Red States Are Looking At Income Tax Cuts. But Will It Help Small Business Growth?

State legislative sessions are kicking off and lawmakers are grappling with pandemic-driven budget deficits — but that’s not stopping some Republican lawmakers from proposing income tax cuts.

Several states including Arkansas, Mississippi, Montana, and West Virginia are calling for cutting personal income taxes. Most proposals are part of ongoing policy to lower the tax rate.

Still, even though lawmakers pitch these cuts as good for small businesses, research shows they tend to have little-to-no impact on saving jobs.

For starters, only 2.1% of personal income taxpayers own a small business with any employees other than the owners. Also, most small businesses don’t earn enough for tax cuts to make a crucial difference. According to research by the Center on Budget and Policy Priorities (CBPP), more than 8 in 10 small businesses have less than $50,000 in annual taxable income. “So,” the center says, “even eliminating the tax wouldn’t come close to paying one full-time worker’s salary.”

In a call with reporters on Thursday, the CBPP’s Erica Williams noted that advocates of income tax cuts like to point to the population growth in no-income-tax states such as Texas and Florida. But there are many factors (weather and job opportunities are two examples) that go into a state’s ability to attract new residents.

“We have several states around the country that do not have income taxes. Some are highly populated, but a lot are not,” she said. “We haven’t seen that claim borne out in Wyoming or Alaska.”

In fact, evidence suggests that income tax cuts can “impede entrepreneurship by taking resources away from education and other public investments key to a strong economy,” the analysis says. Because states must balance their budgets, tax cuts tend to reduce support for schools, transportation, safe communities, and other building blocks of a strong economy that help small businesses grow.

Even the conservative-leaning Tax Foundation notes that tax cuts can’t happen in a vacuum. In the case of Mississippi, which is in the middle of a 15-year plan to repeal its income tax, the foundation says that revenue gains would have to come from taxes other than the income tax if income taxes were to be eliminated entirely. The $1.9 billion Mississippi collected from the income tax in 2019 accounted for about 43% of its budget.

“Economic growth could increase income tax collections to the point that the state could afford to exempt more income while still experiencing revenue growth,” the foundation’s Katherine Loughead wrote, “but continuing the phasedown to the outright repeal of individual and corporate income taxes would require growth of other tax collections sufficient to cover the difference, no easy matter.”

But in Arkansas, Gov. Asa Hutchinson argues his “measured approach and an emphasis upon private sector growth” has allowed the state to steadily lower its income tax rate for the past six years. “We have lowered taxes, fully funded K-12 education, increased funding for higher education, and created not only a surplus, but the first Long-Term Reserve Fund in history,” he said in his State of the State speech this month.

Hutchinson is also creating an incentive as a means of wooing new Arkansas residents and thus using income tax cuts to promote economic growth: he is proposing immediately lowering the state’s top rate of 5.9% to 4.9% for new residents.

The proposal would also cut the top rate to 4.9% for everyone over the next five years.

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