The Tax Foundation’s Hocus Pocus

The Tax Foundation's corporate tax ranking system is unconventional, to say the least.

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If you were a business owner deciding where to build your next plant, would you just throw a dart at a map? Probably not. But that would make just about as much sense as relying on the Tax Foundation’s ranking of state business climates.

Every year the Tax Foundation creates a new State Business Tax Climate Index (SBTCI) by stirring together over 100 features of state tax law and producing out of that stew a single number for each state. (Oregon’s number gets it ranked 11th best.) But that number, supposedly representing the tax climate, bears very little relationship to what businesses actually pay in taxes.

On my web site devoted to debunking business climate rankings, I compared the Tax Foundation’s scores with conventional and much more defensible measures of the actual taxes businesses pay in one state versus another, published by the Council on State Taxation. Of the Foundation’s top 10 states — those with supposedly the most competitive tax systems —seven actually have business tax levels higher than the average among the 50 states. Two of those states are among the ten with the highest business taxes according to COST.

The Tax Foundation acknowledges that it is not measuring actual tax levels on business, but rather the states’ tax structure. But the Foundation provides no evidence that its index, or that tax structure, influences business decisions. If you were a business owner, 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 COST, the property tax accounts for 43 percent of all business taxes, the corporate income tax just 11 percent. Yet in coming up with the overall state rankings, the Tax Foundation weights the property tax 15 percent, the corporate income tax 18.5 percent.

More importantly, the whole focus on business tax competitiveness is misplaced. First of all, state and local taxes are a very small share of overall business costs, and have been shown by numerous research studies to have little measurable effect on location decisions. Furthermore, state job growth depends very little on the migration of businesses into and out of a state to begin with. What really matters is the rate of new business formation and the expansion of existing firms.  And what matters most for entrepreneurial vibrancy is the education level of the state’s residents.

Should Oregonians care about Oregon’s ranking on the State Business Tax Climate Index? If they want to predict how the state economy would fare under a new tax system, they would do about as well consulting an astrologer.

Peter Fisher
Research Director, The Iowa Policy Project

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