This blog was co-authored by Research Director Carl Davis and Senior Fellow Matthew Gardner
Last week, the Tax Foundation released its 2023 State Business Tax Climate Index, the latest in its annual series, which purports to provide a single overall ranking of business tax structures in each state. States at the top of the index have one thing in common: There is one major tax, mostly the income tax, which other states levy, the “best” states don’t. However, the index is constructed in an arbitrary and inconsistent manner and bears no relation to the actual tax contributions of US companies. Additionally, the Index’s discussion tends to focus on the need for lower (or non-existent) taxation, even though state and local taxes represent a tiny fraction of the total cost of doing business, and the services paid for with that taxpayer’s money are critical to the success of any business. Ultimately, the State Business Tax Climate Index measures very little about a state’s ability to attract and grow businesses and jobs.
Each state’s index value is determined by separately ranking five different major taxes levied by state and local governments – corporate income, personal income, sales, unemployment and property taxes – and then merging these rankings to create a single mega-ranking . The components of each tax’s index value are arbitrarily weighted and contain a peculiar mix of items with, at best, tenuous connections to business sentiment. For example, having more than one income tax bracket is considered bad for business, although it tends to lower tax bills for start-ups and small businesses with small amounts of profit. On the other hand, the taxation of dry cleaning is seen as a contribution to promoting a better business climate.
On more than one occasion, the hodgepodge of items mixed into each state’s index score is in direct contradiction to one another. For example, states are rewarded in their points when they peg their personal income tax brackets to inflation, but later penalized when their tax brackets are deemed too broad, which is exactly what inflation indexing does over time. The index also penalizes states that levy a high overall gasoline tax rate, while rewarding states that choose to tax gasoline through their sales taxes.
What is most striking about the tax foundation’s weights, however, is that they bear no relation to the companies’ total tax shares. Combined, income taxes and corporate income taxes make up more than half (51.7 percent) of each state’s index score, even though those two taxes make up just 14.5 percent of total state and local taxes paid by businesses, as determined by the Council on State Taxation and Ernst & Young.
The states that perform best in the index — Wyoming and South Dakota — both have no income or corporate taxes. Next on the list are Alaska and Florida, both with no personal income tax (Alaska also has no state sales tax). The obvious implication is that from the perspective of the State Business Tax Climate Index, the perfect corporate tax regime is one that levies no taxes anything. That being said, the index favors states that levy taxes that are more likely to be paid by small businesses with no significant profits, such as B. Property and sales taxes.
Taking a step back, the index is simply a poor measure of countries’ economic potential. The top countries are not the countries with the highest gross domestic product, the highest median income or the lowest poverty. They are not the countries with the best educated workforce, the longest life expectancy or the lowest infant mortality. For the Tax Foundation, the best climate is simply the one that demands the least from large, highly profitable corporations and other businesses. And that’s hardly what makes for the best economy for workers, or families, or businesses themselves.
Updating a calculation by Peter Fisher, we find that state and local corporate taxes represent, on average, about 2.3 percent of the cost of doing business. The Index tends to get readers overly focused on tax levels, when in reality nearly 98 percent of what it takes to run a successful business is tied up in other areas — including human resources and infrastructure issues, which can strengthen well-funded state and local governments.
Take, for example, the relative attractiveness to companies of the lowest-ranked state (New Jersey) and the highest-ranked state (Wyoming). On almost every economic measure, from the number of Fortune 500 companies to overall economic output to entrepreneurship, New Jersey outperforms Wyoming — and by a wide margin. That’s because New Jersey has top-notch public schools, a robust transportation infrastructure, and other public goods — all made possible by revenue from taxes that put it last on the Tax Foundation’s index.
The big problem with the index is that it offers a solution that not only falls short of the goal of generating business investment, but also actively interferes with state legislatures’ ability to provide public goods like good schools and modern, efficient transportation networks – the companies need and want.