Bartik and Eberts (2012) estimate that state and local governments spend $40 billion annually on tax credits and other business incentives. The economic impact of these tax credits and economic incentives on economic growth and job creation has been debated extensively in the academic literature. Peters and Fisher (2004) acknowledged that a “new consensus” position emerged in the late 1990s and early 2000s. This “new consensus” position argued that lower taxes or increased tax incentives generated economic growth. This position was supported by a number of studies, including Newman and Sullivan (1988), Bartik (1991), and Wasylenko (1997).  Yet, Peters and Fisher (2004) found that the magnitude of these effects is often lower than projected by political leaders and economic developers. Despite the limited magnitude of the effect of select tax incentives, some scholars (see Bartik, 2005) have argued that tax incentives targeted to certain industries remain a preferred strategy to untargeted, broad based tax reduction. Other scholars argue the broad based tax reduction is conducive to economic growth (Kolko, Newmark, & Meija, 2013).

This paper adds to the broader discussion of economic development tax credits by examining the distributional effects of corporate tax reduction versus select tax credits in North Carolina. The authors were part of a research team contracted by the North Carolina General Assembly to evaluate the effectiveness the state’s economic development programs, including estimating the amount by which the state’s corporate income tax could be reduced if incentive programs were eliminated.  To conduct this analysis, the authors were provided confidential tax returns for companies taking the William S. Lee Act tax credit between 2002 and 2005. The Lee Act allows companies to take a tax credit toward 50 percent of their tax liability for qualifying job creation, machinery and equipment investment, or research and development investment. Eliminating the Lee Act tax credit program would have allowed the State of North Carolina to reduce its corporate tax revenue from 6.9 percent to 6.3 percent while remaining revenue neutral.

Reducing the corporate tax rate would clearly benefit most of the roughly 80,000 firms filing corporate income tax returns in North Carolina on an annual basis.  Yet, it is not clear prior to this study how a revenue neutral corporate tax rate reduction would affect those firms receiving a Lee Act tax credit if the program were eliminated. We utilize a stratified sample of tax returns for companies receiving a Lee Act tax credit in each year from 2002 to 2005 and determined how each firm might be impacted by general corporate tax reduction. We find differences in winners and losers under the prospective tax change across firm size.