific focus