The states of taxation: Latest index reveals the best and the worst

Raymond Keating
Raymond Keating

During the recession and subsequent recovery, the general move on taxes in the states has been in a distinctly negative direction. That is, faced with budget deficits, states have reacted by raising taxes.

This past July, for example, the National Conference of State Legislatures reported: “The impact of the severe economic recession that began in 2007 continued to create substantial revenue shortfalls during 2010 legislative sessions. As a result, state legislatures were prompted to increase taxes and fees for the ninth consecutive year as they worked to shore up state budgets.”

The use of the word “prompted” is a bit odd, given the option to reduce or restrain spending is always present.

The effects of raising taxes for entrepreneurship, small businesses, investment and job creation are significant. Tax increases shift resources away from the private sector, diminish incentives for entrepreneurship and investment, hurt competitiveness and restrain economic activity. In the end, economic growth, incomes and job creation suffer.

The tax story, and how it affects entrepreneurs and businesses, has been laid out in the latest version of the Business Tax Index recently published by the Small Business & Entrepreneurship Council. The 2011 edition pulls together 18 different tax measures and combines those into one tax score. The 50 states and District of Columbia are then compared and ranked.

According to the index, the 15 best tax systems are found, in descending order, in: South Dakota, Texas, Nevada, Wyoming, Washington, Florida, Alabama, Alaska, Ohio, Colorado, South Carolina, Mississippi, Oklahoma, Virginia and Missouri.

The 15 worst state tax systems, from less worst to most worst, are: Illinois, North Carolina, Nebraska, Connecticut, Oregon, Rhode Island, Hawaii, Vermont, California, Maine, Iowa, New York, New Jersey, Minnesota and the District of Columbia.

Interestingly, some states in recent times have moved in a more positive direction, as opposed to increasing taxes on business and individuals. At least a few states have allowed bad policies to expire.

That was the case recently in terms of the expiration of temporary increases in personal income tax rates. The top rate declined, for example, from 10.55 percent to 10.3 percent in California, from 10.75 percent to 8.97 percent in New Jersey and from 7.983 percent to 7.75 percent in North Carolina.

Some small changes occurred in a few places on the corporate tax front as well. For example, the corporate income tax rate fell from 7.9 percent to 7.6 percent in Oregon, from 9.36 percent to 9 percent in New Jersey and from 9.5 percent to 8.25 percent in Massachusetts.

No doubt, these moves were small. And in each of these particular cases, given that rates are still so high and that these states rank poorly on the Business Tax Index, much more is needed to make each state competitive. But at least these are baby steps in the right direction.

In addition, an income tax surcharge is due to expire in New York at the end of this year. Maine passed a tax measure that will reduce its top personal rate from 8.5 percent to 7.95 percent in 2013. Again, small steps, but at least in a more positive direction.

These steps are certainly preferable to what happened in Illinois. A massive tax increase featured a jump in the personal income tax rate from 3 percent to 5 percent and the corporate tax leaped from 7.3 percent to 9.5 percent. That dragged Illinois down from 18th on the Business Tax Index in 2010 to 37th on the Business Tax Index in 2011.

In this climate of tax increases, just standing still or making a few smallish reductions in taxes can be viewed as positive. But especially in the states that rank poorly on the Business Tax Index, substantive and permanent tax relief is needed to spur innovation, investment, economic growth and job creation.


Raymond Keating is chief economist for the Small Business & Entrepreneurship Council.

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