State Tax Trends: Corporate Tax Reductions

States Take Opposing Paths to Stay Competitive

Washington, D.C., June 13, 2012—High corporate tax rates at the federal level have led to state lawmakers seeking to lower the tax costs of corporations within their borders, an effort that has included both across the board rate cuts and tax incentives targeted at particular industries or types of businesses, according to a new analysis by the Tax Foundation. More business owners have also chosen to avoid corporate taxes altogether by declaring business income under the individual tax code.

Japan’s corporate tax rate reduction in April of this year left America with the highest corporate income tax rate in the industrialized world. Because state corporate income taxes are levied on top of this high federal tax, state tax systems are not competitive internationally even if the state system by itself is reasonable. Every state corporate income tax, when combined with the federal corporate income tax, is higher than France, Germany, the UK, and many other countries.

High corporate rates have also played a role in the tremendous growth in the number of taxpayers reporting business income as sole proprietors, S corporations, limited liability corporations, and partnerships. These non-corporate firm types are often referred to as “pass-through” entities because the firm’s profits are passed directly through to the owners and taxed on the owner’s individual tax return.

To help their in-state businesses stay competitive, many states have reduced corporate tax rates, including eight since 2008: Indiana, Kansas, Massachusetts, New Jersey, New York, North Dakota, Vermont, and West Virginia. The Indiana reform, for example, will reduce its current 8.5 percent tax rate in half-percentage steps from 2012 through 2015, until it reaches 6.5 percent.

Second, most states offer generous targeted incentive packages to new or expanding businesses. A comparison of the tax costs of seven “model firms” recently found that, for example, a pre-existing manufacturing plant in New Jersey pays an effective tax rate of 10.6% while an identical but new plant would pay only 5.9%, thanks to targeted tax incentives.  It remains disputed, however, whether such targeted tax incentive packages are effective at long-term economic development.

“Until federal tax reform reduces competitive pressures, states should instead focus on reducing rates and minimizing incentive packages that hollow out the base and pick winners and losers,” said Tax Foundation Vice President for Legal & State Projects Joseph Henchman.

Tax Foundation Fiscal Fact No. 311, “Trend #3: Corporate Tax Reductions” by Joseph Henchman is available online.

Read about all of the Top 10 State Tax Trends in the Recession and Recovery here.

The Tax Foundation is a nonpartisan research organization that has monitored fiscal policy at the federal, state and local levels since 1937. To schedule an interview, please contact Richard Morrison, the Tax Foundation’s Manager of Communications, at 202-464-5102 or morrison@taxfoundation.org.