 It only makes sense that a business will decide to locate or expand in a state depending on its business climate. Economists, however, have debated this for decades. Fortunately for the rest of us, the Tax Foundation (a nonprofit, nonpartisan research and public education organization) has released a State Business Tax Climate Index that takes this complicated question and puts it into a well-thought-out formula ranking all 50 states. The Tax Foundation, which has been in existence since 1937, is considered one of the most credible and objective sources of information about tax policy in the United States.
The index (available as a Tax Foundation Background Paper, October 2004, Number 45) may be found at www.taxfoundation.org. The authors have painstakingly dissected the tax laws of all 50 states and created a mechanism to compare these tax systems according to how businesses are affected. All states are ranked according to five different indices: Corporate Income Tax, Individual Income Tax, Sales and Gross Receipts Tax, Unemployment Tax, and the Fiscal Balance Index.
The primary criterion to determine a state’s ranking is neutrality. To quote the study, “If a state’s tax system maintains a ‘level playing field’ for all types of businesses and business transactions, we consider it neutral and rate it highly.”
The good news for Texas is that we ranked No. 4 nationally, after South Dakota, Florida, and Alaska, for our overall business tax climate. That’s good news for Texas businesses (and businesses considering locating in Texas) and therefore Texas real estate. Many studies have confirmed that one of the primary factors in determining whether a business will locate or expand in a particular state is the tax laws of that state. Of course, other things such as an educated work force, transportation, and natural resources are also significant factors affecting where a business decides to locate. From a public policy point of view, however, tax laws are something clearly within the control of state government. It is good news that Texas has been able to construct a tax system that ranks so well nationally.
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The Texas legislature will likely consider changes to our state system of taxation in the near future. The debate is driven by a judicial decision (under appeal to the Supreme Court of Texas) that our current system of funding education is unconstitutional. Legislators would do well to consider any proposed legislative changes in the context of the Tax Foundation’s Tax Climate Index. Indeed, it is possible that the Legislature could enact legislation that would bump Texas into the top spot on the index, something that would further improve our ability to attract and expand business.
Our current system ranks well in the index because of our lack of a personal income tax and the relatively low level of state taxation overall. The high ranking on the latter index is somewhat misleading because of the significant local contribution to the cost of public education, something that isn’t measured in the index. Texas also ranked relatively high due to the structure of our unemployment tax.
Texas did not rank as well on the corporate income index, primarily because of the way our franchise tax works. It should be noted that many legislators are calling for reform or repeal of the franchise tax due to loopholes that allow many corporations to escape paying it entirely. Also, Texas did not rank as well on the sales-tax index, because of our relatively high sales-tax rate.
There is no question that tax policy will be one of the most important debates before the Texas Legislature in 2005. The Tax Foundation’s State Business Tax Climate Index is a useful tool to help guide that debate.
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