NC Budget and Tax Center

Tax Foundation ranking not a true indicator of North Carolina’s health

You may have heard that North Carolina’s business climate is nearing top-10 status according to a new ranking by the Tax Foundation, a tax policy research organization that favors tax cuts. If that sounds strange to you, it should.  Many of the inputs that businesses look to in order to succeed have failed to rebound after the recession because of neglect from state policymakers.

The 2016 State Business Tax Climate Index has many flaws that have been highlighted by critics over the years. It is clear, however, that one way to zip up the ranking is to simply cut taxes, often in ways that primarily benefit large multi-state corporations. And this result in forgoing the kinds of investments needed to improve the economic climate that allows all businesses and all North Carolinians to prosper.

As I’ve noted in a prior post, proclaiming that North Carolina’s business tax climate has leapt from one of the worst to now one of the best largely as a result of tax cuts provides no insight regarding the fiscal and economic health of the state.

Here are five reasons that the Tax Foundation rankings are the wrong foundation for making tax policy in North Carolina.

  1. Ranking focuses on cherry-picked tax policies that the Tax Foundation doesn’t like, rather than on the range of factors that genuinely drive business investment decisions.

The Tax Foundation index simply chooses elements of tax policy it likes best – e.g. a flat income tax rather than a progressive income tax structure – without solid empirical evidence as to the impact of favored tax policies on states’ economic growth. A flat tax income tax, for example, which the Tax Foundation favors, doesn’t take a taxpayer’s ability to pay into account and largely benefits the well-off. A progressive income tax structure, by contrast, considers ability to pay but is not favored in the ranking. Furthermore, states with relatively lower tax rates are favored without considering the impact of lower tax rates on their ability to raise adequate revenue for public services. The Tax Foundation mixes these selected tax policies together and labels the result a state’s “business climate.”

This sole focus on a state’s tax structure leads to an index that mistakenly assumes taxes are the most important factor in shaping states’ business climates and tells us nothing about a state’s economic health – like whether schools are good, higher education is affordable, roads and rails are in good shape, or the workforce has the skills needed for 21st century business.

  1. This business climate ranking bears no relationship to actual economic performance or conditions for businesses.

Due to its single-minded focus on taxes, the Tax Foundation’s approach simply ranks states according to how low their taxes are, which is not the same as their economic health or the health of their business climate.

For example, according to the Tax Foundation Wyoming has the best business climate, yet the Cowboy State has the lowest population in the United States and is home to not one Fortune 500 company. “If the rankings were meaningful, the streets of Cheyenne should be crawling with CEOs,” notes Jon Shure at the Center on Budget and Policy Priorities.

Similarly, Nevada—a no-income-tax state ranked as having the fifth best business climate — has an unemployment rate of 6.6 percent, third highest in the nation and significantly more than the 4.8 percent rate in New York, the state ranked next to last as having the worst business climate. So much for the predictive power of the Tax Foundation rankings for economic growth.

  1. The business climate rankings are glaringly different than other business climate rankings.

North Carolina leapt to 15th from 44th last year in the Tax Foundation business climate ranking yet has consistently ranked among the top 5 states for business nine of the past 10 years according to Site Selection Magazine. Obviously, businesses consider more than state tax rates when deciding where to locate their businesses. This is in part because state and local taxes typically represent a small share, only around 2 percent or less, of business costs. Far more important to businesses’ decisions about creating new jobs is whether there is customer demand for their goods and services. This fundamental Business 101 lesson is not reflected in the Tax Foundation ranking.

  1. Tax cuts shift tax responsibility to low- and middle-income taxpayers

Overall, tax changes passed by state lawmakers since 2013 shift the tax responsibility to low- and middle-income taxpayers and away from the well-off and profitable corporations. Under the tax changes in the new state budget, the top 1 percent of earners on average get a tax cut of nearly $2,000 while low-income taxpayers will pay slightly more in taxes. This tax cut for the most well-off in the state builds on the huge tax cut they received under the 2013 tax plan. Furthermore, North Carolinians will pay more in sales taxes as a result of state lawmakers expanding the sales tax base, which contributes to the tax shift. As wages for average North Carolina workers have declined or remained stagnant at best, making ends meet will continue to be a challenge for low-and middle-income families and individuals.  And that means the state’s businesses will continue to struggle to reach the level of demand for goods and services needed to stimulate economic growth.

  1. Significant revenue loss resulting from tax changes

The tax plan passed by state lawmakers in 2013 reduced annual revenue by nearly $1 billion and the tax cuts included in the new state budget passed this year reduce annual revenue by an additional more than $1 billion once all tax changes take effect. These are dollars that would otherwise be available under the old tax code in place prior to the tax changes. These dollars could be invested in quality infrastructure to support the success of businesses and would go a long way to help ensure that small businesses in communities across the state have access to capital, start-up support and other infrastructure to facilitate their growth.  As my colleague highlights, North Carolina’s small businesses have not grown in line with the nation or big businesses in the state.

State leaders would like to pass more tax cuts that would largely benefit the well-off and profitable corporations in the coming years.  Already, a phase-down of the corporate income tax rate to 3 percent from the current 5 percent is scheduled to go into effect by January 2017. Eliminating the capital gains tax, further reducing income tax rates and cutting the business franchise tax are also on the table.

These tax cuts would further reduce available revenue at a time with the state is challenged with adequately funding public services that drive the state forward and contribute to the success of businesses in the state. Consequently, while some state leaders might like to continue to rise up the Tax Foundation ranking, the state’s ability to compete and attract economy-boosting jobs would decline as a result.

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