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Curtis S. Dubay is an economist at the Tax Foundation.Chris Atkins is the foundation's senior tax counsel and director of state fiscal projects. He specializes in analyzing federal, state and international tax policy from a legal and economic perspective, and his work often focuses on business tax policy.
The Tax Foundation is a nonpartisan tax research group based in Washington, D.C.
The Tax Foundation presents the 2008 version of the State Business Tax Climate Index (SBTCI) as a tool for lawmakers, the media, and individuals alike to gauge how their states' tax systems compare. Policymakers can use the SBTCI to pinpoint changes to their tax systems that will explicitly improve their states' standing in relation to competing states.
American companies often function at a competitive disadvantage in the global economy. They pay one of the highest corporate tax rates of any of the industrialized countries. The top federal rate on corporate income is 35%, and states with punitive tax systems cause companies to be even less competitive globally.
The modern market is characterized by mobile capital and labor. Therefore, companies will locate where they have the greatest competitive advantage. States with the best tax systems will be the most competitive in attracting new businesses and most effective at generating economic and employment growth.
Although the market is now global, 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. 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 Indianapolis to Ithaca, N.Y., rather than from Indianapolis to India. 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.
A recent report from the Rockefeller Institute said that state tax revenues were 4.8% higher in the first quarter of 2007 than during the same period a year earlier. This continues a trend of growing state revenues that the Rockefeller Institute traces back to the latter half of 2003. Budget surpluses offer many state lawmakers the opportunity to reform their tax codes in order to make their states more attractive to domestic and foreign investment. Indeed, this is why many states have created tax reform commissions to study pro-competitive tax reform.
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 a case in Florida illustrates. In July of 2004, Florida lawmakers cried foul because a major credit card company announced it would close its Tampa call center, lay off 1,110 workers, and outsource those jobs to another company. The reason for the lawmakers' ire was that the company had been lured to Florida with a generous tax incentive package and had enjoyed nearly $3 million worth of tax breaks during the past nine years.
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 these 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), workers (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.
The Rankings
The 2008 SBTCI (which represents the tax climate of each state as of July 1, 2007, the first day of the standard 2008 fiscal year) compares the states on five separate aspects of their tax systems and then adds the results up to a final, overall ranking. This approach has the advantage of rewarding states on particularly strong aspects of their tax systems (or penalizing them on particularly weak aspects) while also measuring the general competitiveness of their overall tax systems. The result is a score that can be compared with other states' scores.
The 10 best states in the Tax Foundation's 2008 State Business Tax Climate Index are as follows:
1. Wyoming
2. South Dakota
3. Nevada
4. Alaska
5. Florida
6. Montana
7. New Hampshire
8. Texas
9. Delaware
10. Oregon
It is obvious that the absence of a major tax is a dominant factor in vaulting 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 either a corporate tax, an individual income tax, or a 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 and Texas have no individual income tax; and New Hampshire, Delaware, Oregon 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, out-compete those states that levy every tax in the state tax collector's arsenal.
The 10 worst states in the SBTCI are as follows:
41. Maine
42. Minnesota
43. Nebraska
44. Vermont
45. Iowa
46. Ohio
47. California
48. New York
49. New Jersey
50. Rhode Island
Rhode Island has the worst unemployment tax system and the third worst property tax and individual income tax systems. New Jersey has the second to worst individual income and property tax systems and the seventh worst sales tax system. New York's individual income, sales, unemployment and property tax systems all rank in the bottom 10, and its sales tax system is second worst. California has the worst individual income tax system, the ninth worst sales tax system and a poorly ranked corporate tax system.
The remaining states in the bottom 10 suffer from the same afflictions that plague these four bottom states: complex, non-neutral taxes with comparatively high rates.
This summary was drawn from a report by the Tax Foundation. To see the entire study, including a map displaying state rankings, click here.
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