The Tax Foundation’s 2014 Business Tax Rankings made a splash by announcing that Texas had fallen to 11th place, down from ninth place in 2013.
We at the Texas Taxpayers and Research Association have a tremendous amount of respect for the Tax Foundation but take issue with its annual scoring of “business” tax climates. It simply isn’t what the foundation claims it to be — a measure of business taxation.
Its rankings are based on a weighted average of five taxes, each separately scored on a mix of factors. States are ranked from 1 to 50, with 1 being the “best” (i.e., lowest). Texas scores well down in the 30s on our major taxes — property, sales and corporate taxes — and 14th in unemployment taxes, but our overall combined rank soars to 11th. That’s because the foundation’s overall score heavily rewards states, like Texas, that don’t have a personal income tax. While the lack of an income tax is a certainly an overall positive for Texas, it is a tax on individuals and not businesses. It should not count as one-third of a state’s “business” tax ranking, which is how the foundation scores it.
This weighting of the various taxes is a key flaw in the analysis because it doesn’t relate to the amounts of taxes businesses actually pay. The biggest tax Texas businesses pay is the property tax, but the foundation considers it less than half as important as the personal income tax. Direct corporate taxes, which account for only about 7.5 percent of a business’s total tax liability, account for 20 percent of a state’s score. And seemingly ignored in the foundation’s scoring are special industry taxes — severance, utility, insurance and excise taxes — that account for almost a fourth of all business taxes.
The foundation makes much of the fact that Texas’ overall score dropped from ninth last year to 11th in 2014, blaming it on the Texas franchise, or margins, tax, which it terms “one of the most destructive taxes around” — even though it’s been around since 2008, and the only changes to the tax since then have been to exempt more businesses, cut the tax rate and reduce the tax base (all of which should improve our ranking).
The foundation’s own data does not support its conclusion. Texas’ margin tax ranked 38th in both years. All other Texas taxes also matched their prior ranking, with one exception: the property tax. Texas fell in the foundation’s overall rankings because of its worsening property tax score, which dropped from 32nd to 35th.
Even more curious is the fact that the foundation subjectively downgrades a state for having credits for research and development, investment and jobs — incentives that economic literature confirms are effective tools to attract new business investment. This session, Texas lawmakers passed a new incentive for research and development that may create nearly 100,000 new jobs in Texas and $13 billion in economic activity. The foundation, though, says these incentives “distort the free market.” No business ever located a research and development facility in a state because it expressly did not offer a tax credit. The foundation’s rankings miss the point. Taxes distort the free market. Relief from taxes does not.
So where does Texas really rank? TTARA’s analysis puts Texas with the 33rd lowest tax burden on business across the states — roughly where the Tax Foundation ranks our property, sales and corporate taxes and leaving plenty of room for improvement. For individuals, we have the third-lowest effective tax rate — outstanding, thanks to the lack of a personal income tax. Both of those numbers draw from the work of the Council on State Taxation and are based on actual dollars paid relative to economic production — no subjectivity, just simple math.
Texas is a wonderful place to do business. We have a strong economy, great people, rational tort laws and an efficient regulatory environment. Our taxes on business are not our best selling point, but even so, the Tax Foundation misses the mark. The problem is not the franchise tax. It is our expansive property taxes — particularly those on business personal property — and our sales taxes on many business purchases. We can do better, but will never improve our tax system if we fail to recognize what the real challenges are.
Dale Craymer, an economist, is president of the Texas Taxpayers and Research Association.