The Tax Foundation has a new study on one of this blog’s favorite subjects, state business climate.
Location Matters: A Comparative Analysis of State Tax Costs on Business compares the states’ business tax structure as they affect two types of companies — “mature firms,” companies 10 years or older, and “new firms,” younger than three years old.
You can probably guess from the headline (my effort to write headlines based on Chicago songs) where Wisconsin ranks — 35th for “mature firms” and fourth for “new firms.” The difference is that, as the study puts it, “Mature firms are typically no longer eligible for any tax incentive programs while the new facility would be eligible for most incentives.”
The study compares the states’ business taxes as of April 1. That date is three months before this state’s 2011–13 state budget became law. The 2011–13 budget included a small number of business tax improvements, but not nearly enough of them.
The Tax Foundation expands on its new vs. old company rankings by ranking the tax climate for mature and new corporate headquarters, R&D facilities and retail stores in metropolitan areas the size of Milwaukee, along with call centers, distribution centers, and capital- and labor-intensive manufacturing firms in metropolitan areas the size of Eau Claire. The study concludes that corporate headquarters, R&D facilities and retail stores are more likely to be found in Milwaukee-size areas, where call centers, distribution centers and manufacturers are more likely to be found in Eau Claire-size communities. (For instance, there is Convergys in Appleton, ShopKo’s distribution center is in De Pere, and Northeast Wisconsin is full of fire truck manufacturers.) Taxes measured include corporate net income taxes, gross receipts and franchise taxes, property taxes, unemployment insurance taxes, and sales taxes on “business equipment, machinery and inputs.”
For mature firms, Wisconsin ranks 38th for corporate headquarters, 16th for R&D facilities, 37th for retail stores, 19th for call centers, 34th for distribution centers, 42nd for capital-intensive manufacturing, and 39th for labor-intensive manufacturing. For new companies, Wisconsin ranks third for corporate headquarters, fourth for R&D facilities, 40th for retail stores, second for call centers, 29th for distribution centers, 14th for capital-intensive manufacturing and sixth for labor-intensive manufacturing.
Explanations for the rankings, from best to worst:
Call centers: “This operation has the lowest income tax costs in the nation due to the state’s generous job and investment tax credits and the sourcing rules that place the operation’s income out of state where the benefits are received. Additionally, the state offers the highest withholding tax rebate in the nation.”
R&D: “The main driver is that this operation has no income tax burden, due to the state’s R&D tax credit and sourcing rules that place much of the operation’s income out of state where the benefits are received. This operation also faces the ninth-lowest sales tax burden in the nation.”
Retail: “The main factor is that this operation faces the ninth-highest property tax burden in the nation, as well as the tenth highest unemployment insurance tax burden.”
Manufacturing: “The main factor is that the income tax burden is seventh-highest in the nation, in part because the state disallows the manufacturing deduction and has a throwback rule on tangible property sales, which exposes all of the operation’s income to in-state tax.”
One of the most surprising revelations is how poorly Wisconsin ranks in manufacturing taxes given how much manufacturing takes place in Wisconsin. The reason may be summed up in three words: “because we can.” State government policy seems to assume that established manufacturers can be heavily taxed because they can’t go anywhere else. People in Janesville, former home of a General Motors plant, and Kenosha, former home of a Chrysler plant, might disagree with that assumption.
The report says this about manufacturing taxes:
The common elements of these 10 highest tax cost states are high corporate income tax burdens and high property tax burdens. All of these states employ a throwback or throwout rule in their apportionment formula and most of them have relatively high corporate income tax rates. …
Many of these states have either high property tax rates on land, buildings, and equipment, or broader property tax bases that include inventories. … There are nine states that tax inventories in addition to land, buildings, and equipment, four of which are represented in this group of uncompetitive states: Arkansas, Mississippi, West Virginia, and Wisconsin.
About Wisconsin’s new-firm rankings, the report says:
Six of the 10 states with the lowest tax burdens for mature firms are also among the 10 states with the lowest tax burdens for new firms. By and large, some of the same factors that lower the tax burdens for mature firms also benefit new firms. These include such things as the lack of an income tax in Wyoming, a low-rate gross receipts tax in Ohio that only taxes in-state sales, or a single-sales factor in Georgia, Louisiana and Nebraska. Indeed, other states such as Wisconsin, Oklahoma, Kentucky, and Arkansas – which were not in the top 10 for mature firms but do rank in the top 10 for new operations – also weight their apportionment factors toward sales.
