Critique of State Business Tax Climate Index Finds Stronger Performance by Top States

January 14, 2014
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This week’s State Tax Notes has a submitted report, “A Critique of the Tax Foundation’s State Business Tax Climate Index” by Matt Wojtkun (subscription required). If you’re unfamiliar, our Index is an annual ranking of each state’s business tax environment, where each state is judged on the business-friendliness of its tax structure. It’s not a measure of how much business are taxed; it’s a measure of the manner in which it is done.

Wojtkun points out that in order to meaningfully compare the experience of highly rated states and poorly rated states in the Index, we should compare how the top and bottom states fare over time, not simply look at annual snapshots. For this reason, he examines ten states that are consistently well-ranked and ten states that are not since 2003. I think he is correct in doing this, as business decisions and economic behavioral changes do not happen overnight. (Caveat: the methodology has changed a bit since we began doing the Index in 2003, but this is still an instructive exercise.)

I was perplexed as Wojtkun’s critique pointed out examples of ways in which states in the top ten had fared better than the bottom tenFor instance, Wojtkun notes that “[a]ccording to Bureau of Labor Statistics (BLS) data, there was net gain in the number of establishments created in both the top and bottom [Index] states” over the 2003 to 2012 period. But there was over thirty times the gain in the top ten Index states (108,687 net establishments) than in the bottom ten Index states (2,819 net establishments). When I see those statistics, I don’t think “all states added new business establishments, regardless of their tax structure,” I think “states with well-structured tax systems added nearly 106,000 more establishments than states with poorly-structured tax systems.” Wojtkun notes that the bottom ten states had 204 Fortune 500 companies in 2013, while the top ten only had 81. That speaks more to the legacy of when some of the bottom states (such as New York, New Jersey, and California) had competitive tax climates.

  Top Index States Bottom Index States
Net Businesses Created +108,687 +2,819
GDP, 2003 $1.94 trillion $3.96 trillion
GDP, 2012 $2.98 trillion $5.32 trillion
GDP Growth, 2003 to 2012 +54% +34%

Wojtkun’s final critique is that the overall GDP of the top ten states is less than the bottom ten states. But while Wojtkun says the bottom ten states are “continu[ing] to lag behind,” in fact his own numbers show the GDP growth from 2003 to 2012 in the top ten states was nearly 20 percentage points more than the growth in the bottom ten states (+54 percent for the top Index states and +34 percent for the bottom Index states). By Wojtkun’s own measure, the top ten states are soaring far ahead of the bottom in GDP growth.

Wojtkun references Robert Tannenwald’s criticism of the Index (essentially arguing that property taxes matter more to economic growth than business taxes), but neglects to link to our response highlighting the evidence on our side. And contrary to Wojtkun's suggestion, we never claim that taxes are the only factor influencing how businesses make choices about how and where to operate (we often note the opposite). We are the Tax Foundation and our job is to examine tax structures and tax policy—not the multitude of other things businesses value in a location (education of workforce and provided public services, for example). Those matter, too, but other people track that stuff.

It’s absolutely true that businesses consider many things when making decisions, and taxes aren’t the only consideration. But a continued commitment to smart tax policy is important to business-owners—and Wojtkun’s numbers actually show they have a demonstrable effect. According to Wojtkun, the top Index states added more establishments and had faster GDP growth over the ten year window in question than the bottom Index states. To me, that’s compelling evidence that the top Index states are doing something right.

Follow Liz on Twitter @elizabeth_malm.

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