Why State Tax Systems Matter

While we all face the same federal tax code, the story on state and local taxes can and does vary considerably state by state. And that most certainly matters as to where entrepreneurs and investors decide to take risks, that is, where to start up, build and invest in businesses, and therefore where jobs are created and where people live.


The just-published “Business Tax Index 2012: Best to Worst State Tax Systems for Entrepreneurship and Small Business” from the Small Business & Entrepreneurship Council (which I author each year) is an annual ranking of the 50 states and District of Columbia according to 18 different broad tax costs.

This index gets at how heavily tax burdens, state by state, fall on the entrepreneurial sector of the economy. Given that entrepreneurship and investment are the sources of innovation, economic growth and job creation, everyone should be concerned about such burdens.

As noted in the report, the 18 measures are: 1) state’s top personal income tax rate, 2) state’s top individual capital gains tax rate, 3) state’s top corporate income tax rate, 4) state’s top corporate capital gains tax rate, 5) any added income tax on S-Corporations, 6) whether or not the state imposes an alternative minimum tax on individuals, 7) whether or not the state imposes an alternative minimum tax on corporations, 8) whether or not the state’s personal income tax brackets are indexed for inflation, 9) property taxes, 10) consumption-based taxes (i.e., sales, gross receipts and excise taxes), 11) whether or not the state imposes a death tax, 12) unemployment taxes, 13) whether or not the state has a tax limitation mechanism, 14) whether or not the state imposes an Internet access tax, 15) “Amazon” taxes, 16) gas tax, 17) diesel tax, and 18) wireless taxes.

The bottom line is that these taxes reduce the incentives and/or resources available for building businesses, serving consumers and expanding employment.

So, which states rank the best? Well, the top 15 states on this year’s “Business Tax Index” are: 1) South Dakota, 2) Texas, 3) Nevada, 4) Wyoming, 5) Washington, 6) Florida, 7) Alaska, 8)Alabama, 9) Ohio, 10) Colorado, 11) Mississippi, 12) Michigan, 13) South Carolina, 14) Tennessee, and 15) Missouri.

The big plusses for the top five states were no personal income, corporate income and capital gains taxes. The next two states impose no personal income tax. For good measure, number eight has the lowest property taxes, and number nine imposes no corporate income tax. Those are huge competitive advantages for those states.

At the other end, the worst 15 states are: 37) Nebraska, 38) North Carolina, 39) Illinois, 40) Oregon, 41) Rhode Island, 42) Connecticut, 43) Hawaii, 44) Vermont, 45) California, 46) Maine, 47) Iowa, 48) New York, 49) New Jersey, 50) Minnesota, and 51) District of Columbia.

These are the states that, with a few exceptions, impose high taxes across the board.

As for other recent actions that have affected where states rank, several states have made positive – to varying degrees – changes in terms of their income taxes, such as Michigan, North Dakota, Delaware, Oklahoma, and Ohio.

Moving in the opposite direction – that is, making matters worse – in recent times have been Connecticut, Illinois, New York and Oregon, along with the District of Columbia.

Besides income-based taxes, another levy that certainly influences decisions as to investment and business is the death tax, which is imposed in 22 states and the District of Columbia. After paying a lifetime of taxes and fees to the government, death taxes are imposed on total assets at death, and therefore, rank as unfair and destructive levies. It is worth noting that Ohio’s death tax will be eliminated next year (to be reflected in next year’s Business Tax Index), and Indiana has begun a long phase out of its death levy. Heading in the other direction was Illinois, which re-imposed a death tax in early 2011.

Finally, consider a few key points contrasting the four largest states in the nation. Texas and Florida rank among the best states (second and sixth, respectively) on the “Business Tax Index,” and are light years ahead of California and New York (ranking 45th and 48th, respectively) in terms of tax burdens.

Texas, again, has no personal and corporate income and capital gains taxes, while Florida has no personal income tax. Meanwhile, both California and New York impose some of the highest individual and corporate income and capital gains taxes in the nation. In fact, California has the highest individual state capital gains tax rate.

Gasoline and diesel taxes are extremely high in California and New York, while relatively low in Texas.

In addition, while Texas and Florida impose no death taxes, New York does inflict such a levy.

By the way, it’s no mere coincidence that California and New York rank as the top exporters of people to other states, while Texas and Florida gain population from the rest of the nation. Why? Well, a big part of the answer is that taxes matter.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His new book is “Chuck” vs. the Business World: Business Tips on TV.