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(2/27/2006)

Study Shows South Dakota Has "Business Friendly" Tax Code

State ranked #2 overall

Washington, D.C.—The ten states with the most business-friendly tax systems this year are: Wyoming, South Dakota, Alaska, Florida, Nevada, New Hampshire, Texas, Delaware, Montana and Oregon.

This ranking comes from the third edition of the Tax Foundation’s State Business Tax Climate Index, by Foundation economist Curtis S. Dubay and Scott A. Hodge, President of the Tax Foundation. The study ranks the 50 states on how “business friendly” their tax systems are, providing a roadmap for state lawmakers concerned with keeping their states tax-competitive. (Click here for audio of the media conference call announcing the study's release.)

“Every one of the best tax systems raises sufficient revenue without imposing at least one of the three major state taxes—sales taxes, personal income taxes and corporate income taxes,” said Dubay.

The ten states with the least hospitable business tax climates are: New York, New Jersey, Rhode Island, Ohio, Vermont, Maine, Kentucky, Nebraska, Iowa and Arkansas.

“States do not enact tax changes in a vacuum,” said Hodge. “Every tax change will affect a state’s competitive position relative to its neighbors, as well as globally.”

The goal of the index is to focus lawmakers on good tax fundamentals in their states, rather than short-term tax abatements and exemptions designed to temporarily lure high-profile companies, baseball teams, and auto plants from other states.

“The temptation is for state lawmakers to lure high-profile companies with packages of tax bonuses,” said Hodge, “but that strategy can backfire.”

For example, in 2000 officials in Columbus, Ohio, lured a moving company with a 5-year package of tax goodies. In 2004, the company had not only failed to add 100 jobs as promised, but it had actually fired 98 employees, sending lawmakers into a panic to yank the final year of tax breaks.

“Ohio’s experience shows preferential tax bonuses don’t guarantee jobs will stay permanently,” said Hodge. “Often they mask deeper flaws in state taxes. The Tax Foundation’s new State Business Tax Climate Index helps draw those to lawmakers’ attention.”

Even states with excellent business tax climates trot out extra tax incentives. In 1996 Florida lawmakers lured a major credit card company to open a call center with a generous $4 million tax refund package. Eight years later lawmakers were shocked at the announcement that the company was closing the Tampa call center and laying off 1,100 workers.

Generally the index rewards tax codes that are neutral; that is, they have low, flat tax rates that apply to everyone. This makes tax law simpler and more transparent and avoids double taxation. Tables 1 and 2 below show the overall results.

The worst state tax codes tend to have:

• complex, multi-rate corporate and individual income taxes;

• above-average sales tax rates that don’t exempt business-to-business purchases;

• complex, high-rate unemployment tax systems; and

• high effective property tax rates, as well as a host of other wealth-based taxes.

“The ideal tax system, whether at the state, federal, or international level, should be neutral to business activity,” said Dubay. “In such a system, people would base their economic decisions on the merits of the transactions rather than the tax implications.”

How it Works The methodology of the State Business Tax Climate Index is centered on the idea of tax competition, and each state’s final score depends on a comparison with the other 49 states.

The overall index is composed of five specific indexes devoted to major features of a state’s tax system: the state’s principal business tax, usually the corporate income tax; the individual income tax; the sales or gross receipts tax; the unemployment insurance tax, and the state’s system for taxing assets, principally the property tax. These five component indexes are themselves composed of several sub-indexes, and a total of 123 variables are taken into account in each state’s tax system.

Each state’s laws and tax collections were assessed as of the beginning of the 2006 fiscal year, which for the states was July 1, 2005. Therefore, the rankings reflect the business tax climate at that time, and do not consider legislative action since then. While the index is comprehensive, it is not exhaustive. Future research into state taxation will lead to new variables and sub-indexes in future editions of the index.

Best known for its annual calculation of Tax Freedom Day®, the Tax Foundation is a nonpartisan, nonprofit organization that has monitored fiscal policy at the federal, state and local levels since 1937.