2013 State Business Tax Climate Index

by Scott Drenkard, Joseph Henchman

The Tax Foundation’s 2013 edition of the State Business Tax Climate Index enables business leaders, government policymakers, and taxpayers to gauge how their states’ tax systems compare.

The 10 best states in this year’s Index are:

• 1. Wyoming
• 2. South Dakota
• 3. Nevada
• 4. Alaska
• 5. Florida
• 6. Washington
• 7. New Hampshire
• 8. Montana
• 9. Texas
• 10. Utah

The absence of a major tax is a dominant factor in vaulting many of these ten states to the top of the rankings. Property taxes and unemployment insurance taxes are levied in every state, but there are several states that do without one or more of the major taxes: the corporate tax, the individual income tax, or the sales tax. Wyoming, Nevada, and South Dakota have no corporate or individual income tax; Alaska has no individual income or state-level sales tax; Florida has no individual income tax; and New Hampshire and Montana have no sales tax.

The lesson is simple: a state that raises sufficient revenue without one of the major taxes will, all things being equal, have an advantage over those states that levy every tax in the state tax collector’s arsenal.

The 10 lowest ranked, or worst, states in this year’s Index are:

• 41. Maryland
• 42. Iowa
• 43. Wisconsin
• 44. North Carolina
• 45. Minnesota
• 46. Rhode Island
• 47. Vermont
• 48. California
• 49. New Jersey
• 50. New York

Despite moderate corporate taxes, New York scores at the bottom this year by having the worst individual income tax, the sixth-worst unemployment insurance taxes, and the sixth-worst property taxes. The states in the bottom 10 suffer from the same afflictions: complex, non-neutral taxes with comparatively high rates.

Maine had the most sizable rank improvement this year, as a repeal of their alternative minimum tax and a change in treatment of net operating losses vaulted them from 37th to 30th best overall. Michigan made a sizable leap by replacing their cumbersome and distortionary gross receipts tax (the Michigan Business Tax) with a flat 6 percent corporate income tax that is largely free of special tax preferences. This improved their overall rank from 18th to 12th best, and their corporate ranking from 49th to 7th best.

(Hawaii dropped from 35th to 37th. – Editor)

The 2013 Index represents the tax climate of each state as of July 1, 2012, the first day of the standard 2013 state fiscal year.

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LINK: FULL TEXT of Report

Hawaii-related Excerpts:

Indexation of the Tax Code (p14).

For states that have multiple-bracket income tax codes, it is important to index the brackets for inflation. That prevents de facto tax increases on the nominal increase in income due to inflation. Put simply, this “inflation tax” results in higher tax burdens on taxpayers, usually without their knowledge or consent. All sixteen states with graduated corporate income taxes fail to index their tax brackets: Alaska, Arkansas, Hawaii, Iowa, Kansas, Kentucky, Louisiana, Maine, Mississippi, Nebraska, New Jersey, New Mexico, North Dakota, Ohio, Oregon, and Vermont.

Individual Income Tax (p16):

The bottom ten states are Hawaii, Ohio, North Carolina, Minnesota, Maryland, Wisconsin, Vermont, New Jersey, California, and New York. The individual income tax systems in these states tend to have high tax rates and very progressive bracket structures. They generally fail to index their brackets, exemptions, and deductions for inflation, do not allow for deductions of foreign or other state taxes, penalize married couples filing jointly, and do not recognize LLCs and S corps.

Top Marginal Tax Rate (p17):

Hawaii has the highest top income tax rate of 11 percent. Other states with high top rates include California (10.3 percent), Oregon (9.9 percent), New Jersey (8.97 percent), Vermont (8.95 percent), and New York (8.82 percent).

Number of Brackets (p18):

Hawaii scores the worst in this variable by having 13 tax brackets. Other states with many brackets include Missouri (with 11 brackets), and Iowa and Ohio (10 brackets).

Sales Tax

(p20) States that create the most tax pyramiding and economic distortion, and therefore score the worst, are states that levy a sales tax that generally allows no exclusions for business inputs. Hawaii, New Mexico, Washington, and South Dakota are examples of states that tax many business inputs. The ideal base for sales taxation is all goods and services at the point of sale to the end user.

