These are excerpts from The Tax Foundation’s “2013 State Business Tax Climate Index.” See entire report here.
By Scott Drenkard and Joseph Henchman
Maine vaulted from 37th to 30th best overall tax climate in The Tax Foundation’s 2013 edition of the State Business Tax Climate Index. The Index enables business leaders, government policymakers and taxpayers to gauge how their states’ tax systems compare.
Maine had the most sizable rank improvement this year, as a repeal of the alternative minimum tax and a change in treatment of net operating losses launched the state from 37th to 30th best overall.
Maine made changes to its corporate and individual income taxes that sizably improved its overall ranking. In the corporate income tax code, a temporary ban on net operating loss carry forwards expired, returning Maine to the widely used standard of allowing such carry forwards for up to 20 years.
In the individual code, the alternative minimum tax was repealed for tax year 2012. These two changes improved Maine’s overall rank from 37th best last year to 30th best this year.
The Index compares the states in five areas of taxation that impact business: corporate taxes; individual income taxes; sales taxes; unemployment insurance taxes; and taxes on property, including residential and commercial property. The ranks of neighboring states are: New Hampshire (7th), Massachusetts (22nd) and Vermont (47th).
Michigan made a sizable leap by replacing their cumbersome and distortionary gross receipts tax (the Michigan Business Tax) with a flat 6 percent corporate income tax that is largely free of special tax preferences. This improved their overall rank from 18th to 12th best, and their corporate ranking from 49th to 7th best.
The 10 best states in this year’s Index are:
2. South Dakota
7. New Hampshire
The absence of a major tax is a dominant factor in vaulting many of these 10 states to the top of the rankings. Property taxes and unemployment insurance taxes are levied in every state, but there are several states that do without one or more of the major taxes: the corporate tax, the individual income tax, or the sales tax.
Wyoming, Nevada and South Dakota have no corporate or individual income tax; Alaska has no individual income or state-level sales tax; Florida has no individual income tax; and New Hampshire and Montana have no sales tax.
The lesson is simple: a state that raises sufficient revenue without one of the major taxes will, all things being equal, have an advantage over those states that levy every tax in the state tax collector’s arsenal.
The 10 lowest ranked, or worst, states in this year’s Index are:
44. North Carolina
46. Rhode Island
49. New Jersey
50. New York
Despite moderate corporate taxes, New York scores at the bottom this year by having the worst individual income tax, the sixth-worst unemployment insurance taxes, and the sixth-worst property taxes. The states in the bottom 10 suffer from the same afflictions: complex, non-neutral taxes with comparatively high rates.
While taxes are a fact of life, not all tax systems are created equal. One measure, total taxes paid, is relevant but other elements of a state tax system can also enhance or harm the competitiveness of a state’s business environment. The Index reduces many complex considerations to an easy-to-use ranking.
The modern market is characterized by mobile capital and labor, with all types of business, small and large, tending to locate where they have the greatest competitive advantage. The evidence shows that states with the best tax systems will be the most competitive in attracting new businesses and most effective at generating economic and employment growth.
It is true that taxes are but one factor in business decision-making. Other concerns, such as raw materials or infrastructure or a skilled labor pool, matter, but a simple, sensible tax system can positively impact business operations with regard to these very resources.
Furthermore, unlike changes to a state’s health care, transportation or education system—which can take decades to implement—changes to the tax code can quickly improve a state’s business climate.
It is important to remember that even in our global economy, states’ stiffest and most direct competition often comes from other states. The Department of Labor reports that most mass job relocations are from one U.S. state to another, rather than to an overseas location.
Certainly job creation is rapid overseas, as previously underdeveloped nations enter the world economy without facing the highest corporate tax rate in the world, as U.S. businesses do. So state lawmakers are right to be concerned about how their states rank in the global competition for jobs and capital, but they need to be more concerned with companies moving from Detroit, Mich., to Dayton, Ohio, rather than from Detroit to New Delhi. This means that state lawmakers must be aware of how their states’ business climates match up to their immediate neighbors and to other states within their regions.
Anecdotes about the impact of state tax systems on business investment are plentiful. In Illinois early last decade, hundreds of millions of dollars of capital investments were delayed when then-governor Rod Blagojevich proposed a hefty gross receipts tax. Only when the legislature resoundingly defeated the bill did the investment resume.
In 2005, California-based Intel decided to build a multi-billion dollar chip-making facility in Arizona due to its favorable corporate income tax system. In 2010, Northrup Grumman chose to move its headquarters to Virginia over Maryland, citing the better business tax climate.
Anecdotes such as these reinforce what we know from economic theory: taxes matter to businesses, and those places with the most competitive tax systems will reap the benefits of business-friendly tax climates.
Tax competition is an unpleasant reality for state revenue and budget officials, but it is an effective restraint on state and local taxes. It also helps to more efficiently allocate resources because businesses can locate in the states where they receive the services they need at the lowest cost.
When a state imposes higher taxes than a neighboring state, businesses will cross the border to some extent. Therefore, states with more competitive tax systems score well in the Index because they are best suited to generate economic growth.
State lawmakers are always mindful of their states’ business tax climates but they are often tempted to lure business with lucrative tax incentives and subsidies instead of broad-based tax reform. This can be a dangerous proposition, as the example of Dell Computers and North Carolina illustrates. North Carolina agreed to $240 million worth of incentives to lure Dell to the state. Many of the incentives came in the form of tax credits from the state and local governments.
Unfortunately, Dell announced in 2009 that it would be closing the plant after only four years of operations. A 2007 USA Today article chronicled similar problems other states are having with companies that receive generous tax incentives.
Lawmakers create these deals under the banner of job creation and economic development, but the truth is that if a state needs to offer such packages, it is most likely covering for a woeful business tax climate. A far more effective approach is to systematically improve the business tax climate for the long term so as to improve the state’s competitiveness. When assessing which changes to make, lawmakers need to remember two rules:
1. Taxes matter to business. Business taxes affect business decisions, job creation and retention, plant location, competitiveness, the transparency of the tax system, and the long-term health of a state’s economy. Most importantly, taxes diminish profits. If taxes take a larger portion of profits, that cost is passed along to either consumers (through higher prices), employees (through lower wages or fewer jobs), or shareholders (through lower dividends or share value). Thus a state with lower tax costs will be more attractive to business investment, and more likely to experience economic growth.
2. States do not enact tax changes (increases or cuts) in a vacuum. Every tax law will in some way change a state’s competitive position relative to its immediate neighbors, its geographic region, and even globally. Ultimately, it will affect the state’s national standing as a place to live and to do business. Entrepreneurial states can take advantage of the tax increases of their neighbors to lure businesses out of high-tax states.
In reality, tax-induced economic distortions are a fact of life, so a more realistic goal is to maximize the occasions when businesses and individuals are guided by business principles and minimize those cases where economic decisions are influenced, micromanaged or even dictated by a tax system. The more riddled a tax system is with politically motivated preferences, the less likely it is that business decisions will be made in response to market forces.
The Index rewards those states that apply these principles.