States' offer of tax breaks no guarantee for jobs

It's recently become an article of faith for many governors as they try to attract jobs: raising taxes during a recession is a nonstarter, choking off growth and damaging a state's fragile economic recovery.

With the notable exception of Illinois, where Democratic Gov. Pat Quinn last month signed a 66 percent temporary personal income tax increase and a separate corporate rate hike to help close a $15 billion budget gap, governors this year are mostly vowing to cut regulations and hold the line on taxes to attract employers and rebuild after a brutal recession.

"We ... hope that every bill you consider passing will be viewed through the lens of its impact on our economic growth," Colorado Democratic Gov. John Hickenlooper told lawmakers in his State of the State address, sounding a theme many governors share. "This doesn't mean we compromise our standards or put our land, air or water at risk, but it does mean that we'll keep a fierce and even relentless focus on jobs."

Whether they can hold to that promise will become clearer in the coming months as governors release their new budget proposals.

But there's a catch to the anti-tax, pro-business rhetoric: Businesses consider a range of factors when deciding where to locate, including the quality of schools, roads and programs that rely on a certain level of public spending and regulation. And evidence suggests there is little correlation between a state's tax rate and its overall economic health.

"Concerns about taxes are overstated," said Matt Murray, a professor of economics at the University of Tennessee who studies state finance. "Labor costs, K-12 education and infrastructure availability are all part of a good business climate. And you can't have those without some degree of taxation."

States' tax rates also do not predict their resilience during an economic downturn.

While high-tax states such as New York, New Jersey and California have been clobbered by the current recession, so too have states that pride themselves on low tax rates, including Nevada, Texas and Arizona. The collapse of the housing market and the financial industry meltdown largely drove the current conditions, sparing almost no state regardless of its level of taxes.

Governors agree this is a particularly challenging budget year, with federal stimulus dollars drying up after years of deep state budget cuts. Some 34 states raised taxes or fees as recently as 2009 to help close budget shortfalls.

Now, chief executives from both parties mostly have little appetite for new tax measures after Republicans successfully ran on tax issues last fall — they now control 29 governorships — and President Obama and Senate Republican leaders teamed up to extend Bush-era tax cuts, even for the wealthiest Americans.

Illinois' big tax hike is considered an anomaly — an emergency measure that includes strict spending limits to close a budget hole that is the largest of any state as a percentage of its overall budget.

Neighboring states such as Wisconsin quickly pounced, urging businesses to relocate from Illinois even though its tax rate remains lower than those of many states in the region.

Meanwhile some other governors have opened the door to potential tax increases, insisting the measures are necessary to offset fiscal calamity.

In California, Democratic Gov. Jerry Brown has been promoting a package of temporary tax increases as a ballot measure for voters to consider, while also proposing deep cuts to higher education and social services.

Two newly installed New England governors — Connecticut's Dan Malloy and Rhode Island's Lincoln Chafee — have told state residents to expect some taxes to go up. Most are pairing their tax increase proposals with targeted spending cuts and promises of fiscal discipline over the long term.

To be sure, several governors, including Republican Chris Christie of New Jersey and Democrat Andrew Cuomo of New York, say they have sworn off tax increases. Some other governors — such as newly sworn-in Republicans John Kasich of Ohio and Rick Scott of Florida — say they plan to cut taxes even as they try to bring their budgets into balance. Scott wants to reduce the Sunshine State's corporate income tax despite the fact that Florida faces a projected budget gap next fiscal year of at least $3.5 billion; the corporate income tax now generates about $2 billion a year.

Other governors, despite tight budgets, want to boost spending on economic development projects to bring jobs to their states.

In Nebraska, Republican Gov. Dave Heineman has proposed a $16.5 million initiative aimed at attracting jobs while saying he will not raise taxes. The money would be spent on several measures, including an internship program pairing graduates of Nebraska universities with state-based companies, and a fund offering start-up cash and technical assistance to small businesses.

In an interview, Heineman said his state must spend money on education and job programs to attract economic development.

"We're competing for jobs with other states and other countries, and I'm trying to do it in a healthy and positive way," Heineman said. "The only way I can compete is to have a better tax and regulatory climate, but education and a quality work force are also key to that."

Kansas Republican Gov. Sam Brownback is requesting $105 million for universities in his state to do targeted research in the areas of animal health, cancer and aviation. Virginia Republican Gov. Bob McDonnell has proposed a $54 million jobs initiative for the state to compete more aggressively against neighbors North Carolina and Maryland.

The quality of a state's labor market is another significant factor for businesses as they choose where to locate, in some cases mitigating the level of taxes they will have to pay.

"As much as Nevada talks about getting California business because of their low taxes, their population would need a substantial amount of retooling," said Kim Reuben, a senior fellow at the Tax Policy Center in Washington. "Nevada has survived largely on growth, a place where people without much education could get relatively good jobs in construction and casinos. California is a place that has great intellectual institutions and will always attract talent and overcome its taxes."

But Kail Padgitt, an economist with the conservative Tax Foundation, said a state's tax burden might not have affected its performance during the recession but certainly will affect the pace of its recovery.

"When the economy starts to pick up, that's where you're going to see more the impact of taxes," Padgitt said. "Where businesses are going to expand operations, where new investments are going to be made — a lot of these companies want to know what their taxes are going to be."

How much the lure of lower taxes acts as an incentive for businesses seeking to relocate or expand remains an open question.

In late 2008 and early 2009, California lawmakers and then-Republican Gov. Arnold Schwarzenegger approved a series of corporate tax breaks that was estimated to save businesses about $1.3 billion a year. At the time, Schwarzenegger and GOP lawmakers promoted the tax cuts and credits as a way to create jobs, but there is little evidence they have done so.

California's unemployment rate rose in December to 12.5 percent and has remained above 12 percent for a year and a half. The questionable connection between corporate tax policy and job creation prompted a Democratic state lawmaker to call for legislation that would force companies to prove they were using tax breaks to boost employment.

"The bill is not to deny them those tax credits. I want to give them those tax credits because they make a rather credible argument why they need them," state Sen. Leland Yee said. "All I'm asking is for them to prove it."

Associated Press writer Don Thompson in Sacramento contributed to this report.