State business tax climates – getting past the hype

State business tax climates – getting past the hype

- in Progressive Voices

What makes for a good business climate? This certainly seems like a question worth asking. The conservative Tax Foundation recently took a stab at an answer to this question as it does every year through its annual "State Business Tax Climate" report. Though filled with several unsubstantiated claims, the report does get its share of media and lawmaker attention so it's worth a quick review.

According to the report North Carolina's business tax climate is ranked 39th – as in only 11 states have lower rankings. North Carolina's 39th place finish makes it the lowest ranked state in the southeast, although its ranking is higher than in past years. This, of course, is a preposterous conclusion. Many influential journals have ranked North Carolina near the top of the national rankings for years.

The Tax Foundation's "index" is not a study in the classic sense. It is essentially a long list of characteristics of state tax systems, for example the presence or absence of a tax on corporate profits and the presence or absence of any tax on inherited wealth. These characteristics are scored and then grouped into major tax categories – i.e. sales, taxes, property taxes, income taxes, etc. Each major tax category is then given a certain weight. The personal income tax is given the most weight in the index (with no clear reason why) and within the personal income tax category a state scores higher if it has certain characteristics like a flat rate structure and lower taxes on investment income relative to wages. The report even claims that North Carolina is no longer in the bottom 10 because the state recently eliminated its top marginal income tax rate.  

There are several fundamental flaws with this particular piece of research, but for simplicity's sake let's discuss only three.

First, the report does not prove that the list of desired characteristics actually affect the business climate. At best, the report cites shoddy and dated research to back up its claims that the items included in its index will have any measurable affect on the business climate. There is no credible research that shows that state without a tax on corporate profits is less competitive, the same for states with progressive income taxes, and so on and so on.

Second, the report reads as if there is no relationship between a successful business climate and maintaining decent public structures. In other words, it's only the tax side of the "tax and spend" equation that matters. Of course we know this is not true. Maintaining healthy public structures, including public institutions like schools and courts and physical structures like roads and parks have significant effects on state economies.

Lastly, another serious methodological shortcoming is that the researchers do not in any way attempt to show that the states with the lowest rankings actually have poor business performance. Has Alabama, the state with allegedly the best business tax climate, actually so outperformed North Carolina as to justify its #1 ranking? Moreover, is the Tax Foundation predicting that Alabama businesses will fare dramatically better than North Carolina's in the next few years? If this index is credible then it should be able to show some correlation between the "ideal" state and local tax system and how well each state's economy has actually performed. The researchers do not even attempt this correlation.

The report goes to great lengths to appear detailed and nuanced. Complexity, however, is no substitute for academic rigor. Despite its fancy design, it is clear that the real agenda is simple – the Tax Foundation believes that the more the state can shift the tax responsibility onto workers and consumers the better the business climate will be. Policymakers would be wise to take a much wider and deeper look at the role that taxes, and public policy in general, play in the creating a healthy economic climate.

Elaine Mejia is the Director of the N.C. Budget and Tax Center