Why do these states rank well overall for new operations? The other common trait that binds these states is that they tend to be very aggressive with tax incentives for new operations. … Wyoming stands out from the pack because it achieved a top 10 ranking without offering targeted tax incentives. Of course, it could be argued that Wyoming’s greatest “incentive” policy is simply not levying an income tax. …
Arkansas, Kentucky, Oklahoma, and Wisconsin all went from ranking in the middle of the pack for mature firms to ranking in the top 10 states for new firms because of the extent of their tax incentive programs. In each of the seven firm types, Wisconsin and Arkansas in particular are consistently among the most generous states in offering a complete array of tax incentives, from property tax abatements to job credits.
Put the measures together, and one can conclude that this state’s tax structure is good for new firms, but not good for existing firms — sort of a carrot-then-stick approach, or a bait-and-switch approach, as if state government policy is to dangle incentives to get firms here, then tax them to the eyeballs assuming they’d never leave or scale back their Wisconsin operations. The former are able to use such tax incentives as new-job-creation tax credits (which “must generally be considered ‘qualified’ by state officials and only be available to certain types of industries”) and payroll tax rebates, investment tax credits, R&D tax credits, and property tax abatements.
Is that a good approach? The study notes:
While many state officials view tax incentives as a necessary tool in their state’s ability to be competitive, others are beginning to question the cost-benefit of incentives and whether they are fair to mature firms that are paying full freight. Indeed, there is growing animosity among many business owners and executives to the generous tax incentives enjoyed by some of their direct competitors.
Put another way, established businesses are paying for the incentive programs used by new businesses, which could be their potential competitors for customers and employees. It could be seen as the Social Security system in reverse if such programs were financially self-contained. (Communities’ revolving business loan funds operate similarly.) This is related to tax-incentive programs for favored industries, such as “green” energy, and we’ve seen how well that’s worked out the past couple of years. If it’s dangerous to use the tax laws to favor certain industries and not others, it’s also dangerous to use the tax laws to favor certain-age businesses and not others.
A state that has a corporate income tax (a tax on profits) instead of a gross receipts or business activity tax (a tax on business revenue, whether profitable or not) obviously will tax new businesses less than established businesses, because it takes time for new businesses to become profitable. Given that no enterprise survives long if it sends out more money than it takes in, a business that’s been in business more than a decade is probably making money, while a business that’s less than three years old may not be yet, depending on the financial contributions of the owners.
Economists will tell you that employment growth is more often found in new businesses. That makes logical sense; for a business that didn’t exist a year ago, its employment from then until now is infinite if it hires one employee, and employment growth doubles if it hires one more employee the next year. A mature business has probably figured out how many employees it needs to do business, and without growth, it has little reason to substantially grow its employment. So new business incentive programs do have a rationale that makes sense behind them.
On the other hand, go to any community, and the largest private-sector employers are among that community’s oldest private-sector employers. Those are the companies that can afford more employee benefits and that make bigger contributions to their communities, whether that means large-scale United Way involvement or their own favorite local causes. So why should tax policy favor new businesses over established businesses?
There is also this reality the study notes:
For the purposes of this study it is assumed that the business bears the entire burden of the tax, which is why the owners are so sensitive to the costs and why states compete to offer tax incentives. Economists, however, typically look at business taxes in terms of who bears the actual economic burden of the tax, not just the legal burden. That is because corporations are simply legal entities, not people per se. In economic terms, the real burden (or incidence) of business taxes is borne by customers through higher prices, workers through lower wages, or owners and shareholders through lower returns on their investment.
Any one of those groups — business customers, workers, and business owners and shareholders — can use the money government siphons off better than government can.
This study’s results are ironic as well given that the same Tax Foundation ranks Wisconsin 43rd in its 2012 State Business Tax Climate Index — 32nd in corporate taxes, 45th in personal income taxes, 16th in sales taxes, 21st in unemployment insurance taxes, and 32nd in property taxes. Location Matters measures only taxes (as well as tax incentives) on business. The State Business Tax Climate Index includes personal income taxes (where Wisconsin ranks worst) and counts them 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.
The ultimate measure of business climate is the state’s economy. And Wisconsin ranks poorly in such business-vitality measures as start-ups and incorporations, in-state corporate headquarters, and abysmally in venture capital spending. The state’s residents, which include business owners as well as their employees, have trailed the nation in per capita personal income growth since “Star Wars” and “Saturday Night Fever” were premiering in a movie theater near you. Gov. Scott Walker and the state Legislature have a lot more work to do.