(p22) States with the worst scores on the base sub-index are Hawaii, New Mexico, Washington, South Dakota, and North Carolina. Their tax systems hamper economic growth by including too many business inputs, excluding too many consumer goods and services, and/or imposing excessive rates of excise taxation.

(p23) States that create the most tax pyramiding and economic distortion, and therefore score the worst, are states that levy a sales tax that generally allows no exclusions for business inputs. Hawaii, New Mexico, South Dakota, and Washington are examples of states that tax many business inputs.

State Sales Tax Rate (p21):

Of the forty-five states with a statewide sales tax, Colorado’s 2.9 percent rate is lowest. Seven states have a 4 percent state-level sales tax: Alabama, Georgia, Hawaii, Louisiana, New York, South Dakota, and Wyoming. At the other end is California with a 7.25 percent state sales tax, including a mandatory statewide local add-on tax of 1 percent. Tied for second-highest are Indiana, Mississippi, New Jersey, Rhode Island, and Tennessee (all at 7 percent). Other states with high statewide rates include Minnesota (6.875 percent) and Nevada (6.85 percent).

Local Option Sales Tax Rates (p21)

States with the highest combined state and average local sales tax rates are Tennessee (9.43 percent), Arizona (9.12 percent), Louisiana (8.86 percent), and Washington (8.83 percent). At the low end are Alaska (1.79 percent), Hawaii (4.35 percent), and Maine and Virginia (both 5 percent).

Sales Tax on Gasoline (p23)

There is no economic reason to exempt gasoline from the sales tax, as it is a final retail purchase by consumers. However, all but six states do so. While all states levy an excise tax on gasoline, these funds are often dedicated for transportation purposes: a form of user tax distinct from the general sales tax. The six states that fully include gasoline in their sales tax base (California, Georgia, Hawaii, Illinois, Indiana, and Michigan) get a better score. Connecticut and New York get partial credit for applying an ad valorem tax to gasoline sales, but at a different rate than for the general sales tax.

Tobacco, spirits, and beer excise taxes (p23)

States with the highest tobacco taxes per pack of twenty cigarettes are New York ($4.35), Rhode Island ($3.50), Connecticut ($3.40), Hawaii ($3.20), and Washington ($3.03) while states with the lowest tobacco taxes are Missouri (17 cents), Virginia (30 cents), Louisiana (36 cents), and Georgia (37 cents).

States with the highest beer taxes on a per gallon basis are Alaska ($1.07), Alabama ($1.05), Georgia ($1.01), and Hawaii ($0.93) while states with the lowest beer taxes are Wyoming (2 cents), Missouri (6 cents), and Wisconsin (6 cents). States with the highest spirits taxes per gallon are Washington ($26.70), Oregon ($23.03), and Virginia ($20.91).

Tax Rates Imposed in the Most Recent Year (p28)

Maximum Tax Rate. States with lower maximum rates score better. The maximum rates in effect in the most recent year range from 5.4 percent (in Alaska, Florida, Hawaii, Mississippi, Nevada, New Mexico, and Oregon) to 13.5

Unemployment Insurance Tax Rate (p29)

Least Favorable Schedule: Minimum Tax Rate. Twelve states receive the best score in this variable with a minimum tax rate of zero percent. The states with the highest minimum tax rates and, thus, the worst minimum tax scores are New Mexico (2.7 percent), Hawaii (2.4 percent), Maryland and Oregon (2.2 percent), and Rhode Island and Connecticut (1.9 percent).

Temporary Disability Insurance (TDI). (p31)

A handful of states—California, New Jersey, Hawaii, and New York—have established a temporary disability insurance (TDI) program that augments the UI program by extending benefits to those unable to work because of sickness or injury. No separate tax funds them; the money comes right out of the state’s unemployment fund, and because the balance of the fund triggers various taxes, the TDIs are included as a negative factor in the calculation of this sub-index.