ITEP staff
This blog is 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,” which ranks each state’s overall business tax structures. The states at the top of the index have one thing in common: they have big taxes, often income taxes, that other states “best” states don’t. But the index is constructed in an arbitrary, self-contradictory way that doesn’t correlate with the actual tax contributions of American businesses. Although state and local taxes are a very small fraction of total business spending and the services paid for with those tax dollars, discussion of the index tends to focus on the need for low (or no) taxes. The success of every business. Ultimately, the “State Business Tax Climate Index” measures a very small measure of a state’s ability to attract and grow businesses and jobs.
Each state’s index score is arrived at by taking five different major taxes levied by state and local governments — corporate income, personal income, sales, unemployment and property taxes — and then combining those levels to create a single mega-rank. The components of each tax index score are randomly weighted and are a unique mix of items that are most closely related to business activity. Having more than one income tax bracket is considered bad for business, for example, although this tends to lower tax bills for startups and small businesses with smaller profits. A tax on dry cleaning has helped promote a better business climate.
More than once, the hodgepodge of items mixed in each state index score directly contradicts each other. For example, states are rewarded for their performance if they tie their personal income tax brackets to inflation, but are later penalized if their tax brackets are deemed too broad, which inflation does over time. The index generally penalizes states that impose high gasoline taxes, while also rewarding states that choose to levy gasoline with their sales tax.
The most surprising feature of the tax foundation weights is that they have nothing to do with the share of total taxes paid by businesses. Combined, personal and corporate income taxes account for more than half (51.7 percent) of each state’s index. State Tax and Ernst & Young
The top states on the index — Wyoming and South Dakota — neither have personal or corporate income taxes. Alaska and Florida continue on the list, both with no personal income tax (Alaska also has no state sales tax). The obvious implication is that the perfect business tax system is tax-free in terms of the State Business Tax Climate Index. anything. In short, the index supports taxes such as property and sales taxes that small businesses may pay without making significant profits.
Taking a step back, the index is simply a poor measure of states’ economic capacity. High-ranking regions are not regions with high GDP or high middle income or low poverty. They are not the states with the most educated workforce, or the longest life expectancy, or the lowest infant mortality. For a tax foundation, the best climate is simply the one that requires the least amount of large, highly profitable corporations and other businesses. And that’s rarely what makes the best economy for workers or families or businesses themselves.
Updating the calculations made by Peter Fisher, we find that state and local business taxes average about 2.3 percent of the cost of doing business. The index leads readers to focus on tax levels, which are actually close to 98 percent of running a successful business – including human resources and infrastructure issues that strengthen well-funded state and local governments.
Take for example the state with the lowest (New Jersey) and the highest (Wyoming) relative attractiveness for businesses. On every economic measure, from the number of Fortune 500 companies to overall economic output to entrepreneurship, New Jersey outperforms Wyoming — and by a long shot. That’s because New Jersey has top-rated public schools, strong transportation infrastructure, and other public goods — all made possible by the revenue raised by taxes that rank at the bottom of the Tax Foundation’s index.
The biggest problem with the index is that it not only falls short of the goal of generating business investment, but also moves to a solution that undermines the ability of state lawmakers to provide the public goods — like good schools and modern, efficient transportation networks — that businesses need and want.
