Want Tax Reform, Encourage Business

                  In his recent Arkansas Business article, “EITC: An Unconventional Income Approach,” Greg Kaza argues that expanding our state’s Earned Income Tax Credit would improve Arkansas per capita personal income, and that Arkansas’s progress in this area already puts us within “striking distance” of leading our region in this statistic. However, those who favor economic growth and lower taxes should recognize that EITC expansion will not meet the first goal and help only a little with the second.

If the goal is to make the average Arkansan wealthier, the best tax-reform strategy is to encourage economic growth. Personal income will grow when more businesses open and hire more people—especially when these businesses face fewer restrictions on their ability to expand and profit, which will allow them to pay for high-quality, high-salaried labor. 

However, expanding the EITC won’t encourage growth. The EITC redistributes money to low earners without improvement of the business climate. Because the EITC does not spur economic growth—the crux of businesses’ ability to generate larger profits and pay higher wages—the amount credited back (or, in many cases, subsidized) to workers is essentially irrelevant. At best, EITC expansion will increase average income slightly in the short run.

Policymakers who are interested in raising Arkansas per-capita income, even if only in the very short term, should note that the effects of changing the EITC are essentially negligible. Kaza cites revenue costs ranging from $72 to $118 million if the EITC were increased. A back-of-the-envelope calculation, assuming a $100 million figure, suggests that this would only lead to a $100.00 credit to the poorest 1/3, which comes out to be around $8 per month. I don’t argue that this is nothing; it simply isn’t very much. In fact, there is little reason to believe that subsidizing low-wage earners is an especially powerful poverty-fighter.

A fairer and more effective income tax reform policy would focus on across-the-board tax cuts for every Arkansas taxpayer. That superior policy choice would consist not only of across-the-board rate reductions; it would also assuage some government revenue concerns by eliminating many of the state tax code’s economically distortive credits, deductions, and exemptions for specific consumers groups and businesses, which do little to benefit broad sectors of the public. A true state-tax-cut policy would allow everyone to earn more and businesses to produce more, both of which would greatly encourage economic activity and raise Arkansas personal income in a deeper and more permanent manner.

                  It is certainly true that the EITC is better than many alternative anti-poverty policies. Although the EITC is not a particularly effective way (short or long term) to boost personal income, it’s certainly more effective at reducing poverty than, say, boosting the minimum wage. Basic economics demonstrates that minimum wage increases cause higher unemployment. The EITC does not retard employment or raise business costs since it does not change the minimum wage, yet the tax credit has the same effects as a salary increase for workers. Thus, the EITC permits workers to be paid more without burdening business any further. Writing redistributive policies into the tax code doesn’t make the policy any less redistributive; it simply makes the policy less visible.        

A better goal than improving a short-term economic indicator is long-term, structural change that will foster economic growth, increase available jobs, and improve the Arkansas business climate. Expanding the EITC will not move Kaza’s desired statistic higher by much; tax reformers should not settle for the extremely marginal benefits of EITC expansion. Those who are serious about raising income in Arkansas should work for policies that encourage long-term economic growth, rather than “welfare-like” policies that only benefit a relatively small group of our citizens only in the short term.

Alex Cartwright is an Economic Policy Analyst at the Advance Arkansas Institute, a public policy research foundation that advocates individual freedom and limited government. 

This piece originally appeared in Arkansas Business & The Northwest Arkansas Business Review on 7/9/12 and 7/23/12 respectively.