Is raising resident taxes and lowering corporate taxes a good idea?

In this article: offthechartblog it talks about how Wisconsin, Michigan and other states are raising taxes for residents and giving tax breaks to corporations. With an increase in taxes the residents of these states now have a decrease in disposable income. The question is will this absence of funds be reflected in a decrease of sales to these corporations that received a tax break? In other words will the demand for goods(clothes, products, cars etc.) decrease as taxes of residents increase? Or will these corporations reflect the tax breaks in there pricing? Or remain unchanged? Of course there are those companies that do much of there sales in other states or countries that have not yet received a tax increase. But for those corporations that do most of their business in state what will be the result of the tax increases and decreases? Would they be better off not increasing or decreasing taxes?


Dr. Tufte said...

This is more of a macro question (which is OK) that isn't likely to appear in a managerial economics text. There are a few "macro for managers" texts out there, but we don't have a class where they might be used.

The answer to your question is that the states can probably get away with this. The reason is that the responsiveness of firms and their customers to tax changes is not the same. For the firm, a tax cut often yields a 1 to 1 change with net income. It's not quite the same for a customer, for 2 reasons:

1) The effect for the consumer is indirect. Their disposable income might change 1 for 1, but that doesn't mean that each component of spending would change 1 for 1.
2) Consumers behavior is more quirky for small expenditures. A tax cut for 1 firm is spread across the tax increases of a multitude of consumers, so the effect on each individual is more choppy.

Jack said...

Dr. Tuft
Do you think that it is a good idea to raise residents taxes and lower corporate taxes?
Would the result be any better off it was reversed? If they increased corporate taxes and lowered resident taxes?

Dr. Tufte said...

Hey ... that "e" in my name isn't even silent, and it's gone missing Jack!

I'm not a great Romney fan, but he's right that taxing corporations is taxing people. So I think this is a false discussion: we label taxes as falling on corporations (with the hope of getting at their owners' wealth) when the tax incidence falls elsewhere. So I'd prefer resident taxes.

I really don't know that it matters though. Our current system is to have taxes on both, and then to give away breaks on the latter for political reasons. The effect of this is to raise taxes on residents anyway.

There is a "folk theorem" in economics that all benefits eventually accrue to the holders of fixed resources. Tax systems are relatively fixed, and are an anti-resource in many cases. So benefits will tend to go away from destructive tax systems. The message that is being sent to politicians is that if you have to give tax breaks at all, then you should change your tax system. They aren't listening.