The latest evidence that Gov. Scott Walker and the state Legislature haven’t done enough to improve the state’s business climate comes from the Tax Foundation’s 2012 State Business Tax Climate Index.

In 2011, after eight years of Democratic Gov. James Doyle and two years of a Democratic-controlled Legislature, Wisconsin ranked 41st among the 50 states.

In 2012, after a year of Republican Gov. Scott Walker and a Republican-controlled Legislature, Wisconsin ranks 43rd — 32nd in corporate taxes, 45th in personal income taxes, 16th in sales taxes, 21st in unemployment insurance taxes, and  32nd in property taxes.

In the Midwest, Wisconsin trails Indiana (11th), Michigan (18th), Illinois (28th, although the Land of Lincoln dropped 12 spots), Ohio (39th) and Iowa (41st), and leads only Minnesota (45th).

Wisconsin dropped because other states improved their business tax climates. Republicans might argue that the Legislature was too busy repairing the fiscal disaster area in which Doyle and Democrats left the state, but that doesn’t help convince someone sitting in an office figuring out how much doing business in Wisconsin will cost that business to come here.

Why does a state’s business tax environment matter?

It is important to remember that even in our global economy, states’ stiffest and most direct competition often comes from other states. The Department of Labor reports that most mass job relocations are from one U.S. state to another, rather than to an overseas location. Certainly job creation is rapid overseas, as previously underdeveloped nations enter the world economy without facing the second-highest corporate tax rate in the world, as U.S. businesses do. So state lawmakers are right to be concerned about how their states rank in the global competition for jobs and capital, but they need to be more concerned with companies moving from Detroit, MI, to Dayton, OH, rather than from Detroit to New Delhi. This means that state lawmakers must be aware of how their states’ business climates match up to their immediate neighbors and to other states within their regions.

Anecdotes about the impact of state tax systems on business investment are plentiful. In Illinois early last decade, hundreds of millions of dollars of capital investments were delayed when then-Governor Rod Blagojevich proposed a hefty gross receipts tax. Only when the legislature resoundingly defeated the bill did the investment resume. In 2005, California-based Intel decided to build a multi-billion dollar chip-making facility in Arizona due to its favorable corporate income tax system. In 2010 Northrup Grumman chose to move its headquarters to Virginia over Maryland, citing the better business tax climate. Anecdotes such as these reinforce what we know from economic theory: taxes matter to businesses, and those places with the most competitive tax systems will reap the benefits of business-friendly tax climates.

The study counts personal income taxes (where Wisconsin ranks worst) most, in  keeping with the large number of sole proprietors, partnerships,  subchapter-S corporations and similar corporate entities in which profits and losses flow through to the shareholders. Sales taxes rank second, since sales taxes certainly affect how much product or service someone can buy. Corporate income taxes, which are paid by a business’ customers, rank third.

Wisconsin has five income tax brackets, from 4.6 percent to 7.75 percent. Under the maxim that if you want less of something, tax it more, Wisconsin’s official policy appears to be that we don’t want “rich” people, since we tax income of more than $152,740 at 6.75 percent and income of more than $224,210 at 7.75 percent.

Wisconsin bombs on personal income taxes not just because the rates (including the new rate the 2009–10 Legislature foisted on us) are too high:

Meanwhile, states where the tax base is found to cause an unnecessary drag on economic activity are New Jersey, New York, Wisconsin, California, Georgia, Maryland, Minnesota, and Virginia.

Marriage Penalty. A marriage penalty exists when a state’s standard deduction and tax brackets for married taxpayers filing jointly are not double those for single filers. As a result, two singles (if combined) can have a lower tax bill than a married couple filing jointly with the same income. This is discriminatory and has serious business ramifications. The top-earning 20 percent of taxpayers is dominated (85 percent) by married couples. This same 20 percent also has the highest concentration of business owners of all income groups . …

Double Taxation of Capital Income. … The ultimate source of most capital income—interest, dividends and capital gains—is corporate profits. The corporate income tax reduces the level of profits that can eventually be used to generate interest or dividend payments or capital gains. This capital income must then be declared by the receiving individual and taxed. The result is the double taxation of this capital income—first at the corporate level and again on the individual level.

All states with an individual wage income tax score poorly by this criterion. …

The Federal Alternative Minimum Tax (AMT). The Alternative Minimum Tax (AMT) was created in 1969 to ensure that all taxpayers paid some minimum level of taxes every year. Unfortunately, it does so by creating a parallel tax system to the standard individual income tax code. Evidence shows that the AMT is an inefficient way to prevent tax deductions and credits from totally eliminating tax liability. As such, states that have mimicked the federal AMT put themselves at a competitive disadvantage through needless tax complexity. Nine states score poorly for having an AMT on individuals: California, Colorado, Connecticut, Iowa, Maine, Minnesota, Nebraska, New
York, and Wisconsin.

Wisconsin’s personal income tax penalizes married couples and taxes investment income. (See previous maxim about getting less of something by taxing it more.)

