Gov. Ed Rendell has proposed dramatic changes in two of the state's primary sources of tax revenue -- the sales tax and the corporate net income tax. Both changes are touted as making the tax system more fair, which is certainly a desirable goal. But how would the governor's proposals affect the Pittsburgh region's ability to compete with other communities for businesses and jobs?

The governor has proposed cutting the sales tax rate by one-third, from 6 percent to 4 percent, and expanding the tax to 74 categories of products and services that are currently exempt. These categories are so large that taxing them would not only offset what would otherwise be a $3 billion loss from the lower tax rate, but increase total revenues from the sales tax by 10 percent.

The fact that popcorn at a movie theater is taxed while candy is not is cited as an example of the unfairness of the current system. But this is not the kind of exemption that affects revenues the most. The majority of the new revenues would come from extending the sales tax to business and professional services such as accounting, architecture, computer programming, law and public relations. These industries would be subjected to more than $2 billion in new taxes.

Only five other states (Delaware, Hawaii, New Mexico, South Dakota and Washington) have a sales tax on major business and professional services, and only three of those have taxes of the magnitude the governor is proposing. Most states don't tax these business-to-business services because it's viewed as double taxation on consumers, since they will pay tax again when they purchase the final product the services helped to create.

Only 13 states tax custom computer programming services as the governor is proposing to do. In fact, Pennsylvania's exemption was enacted in 1997 specifically to make the state more competitive in attracting and retaining businesses in the information technology industry.

Consequently, expanding the sales tax to business services, computer services and professional services would make the Pittsburgh region dramatically less competitive in attracting and retaining businesses and jobs. Moreover, lowering the sales tax rate on currently taxable items seems to give up revenue unnecessarily; only five states that exempt food from sales tax as Pennsylvania does have a tax rate as low as the 4 percent rate the governor has proposed (an additional five states have no sales tax at all).

Mr. Rendell also has proposed several significant and desirable changes in the corporate net income tax, including lowering the 9.99 percent rate (currently the second highest in the country) to 8.99 percent (still leaving the state with the seventh highest rate) and eliminating the cap on net operating loss carryforwards (which would help startup businesses and manufacturing firms).

To pay for this, Mr. Rendell has proposed to institute "combined reporting," which would force national companies to pay Pennsylvania's high taxes on all of their businesses, not just the ones located in Pennsylvania. The governor claims that many large corporations are escaping Pennsylvania taxes by shifting profits to businesses located in other states, citing as evidence the fact that 71 percent of corporations in the state don't pay any state corporate income tax.

However, he fails to point out that the reason most corporations don't pay corporate taxes is that they have no income to tax. In fact, a study by the U.S. General Accountability Office showed that 67 percent of corporations in the entire country had no federal tax liability, so the 71 percent figure in Pennsylvania does not suggest a major tax avoidance problem in the state. Moreover, there is no evidence that states which have instituted combined reporting or used other methods of closing tax loopholes have a higher percentage of their businesses paying taxes than Pennsylvania currently does.

Most worrisome is the fact that combined reporting would dramatically increase taxes on the sector the state needs to compete for most aggressively -- manufacturing. A study done by the Pennsylvania Department of Revenue showed that even with the other improvements in the corporate tax proposed by the governor, combined reporting would increase taxes on manufacturers by more than 21 percent, which could well result in thousands of high-paying manufacturing jobs leaving the state.

Balancing the state budget is clearly a challenging task in these difficult economic times. However, the best way to increase state revenues is not to increase taxes, but to stimulate economic growth. National studies have shown that Pennsylvania both spends more and taxes more than the majority of states, so the first priority should be to reduce expenditures wherever possible. Any tax changes should be evaluated not by how much money they raise, but whether they improve the state's economic competitiveness.

"Money Q&A" and "Company Town" are featured exclusively at PG+, a members-only web site of the Pittsburgh Post-Gazette. Our introduction to PG+ gives you all the details.