Policy Documents

The Texas Margin Tax and Its Impact on the State’s Economic Competitiveness

James Quintero, Robert McDowall and Talmadge Heflin –
September 18, 2012

The relatively low-tax and limited-regulation policies adopted by the state of Texas have provided it with many economic and commercial advantages over other states, but policymakers and elected officials must be careful not to overlook potential problems in those areas where the state has failed to restrain the size and scope of government. While not always readily observed, these faults have the potential to blossom into something much larger if left unattended-especially as the nation’s economic situation improves in the coming years and other states follow Texas’ lead in their efforts to attract investors and entrepreneurs.

One problematic area for Texas is the revised franchise tax or “margin tax.” Mounting evidence suggests that the four-year old margin tax, the state’s primary business tax, has harmed Texas’ economic competitiveness because of its costly and complicated nature, its imposition irrespective of an employer’s profitability, and its contribution to an overall increase in the total business tax burden. Collectively, these factors are putting downward pressure on the state’s economy and weakening its economic competitiveness among the states.

Analyses from three entities—the Tax Foundation, the American Legislative Exchange Council (ALEC), and the State Business Tax Advisory Committee (SBTAC)—all reveal a deterioration of Texas’ economic environment in the years since the margin tax went into effect. In the Tax Foundation’s State Business Tax Climate Index—a national ranking of state business climates—Texas’ relatively business-friendly climate is shown to have become less-friendly in recent years. In ALEC’s Economic Outlook Rankings—a national ranking of states based on certain policy positions—the Lone Star State’s economic outlook ranking has gradually declined since 2008, largely attributable to its uncompetitive corporate tax structure. Finally, the SBTAC’s biennial report suggests that the state’s margin tax is contributing to a growing state and local business tax burden, which when calculated as a percentage of Gross State Product ranks the state higher than the national average and near the middle of the pack in an all-state comparison.

An obvious pattern emerges after studying the reports above. That is, the Texas margin tax has been a net negative for Texas’ economic and business competitiveness, and without significant reform, or even abolition, the state’s economy will continue to perform below its full potential.