State Business Taxes: Havens and Hellholes

November 4, 2010

“Any tax increase, I will veto it.”

That’s Brian Sandoval, Nevada’s governor-elect, whose vow stares down a Silver State budget deficit in the billions.

Sandoval’s got company. According to The Pew Center on the States, 11 victorious governors and governors-elect signed Americans for Tax Reform’s Taxpayer Protection Pledge. Sandoval, New Mexico’s Susana Martinez, and New York’s Andrew Cuomo did not put their pledges in ink, but publicly committed to not hiking taxes.

Excluding Illinois, where the gubernatorial outcome is still in dispute, Pew estimates that “40 percent of the U.S. population will be represented starting next year by governors who have vowed not to raise taxes.”

If the Tax Foundation’s “2011 State Business Tax Climate Index” is reliable, the governors who keep their election-era promises about taxes stand to boost their states’ attractiveness to entrepreneurs.

“The modern market is characterized by mobile capital and labor,” writes the foundation’s Kail M. Padgitt, Ph.D. “Therefore, companies will locate where they have the greatest competitive advantage. States with the best tax systems will be the … most effective at generating economic and employment growth.”

Seems a rather obvious conclusion. But in a cagey tactic, Padgitt debunks the arguments of the well-funded and media-savvy advocates who argue that taxes don’t matter. Yes, other costs influence business decisionmaking. A startup shipbuilder isn’t interested in Nebraska. No ski resort is planning to relocate to Florida. And heirloom-tomato farmers can’t afford expansion cropland in Manhattan. Still, after reviewing decades of economic literature, Padgitt concluded that there’s ample studies and anecdotal research behind the principle that “business decisions are significantly impacted by tax considerations.”

The foundation’s methodology is a “hierarchical structure built from five component indexes.” The states’ taxes on corporate income, personal income, sales, property, and unemployment insurance are scrutinized in a model the organization continues to refine.

Which states get taxes right? South Dakota, Alaska, Wyoming, Nevada, and Florida take slots one through five. New York is the most inhospitable to entrepreneurship. California, New Jersey, Connecticut, and Ohio also get dunce caps.

Strictly speaking, no business pays taxes -- its owners, employees, and customers do. But that doesn’t stop 47 states from imposing levies on companies’ income or gross receipts. Iowa’s rate of 12 percent heads the offender list in this category, while Colorado (4.63 percent) is friendliest, with the notable exceptions of tax-free Nevada, South Dakota, and Wyoming.

Income taxes account for the largest portion of the foundation’s model, because gone are the days when the levies impacted only wages and salaries. Sole proprietorships, partnerships, S-corporations, and LLCs aren’t touched by the corporate tax. “Indeed,” writes Padgitt, “the number of individuals filing federal tax returns with business income has more than doubled over the past 30 years, from 13.3 million in 1980 to 30 million in 2009.” Income-tax all stars include Alaska, Florida, Washington, South Dakota, Nevada, Texas, and Wyoming. They’ve made the wise decision to forego the levies entirely. (New Hampshire and Tennessee go after interest and dividends.)

Just four states -- Oregon, Delaware, Montana, and New Hampshire -- do not impose sales taxes. (Alaska does not have the levy at the statewide level, but allows local governments to impose it.) The tax hits businesses in two ways: it drives up costs, and reduces income by encouraging border-jumping shoppers to make their purchases where rates are lower.

Taxes on “real and personal property, net worth, and the transfer of assets” are lowest in New Mexico, Idaho, Utah, Indiana, and Oregon. Light unemployment-insurance taxes can be found in Oklahoma, Arizona, Florida, Mississippi, and Louisiana. 

Don’t own a business, and thus, unconcerned with how taxes impact companies? Padgitt doesn’t include any, but some brief standard-of-living data might change your mind. U.S. Census Bureau figures on median household income (MHI) -- half earn more, half earn less -- are useful metrics to examine Americans’ economic well-being. In the last two decades, U.S. MHI, adjusted for inflation, didn’t budge. That’s not the case for the states in the top ten of the foundation’s business-tax index. Average MHI rose by 3.4 percent in high-scoring states. (In Utah, it soared by 16.6 percent.) For the bottom ten, MHI fell by 1.7 percent.

It’s safe to assume that several anti-tax governors will weasel out of their commitments. Even in Tea Party America, pro-spending pressure groups have far more resources than pro-taxpayer activists.

Governors who keep their pledge won’t be merely men and women of their word. They’ll be bold leaders who positioned their states to reap the benefits of competitors’ tax follies.

D. Dowd Muska (www.dowdmuska.com) writes about government, economics, and technology. He lives in Broad Brook, Connecticut.

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