If Marylanders think they recently heard a loud boom to our south, they are not mistaken. It came from Virginia, where Gov. Terry McAuliffe fired a warning shot across the bow of Maryland's elected leaders.
Governor McAuliffe, a Democrat, pledged to cut his state's corporate income tax rate from 6 percent to 5.75 percent, which would increase the gap between his state's tax rate and Maryland's, which stands at 8.25 percent.
The corporate income tax is one of the key tools states use to spur economic growth. Like the typical shopper, companies compare states' tax rates when determining where to locate their headquarters and jobs. Thus, Governor McAuliffe has raised the stakes in the decades-old competition between Maryland and Virginia for economic supremacy in our region.
With Maryland's General Assembly set to convene next month, it begs the question: Should Maryland reduce its tax on corporations as well?
To answer that question, we conducted an analysis of Maryland's corporate income tax on behalf of the Maryland Public Policy Institute. We also estimated the impact of a tax cut on state tax coffers. Here are the results:
First, the analysis shows that a reduction in Maryland's corporate tax rate to 6 percent may actually increase the long-term corporate income tax revenue by 7.4 percent, if all other factors remain the same. This finding should alleviate concerns among Marylanders who fear tax cuts may hurt government's ability to provide core services over the long term.
Second, our research shows that Maryland's corporate tax rate, combined with the federal corporate income tax rate, is higher than 90 percent of tax jurisdictions in the world.
Third, large firms are better positioned than smaller firms to take advantage of tax avoidance schemes, placing a heavier corporate tax burden on small businesses. Capital is more mobile in larger firms that may have assets in several states, while smaller firms are less capable of escaping to lower-tax jurisdictions. With 99.7 percent of all businesses classified as small businesses, nearly every employer shares this burden.
Thus, lowering the corporate income tax, which economists rank as one of the most distortionary taxes, would improve the state's economic competitiveness, bolster small businesses and likely increase Maryland's tax revenue over the long term.
If Maryland lawmakers choose to lower the corporate tax to 6 percent, it would not be a radical move. The average corporate income tax rate among U.S. states is 5.9 percent, considerably lower than Maryland's current rate of 8.25 percent. Of the 10 states Forbes lists as the best for future job growth, nine have corporate tax rates lower than Maryland.
To be clear, the desired effects of this tax reform are likely to be seen in the long term. Our study indicates that a tax reduction may lead to short-term revenue losses as it takes time for incentives to affect economic activity. Those benefits, however, are worth the wait. They would include increased local investment, more and better paying jobs, and a more efficient tax structure.
Virginia has laid bare its hand in the high-stakes game of regional economic growth. With Maryland's legislative session set to start in just a few weeks, the question now is how, if at all, our state's policy makers choose to keep up with its closest rival.
Pavel Yakovlev (firstname.lastname@example.org) is an associate professor of economics at Duquesne University's Palumbo Donahue School of Business. Kanybek Nur-tegin (KNURTEGI@fau.edu) is an associate professor of economics at Florida Atlantic University's Harriet L. Wilkes Honors College.