October 31, 2023
2024 State Business Tax Climate Index: Complete Analysis
The 2024 State Business Tax Climate Index by the Tax Foundation provides an in-depth assessment of the competitiveness of the tax systems in the 50 U.S. states. This analysis is enhanced by considering the discussion around the very real complexities of comparing these diverse tax systems and their real-world impacts. While it may seem challenging to rank states with significantly different tax structures, such as Indiana and Alaska, which prioritize different tax types, the Index accomplishes this by evaluating more than 120 variables across five major areas of taxation, including corporate taxes, individual income taxes, sales taxes, unemployment insurance taxes, and property taxes.
By carefully assessing these variables, the Index provides a full view of how state tax systems impact business climates and overall economic prosperity. Here, we take a look at the key findings and methodologies of the 2024 Index, taking into account both the Index's results and relevant literature.
Key Findings From the 2024 State Business Tax Climate Index
Top 10 States: The top 10 states in the 2024 Index are Wyoming, South Dakota, Alaska, Florida, Montana, New Hampshire, Nevada, Utah, North Carolina, and Indiana. Notably, many of these states distinguish themselves by eliminating or significantly reducing major taxes like corporate income tax, individual income tax, or sales tax.
Bottom 10 States: The bottom 10 states include Rhode Island, Hawaii, Vermont, Minnesota, Maryland, Massachusetts, Connecticut, California, New York, and New Jersey. These states face challenges arising from complex, non-neutral taxes with relatively high rates, leading to less favorable business environments.
Key Ranking Changes in 2024: Several states have implemented tax reforms and changes in 2024, impacting their rankings in the Index. These changes encompass reductions in individual income tax rates, the elimination of taxes, and other reforms, which have contributed to improvements in the business tax climate in these states.
Upcoming Changes: The Index also acknowledges that some states have scheduled or enacted changes that are likely to influence their rankings in the future. These changes include alterations to individual and corporate income tax rates, property tax reforms, and other adjustments aimed at improving the business tax climate.
Literature ReviewThe economic literature has long debated the extent to which taxes influence individual and business decisions. Early theories like Charles Tiebout's concept of "voting with their feet" proposed that citizens would select communities offering the best combination of public services and taxes. This theory highlights the role of local taxes in shaping decisions about where to live.
However, businesses, driven by profitability, respond to taxes differently. Tax considerations weigh more heavily on corporate decisions due to their potential to reduce profitability. The economic literature over the last half-century gradually cohered around the notion that taxes indeed impact business location decisions. Studies and analyses found that taxes significantly affect the location of businesses, employment levels, and investment.
For example, research shows that state taxes, particularly corporate income tax rates, can have a substantial impact on the location decisions of businesses. Studies have also highlighted the importance of property taxes and other local taxes in influencing business start-ups and growth. Furthermore, research indicates that businesses are sensitive to relative tax burdens and often engage in "yardstick competition," comparing the costs of government services across jurisdictions.
Critically, several authors have argued against the notion that taxes have a significant influence on business location decisions, emphasizing the role of other factors, such as public expenditures. However, the evidence from recent literature, anecdotal accounts, and state-level tax policies suggests that taxes indeed play a vital role in business decision-making and economic growth.
Methodology of the State Business Tax Climate Index
The State Business Tax Climate Index employs a comprehensive methodology to assess the competitiveness of state tax systems, incorporating five major components: individual income tax, sales tax, corporate income tax, property tax, and unemployment insurance tax. Each component is evaluated based on the impact of tax rates and tax bases, which are composed of scalar and dummy variables.
To ensure the Index's fairness, components are not weighted equally – they are weighted based on the variability of the 50 states' scores from the mean. This approach allows for a more significant weighting of components with greater variability, reflecting areas of tax law where some states have substantial competitive advantages.
The Index utilizes a total of 125 variables, categorized into scalar variables (weighted at 80%) and dummy variables (weighted at 20%) within the subindices. This comprehensive approach offers a nuanced perspective on how state tax systems impact business environments, providing a valuable tool for policymakers and businesses looking to make informed decisions about their locations.
Additional Details About the Index’s AnalysisRelative Scoring: The State Business Tax Climate Index employs a relative scoring system, ranging from 0 to 10, where 0 does not represent the "worst possible" but rather the worst among the 50 states. This relative approach is beneficial as it helps identify variations among states with similar tax rates and provides valuable insights for business owners seeking the best tax systems within their respective regions.
Comparing States With and Without a Given Tax: A major challenge with relative scaling is that it's mathematically impossible to compare states with a specific tax to states without that tax. As states without a particular tax, like income or sales tax, enjoy a competitive advantage, they generally receive a score of 10, and the Index measures other states against each other. There are a few exceptions to this rule for states like Washington, Tennessee, and Texas, which tax some aspects differently, and zero sales tax states like Alaska, Montana, New Hampshire, Oregon, and Delaware, which don't score a perfect 10 due to excise taxes.
Normalizing Final Scores: To address the variation in average scores across the five components, scores are normalized to bring the average score for all components to 5. This ensures that each component carries an equal weight in the overall Index, allowing for meaningful comparisons between states. Normalization makes it possible to assert, for example, that a state's score on corporate income taxes is better than its score on individual income tax.
Time Frame (Snapshot Date): The Index provides a snapshot of each state's business tax climate at the start of the standard state fiscal year, which is July 1. Consequently, the 2024 Index reflects the tax climate as of July 1, 2023, corresponding to the first day of fiscal year 2024 for most states.
District of Columbia: The District of Columbia is included in the Index as an exhibit – and for the benefit of those who may operate businesses in Washington D.C. – but does not affect the scores or ranks of other states.
Past Rankings and Scores: The report includes rankings from 2014 to 2023 for comparison with the 2024 rankings. Discrepancies in rankings and scores may occur due to retroactive statutes, methodological changes, or corrections to variables.
Corporate Tax Component: The corporate tax component accounts for 20.9% of a state’s total score and evaluates the impact of each state's principal tax on business activities. The corporate tax component considers the top tax rate, the level at which the top rate applies, the number of tax brackets, tax credits, treatment of net operating losses, and other factors.
Corporate Tax Rate: The subindex assesses a state's corporate income tax top marginal rate, bracket structure, and gross receipts rate relative to other states. The top tax rate and the structure of brackets are considered in this assessment. States with low rates and simple structures score well.
Graduated Rate Structure: This aspect evaluates the application of multiple-rate corporate income tax systems, considering the income level at which the highest tax rate starts to apply and the number of tax brackets. Single-rate systems are preferred for simplicity and neutrality.
Corporate Tax Base: This subindex measures the economic impact of a state's corporate tax base. It assesses the availability of credits, deductions, and exemptions, the deductibility of net operating losses, and other factors.
Alternative Minimum Tax: The federal Alternative Minimum Tax (AMT) and its state-level counterparts are evaluated. States with an AMT are considered to have unnecessary tax complexity for the purposes of the Index and, generally, in practice.
The 2024 State Business Tax Climate Index not only offers insights into how state tax systems rank but also integrates valuable knowledge from economic literature to provide a broader context. It is clear that state tax systems have a significant impact on business location decisions and overall economic growth.
While the intricacies of tax structures across states make comparisons challenging, the Index effectively assesses these diverse systems, helping businesses and policymakers understand the competitive landscape. In an era where states are actively competing to attract businesses and talent, the role of tax systems in shaping business environments cannot be overstated.
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