The fact the state has a flat corporate income tax rate is good. The fact that the corporate income tax rate is 7.9 percent is bad. Three states — Nevada, South Dakota and Wyoming — have the correct corporate income tax rate: Zero. And when there are no corporate income taxes (or substitutes such as gross receipts taxes), there is no need for job, R&D, investment or any other tax credits. Nor are there issues about what’s deductible from corporate income taxes, or carrybacks or carryforwards. Nor is there any legislative lobbying over corporate income tax provisions.

The state’s sales tax rate of 5 percent is lower than our neighbors, until a future Legislature increases the sales tax for education, as if more school spending means better schools. (The only thing preventing the sales tax from being extended to groceries is the likelihood of legislators’ surviving the day they vote for that.) There also have been proposals to extend the sales tax to professional services that are not currently taxable; those proposals never include words like “and then reduce the sales tax rate,” of course. The state has high gas and diesel taxes, though no longer the highest since automatic indexing of fuel taxes ended, and at least we don’t also pay sales taxes on gas and diesel.

The one state tax that could be considered low is the alcohol tax — 6 cents per gallon of beer and $3.25 per gallon of liquor — until, that is, the anti-alcohol scolds succeed in getting a future Legislature to raise alcohol taxes because alcohol makes people do dumb things. (That’s the same rationale as banning guns because guns kill people.)

As I’ve written here before, taxes are one component — arguably the most important component, but not the only component — of a state’s business climate. Of course, overregulation inevitably shows up in taxes too, because regulations take government employees to enforce, and employees and what supports government employees (office space, computers, etc.) cost money. The only thing state government spends more money on than employees is shared revenues to the state’s 3,120 units of government.

So how should the Legislature improve the state’s business tax climate? The Tax Foundation has two guiding principles:

1. Taxes matter to business. Business taxes affect business decisions, job creation and retention, plant location, competitiveness, the transparency of the tax system, and the long-term health of a state’s economy. Most importantly, taxes diminish profits. If taxes take a larger portion of profits, that cost is passed along to either consumers (through higher prices), employees (through lower wages or fewer jobs), or shareholders (through lower dividends or share value). Thus a state with lower tax costs will be more attractive to business investment, and more likely to experience economic growth.

2. States do not enact tax changes (increases or cuts) in a vacuum. Every tax law will in some way change a state’s competitive position relative to its immediate neighbors, its geographic region, and even globally. Ultimately it will affect the state’s national standing as a place to live and to do business. Entrepreneurial states can take advantage of the tax increases of their neighbors to lure businesses out of high-tax states.

In reality, tax-induced economic distortions are a fact of life, so a more realistic goal is to maximize the occasions when businesses and individuals are guided by business principles and minimize those cases where economic decisions are influenced, micromanaged, or even dictated by a tax system. The more riddled a tax system is with politically motivated preferences, the less likely it is that business decisions will be made in response to market forces.

That first point — taxes diminish profits — gets to the core of a business, and in fact so-called “nonprofits” as well. Nothing happens unless there’s more money coming in than going out. No business or organization that has more money going out than coming in has much of a future.

If this makes you wonder about the Legislature’s priorities, it should. Walker seems likely to survive his recall attempt, but Republican state senators may not. If the Senate switches sides, that will end any chance of tax cuts, since we know that Democrats have already proposed business tax increases as part of their proposal to reduce government waste, fraud and abuse.

The Legislature needs to eliminate corporate income taxes (and not replace them with something worse, such as gross receipts taxes) and reduce personal income taxes, both in rate and in ending the marriage penalty and investment taxation. If that means, as inconceivable in the People’s Republic of Wisconsin as it may seem, cutting government spending (instead of crowing about how government spending increased by only 1 percent), then that is what’s required. Holding the line on property taxes was fine, except that property taxes are relatively low for manufacturers, thanks to the Manufacturing & Equipment exemption (signed into law by Gov. Patrick Lucey, Wisconsin’s last pro-business Democrat). Holding the line on other business taxes, particularly the sales tax, should go without saying.

Business tax climate is less about the businesses in Wisconsin now than it is about the businesses that may, or may not, decide to locate in Wisconsin. It could be argued that businesses now in Wisconsin have reconciled themselves to the state’s crappy tax climate. (Except, of course, for those that decide to leave Wisconsin.) But Wisconsin trails the nation in such measures of business vitality as start-ups and incorporations, venture capital and, for nearly three and a half decades, per capita personal income growth. Wisconsin also is a leader, if you want to call it that, in business corporate headquarters leaving the state, beginning with Kimberly–Clark’s headquarters departure for Texas in the 1980s.

That previous paragraph means that if you want to see the bad business trends reversed and as a result see more private-sector jobs in Wisconsin (because private-sector jobs are the only jobs that count from a macroeconomic perspective), you need to improve the environment into one where business will not be penalized by government by onerous taxation. The word “Wisconsin” does not mean “onerous taxation” in either an American Indian language or in French, but it should.