Lowest Business Tax States Have Best Economies: Study

Published December 1, 2006

The states with the most competitive business tax climates have much faster rates of growth in population, employment, economic output, and personal income than those with unfriendly business tax climates, according to the Tax Foundation’s recently released 2007 State Business Tax Climate Index.

“Taxes matter to business,” said Tax Foundation President Scott A. Hodge in announcing the October 11 release of the fourth annual index, which ranks the business tax climate of all 50 states. “Taxes are an important cost to business, as important as the cost of labor and raw materials.”

Hodge pointed out these tax costs get passed on to consumers and investors, the ultimate payers.

Income Rose Much Faster

The 2007 State Business Tax Climate Index shows that between 2000 and 2005:

  • Personal income in the top 10 states in the index grew 44 percent faster than in the bottom 10 states.
  • Employment in the top 10 states grew 115 percent faster.
  • Economic output grew 52 percent faster.
  • Population grew 164 percent faster.

“The Business Tax Climate Index gives lawmakers a benchmark comparison to other states and a road map to make their state more attractive to business and investment,” Hodge said. He noted, “Nearly all of the best states raise sufficient revenue without imposing at least one of the three major state taxes: sales taxes, personal income taxes, and corporate income taxes.”

The state with the best-ranked tax climate is Wyoming, followed by South Dakota, Alaska, Nevada, Florida, Texas, New Hampshire, Montana, Delaware, and Oregon.

The state with the worst-ranked tax climate is Rhode Island, followed by Ohio, New Jersey, New York, Vermont, California, Nebraska, Iowa, Maine, and Minnesota at 41st.

Corporate Taxes Hurt Nation

Hodge noted states are competing for investment in a global environment as well as a national one. On the global front the United States has one of the highest corporate income tax rates in the industrialized world, at nearly 40 percent when federal and state corporate income taxes are averaged. That exceeds corporate income tax burdens in France, Germany, and Sweden, all known for high taxes.

“Ireland has a 12.5 percent corporate income tax rate. Slovakia has a 20 percent flat tax. US Steel has a plant in Slovakia, and it is one of its most profitable plants because of the low corporate tax rate. We’re at a disadvantage,” Hodge said.

Even so, states are much more likely to lose jobs to other states than to other countries.

For this reason, policymakers “should be less concerned about competition from India and more concerned about competition from other states,” Hodge said. “Eighty percent of business moves [since 2000] were from state to state.”

Tax Neutrality Key

Index authors Curtis Dubay and Chris Atkins, Tax Foundation economist and staff attorney, respectively, in an interview for this article, said the guiding principle of the index is tax neutrality. Tax neutrality means the system does not reward or punish particular types of taxpayers.

The index evaluates the tax rate and tax base in each of five areas: corporate taxes, individual taxes, sales taxes, unemployment insurance taxes, and property taxes. There are 113 variables in these five areas. States are measured on the five indices to arrive at an overall ranking.

“People are making their own decisions to invest and can make those decisions better than lawmakers can,” Atkins said.

Atkins pointed out that in states where lawmakers use the tax system to manipulate the economy, “Overall economic growth is lower because government can’t pick better than the market can. The index punishes states that offer certain types of credits, and rewards those that don’t.”

Targeted Incentives Fail

“A trend we have detected is that states feel tax incentives are the road to economic development,” said Dubay. On the contrary, Dubay said, “The data show the way to spur economic growth is to have a broad-based tax with a low rate that is fair, simple, and neutral.”

Dubay also addressed what he said is a flawed argument often put forth by defenders of heavily developed high-tax states such as New Jersey and New York, whose key economic indicators are growing more slowly than those in developing states. Defenders of high taxes say economic indicators in those states cannot be expected to climb as rapidly because they are already much higher than those of developing states.

Dubay pointed to Texas to debunk that reasoning.

“Texas comes in seventh in population growth, 11th in output growth, and 17th in increasing personal income,” even though it is one of the nation’s largest and most developed states, Dubay noted.

Low Taxes Bring Jobs

“State tax systems that are simple, fair, broad-based, and low-rate can experience significant growth regardless of size or level of economic development,” Dubay said.

“We can see this trend clearly by looking at the labor force growth rates of highly competitive states that neighbor those with poor business tax climates,” Dubay noted. “Since the beginning of 2004, the average labor force in each state has grown by about 3 percent nationwide.

“However, California, with its punitive business tax climate, saw only a 2 percent growth in labor, while its more business-friendly neighbors, Nevada and Arizona, doubled and tripled the national average, respectively,” Dubay said.

Hodge said policymakers need to look at where new investment is going, not just at where corporations are headquartered.

“Is investment going to New York or California or somewhere else?” Hodge asked. “Intel built a $3 billion wafer manufacturing plant in New Mexico. Why? Because it’s more expensive in California. New investment is going elsewhere” even though corporate headquarters may remain in place.

Tax Cuts Spur Competitiveness

With most states seeing a big surge in revenues, now is the time for policymakers to focus on how to improve competitiveness and economic growth, Hodge noted.

“We think the fastest way is to improve the tax system,” Hodge said. “Increased funding for education, roads, and other infrastructure can take years, if not decades, to have any effect. Modest improvements in a state’s business tax climate can produce rapid growth in income, output, employment, and population.”

Steve Stanek ([email protected]) is managing editor of Budget & Tax News.

For more information …

The Tax Foundation’s 2007 State Business Tax Climate Index is available at http://www.taxfoundation.org/publications/show/1371.html.