Competitiveness of State and Local Business Taxes

Tax burden is a high profile consideration in making a capital investment decision despite the fact that non-tax costs of doing business in a given location are typically far more significant to a projects’ internal rate of return or net present value.

The Tax Foundation offers some perspective on the relationship between tax burden and foreign direct investment.

“Q: Do businesses really decide where to locate based on taxes? How important is this compared to other factors, such as wages, cost of living, and travel costs?

A. Taxes do factor into business location decisions. For example, a growing body of academic research indicates that foreign direct investment (FDI) can be quite sensitive to the corporate tax rates imposed by a state or country. One recent study of the effects of corporate income taxes on the location of foreign direct investment in the United States found a strong relationship between state corporate tax rates and FDI—for every 1 percent increase in a state’s corporate tax rate, FDI can be expected to fall by 1 percent.1

A new study of income tax rates in 85 countries by economists at the World Bank and Harvard University found a strong effect of both statutory and effective corporate tax rates on FDI as well as entrepreneurship. For example, the average rate of FDI as a share of GDP is 3.36 percent. But a 10-percentage point increase in the statutory corporate rate can be expected to reduce FDI by nearly 2 percentage points.”

Historically, the Tax Foundation State Business Tax Climate Index has been the standard for making state-to-state tax burden comparisons. The methodology used by the Tax Foundation creates a relative index based on five specific component indices that are weighted in the final calculation – 1) corporate tax, 2) individual income tax, 3) sales tax, 4) unemployment tax and 5) property tax. Most third-party business rankings rely on the Index in their assessment of cost-of-doing-business.

Recently, Ernst & Young LLP partnered with COST (Council on State Taxation) to create a new study that provides a state-by-state comparison of tax liabilities that new investments would incur. The results are reported to reflect the type of analysis that businesses use to evaluate site selection decisions. This analysis focuses only on business tax burden and does not include any consumer tax liabilities.

Understanding the actual state tax burden is important in economic development. But, understanding what capital investors are reviewing as they contemplate which locations to include on a short list for due diligence is critical. Without that understanding, it will be difficult to effectively position your community for consideration.

It is important to understand the data, methodology and study limitations of the rankings published by both the Tax Foundation and E&Y/COST. As an economic development professional, you need to be sufficiently conversant with both these reports that you can confidently explain the ranking results for your state.

You should have answers to these 5 key questions –

1.     Where does your state rank relative to other states?

2.     What are the key drivers of that ranking?

3.     Why are the rankings different between the two studies?

4.     What is your state’s strategic approach to tax legislation?

5.     Have there been any recent relevant changes in the tax code of your state?

You often only get one chance to make an impression on a potential capital investor or a site selection consultant. Andy Levine (Voice of Your Customer post) counsels that you need to be ready with a solid command the facts about your community and state in order to take advantage of it. You can expect questions about your state tax burden, so be sure you are ready with data based answers.

What is Your Experience?

Have you used either of these national state tax ranking reports in conversations with site selection consultants or capital investors? If you have, what kind of questions do you have to deal with most often? What misperceptions regarding the rankings have you encountered? Please leave a comment and share your experience. By sharing typical questions and answers we can all be better prepared.

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2 Comments so far

  1. MARSHALL SHANNON

    July 14, 2011

    No one tells small business owners the real tax burdens. In fact I truly believe the state intensionally makes and hides new taxes so they can collect 35-45% imposed penalties for non-compliance and of course their favorite is ignorance to the change is not a valid argument.

