The Tax Foundation released the 14th edition of its State Business Tax Climate Index (SBTCI) today (Sept. 28). The basic flaws that have rendered it of little use as a guide to state economic policy remain. While a few methodological tweaks have been made, it is still a hodge-podge of over 100 different features of state tax law, mashed together into an index number. The components are weighted illogically, and the result is a ranking that bears little or no relation to the taxes businesses actually pay in one state versus another.
The Tax Foundation acknowledges that they are not measuring actual tax levels on business, but rather the states’ tax structure. But they provide no evidence that tax structure influences business decisions. If you were a business, what would you care more about: the bottom line amount you will pay, or whether there were three tax brackets or five tax brackets involved in the calculation that got you there? The Tax Foundation would have you count brackets, and ignore the dollars.
The SBTCI has separate components for the corporate income tax, the individual income tax, property taxes, etc. So let’s consider the corporate tax component. Even as a measure of “structure” somehow, it falls short because it leaves out two major determinants of corporate income tax liabilities — federal deductibility and the apportionment rule — while including numerous minor features. As a result, the corporate tax index is a meaningless number.
Furthermore, the corporate income tax is much less important than the property tax, for most businesses. According to the Council on State Taxation, the property tax accounted for 43 percent of all business taxes, the corporate income tax just 11 percent, in 2014. Yet in coming up with the overall state rankings, the latest Tax Foundation index weights the property tax 14.9 percent, the corporate income tax 19.7 percent. That makes states with high property taxes and low corporate income taxes look much better on the index than they really are, and penalizes the states with a robust corporate income tax, a high state share of education funding, and low property taxes.
To make matters worse, the index weights change every year. This makes it impossible to know if a change in a state’s rank from one year to the next is due to a change in tax law, or just a change in the weights.
More importantly, the whole focus on business tax competitiveness is misplaced. State and local taxes are a very small share of overall business costs. What really drives state growth is the rate of new business formation. And what matters most for entrepreneurial vibrancy is the education level of the state’s residents.
Editor’s Note: Peter Fisher, research director of the nonpartisan Iowa Policy Project (IPP), wrote this blog for GradingStates.org, IPP’s separate website devoted to promoting a better understanding of various state business climate rankings. For a look at components of state policies that can promote prosperity, see this page on the GradingStates.org site.