    In Texas, here we go:
    #1 Property Tax *Since we have no income tax, just take your property tax, add your income tax and multiply by two and that is what the state of Texas imposes.
    #2 Francise Tax *Even if you owe ZERO they have a way of charging a BASE fee so they cannot break the law by charging extra for filing a Zero Return.
    #3 Inventory Tax *They have a book they use and somehow without seeing your inventory or doing any inspections, they come up with a number 3-4x times what you submitted as a rendition.
    #4 Licensure Tax *Another hit at the industry your in, if the industry makes more, they charge you more. No real regulation, except a way to have more income
    #5 School Tax, usually 2x time property tax, and businesses get no breaks and actually are charged more for making jobs in the State.
    #6 Fuel Surcharge Tax, so we pay more at the pump, then pay extra because we own trucks. This must have come from Obama himself.
    #7 Payroll Tax
    #8 Social Security Tax
    #9 Medicare Tax
    #10 Workmans comp Tax
    #11 Workforce commission Tax
    #12 Special Session Tax
    #13 Cell Phone Tax
    #14 Normal Phone line Federal TALK tax
    #15 Alarm Tax
    #16 Alarm Registration Tax
    #17 Garbage Collection Tax, then business pay for own Garbage anyway as cities exclude businesses from pickup, but do not exclude from the Tax
    #18 Sewer Tax, based on water consumption, so if you use water for other purposes too bad so sad.
    #19 Registration and Vehicle Tax
    #20 Special Tax on Insurance Premiums and Insurance claims
    #21 Gift Tax
    #22 City Operation Tax
    #23 State Withholding and Sales Taxes, again, one hour late filing, they penalize you 37%.
    #24 Federal Income Tax, one hour late filing and pay 47% penalty.
    #25 Railroad Commission Forklift Tax
    #26 Fire Alarm Tax
    #27 Water Backflow Tax
    #28 Advalorum Tax
    #29 Internet Federal Tax
    #30 The state even charges you extra for stamps and mailing of your tax, an extra $1.00 for the mailing and an extra $1.00 to print you the form they send so you can pay your tax. Again a work around since it is illegal, so they call it a connivence charge and mailing charge.
    #31 TOLL ROAD tax, in Texas we pay tolls on roads built with Tax payer dollars to begin with. Totally against the law but they are still collecting tax on roads built with our tax dollars and federal dollars.
    #32 Tire and Battery Disposal Tax
    #33 Computer and Monitor Disposal Tax
    #34 Land Fill Tax, see above they already charge us garbage tax
    #35 Cable-vision Federal DeliveryTax – like they installed the lines
    #36 My PERSONAL FAVORITE – LOTTERY TAX

    YOU BUY A LOTTERY TICKET WITH A DOLLAR YOU HAVE PAID TAX ON 3.7 TIMES BY THEY TIME YOU SPEND IT, THEN THE GOVERNMENT WANTS 48% OF THE WINNINGS…..THAT IS THE BEST

    #37 INHERITANCE TAX – 2nd Favorite.

    YOUR PARENTS DIE, THEY LEAVE YOU 100,000 IN INHERITANCE, THEY HAVE PAID TAXES THIER ENTIRE LIFE AND THIS 100,000 HAD TAXES PAID ON IT OVER AND OVER, AND THEY PAID TAX ON THE INTEREST THEY GAINED ON THE 100,000 AND NOW THE GOVERNMENT – YOUR PARENTS ARE DEAD AND CANT COMPLAIN – SO THEY CHARGE YOU ANOTHER 48% ON THIS MONEY. WHO THINKS UP THIS SHIT? DO THEY SIT IN A ROOM AND COME UP WITH LOOPHOLES IN THE LAW THEY CAN EXPLOIT FOR GAIN OF ANY MONEY THEY THINK THEY CAN GET AWAY WITH.

    Oh Well, you did ask, so now my blood pressure is up

    What NON-BUSINESS owners will never understand are above, they average employee has NO IDEA what true burdens are on SMALL BUSINESS.

    AND EVEN WITH AN ACCOUNTANT ON STAFF, MISTAKES ARE STILL MADE.

  2. L.J. Barnett

    July 21, 2011

    Hello Ed, really salient point. It is just a matter of research to see tax rates for states/ counties and compare. One must look at geographic factors (especially in terms of manufacturing) as well as business attractiveness (place to recruit workers, logistics, financial relationships, etc.) but in terms of FDI and taxes then it can get pretty complicated. I guess I am trying to be succinct in saying that the burden depends on the state’s statues on incentives relative to taxes and thus the burden can change exponentially.

    For example; the state of Georgia offers an employer a state tax break of between $ 500 to $ 3500 for every employee hired (5-25 employees for up to 10 years). It is based on a tier system that is linked to local development authorities and can get a bit complicated.

    But many times the tax burden is offset by other factors; land or capital deals. Many county or states incentives work with lease deals that come from either or both investing in land for the sake of attracting an FDI company. If the state sees a real estate deal that is really worth jumping into, with the value of offering it later to attract large companies to manufacture or build another facility on, then the tax burden may be offset due to the attractiveness of the site; and how much the local gov is ponying up from their budgets/ IRBs/ etc.

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