When most people think about “business taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es,” the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. is usually the first that comes to mind. Corporate income taxes generate sizable tax burdens for businesses—especially at the federal level—but at the state level, the corporate income tax is just one of many taxes businesses pay. For many companies, state corporate tax burdens are dwarfed by other state and local taxes owed, which have far more bearing on a company’s location and investment decisions than many people realize.
Furthermore, high tax rates are only part of the equation; for many businesses, the composition of a state’s tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. is a factor that is just as important, if not more important, than the tax rates. Our Location Matters study helps illustrate the extent to which property, sales, and other non-income taxes drive corporations’ overall state and local tax burdens, as well as the extent to which differences in tax bases across states drive differences in overall tax liability.
With Location Matters, we design eight model firms and place them in each state (as both a new and mature firm, since new firms are eligible for many incentives denied to long-established firms), calculating their tax liability. Across all mature firms in our study, income and other general business taxes that exist in some states (including gross receipts taxA gross receipts tax is a tax applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. es) accounted for only 19 percent of firms’ tax liability, compared to 60 percent for property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. es, 15 percent for sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. es, and 5 percent for unemployment insurance taxes. New firms often received such significant incentives as to experience negative income tax liability, though these firms often still face high burdens under other taxes.
The Location Matters study focuses on businesses with significant capital investment, and income-based taxes are likely to be more significant for other business models not included in the study. Additionally, we look only at tax burdens in the state where a business is based. Businesses pay taxes in many states, and in other states in which they operate—but have less property and payroll—income taxes may predominate. But for purposes of location decision-making, the home state is what matters, and our study illustrates just how significant non-“business” taxes can be to many businesses.
Property taxes are the single largest source of revenue for local governments in the United States, generating approximately 72 percent of local tax collections nationwide. Almost every local government across the U.S. levies property taxes, and in some states, property taxes help fund state government services as well, or are redistributed across jurisdictions for purposes like school funding equalization.
When most people think about property taxes, they think of taxes on the value of land and buildings, but for businesses, property taxes extend far beyond real property, often applying to tangible property like machinery, equipment, and inventory, and sometimes even to intangible property, like the value of a company’s patents, trademarks, investments, and goodwill. (Capital stock taxes are also a form of property taxes, and are treated as such in Location Matters, though they are collected separately from other property taxes.) Real property is an appropriate property tax base, as the value of land and buildings is a reasonable proxy for the value of local services received, but tangible and intangible property taxes ought to be avoided. The value of a company’s tangible property has little relation to the value of local services it receives, and such taxes are non-neutral in their application, complex to administer and comply with, and distort investment decisions.
Currently, in addition to taxes on real property, taxes on the value of business machinery are levied in 38 states, and taxes on the value of business inventory are collected in 10 states. These taxes are a significant driver of overall tax burdens for businesses in capital- or inventory-intensive industries like manufacturing, agriculture, and retail, among others.
For example, for our model distribution centers, property taxes frequently represent more than two-thirds of a firm’s total state and local tax burden, especially when business equipment is included in the property tax base. For instance, Indiana has the ninth most competitive tax code overall on our State Business Tax Climate Index, but because the property tax base includes business equipment, Indiana’s tax code is far less hospitable to distribution centers than it is to most other types of businesses. In our Location Matters study, the mature distribution center faces an effective property tax rate of 43.5 percent of net income in Indiana, while the mature technology center faces an effective property tax rate of only 5.1 percent.
Another significant driver of corporations’ state tax burdens is the sales tax. Under an ideal tax code, the sales tax would apply to a broad base of final consumer goods and services while exempting business inputs. However, most states’ tax codes depart from this ideal, with sales taxes applying to intermediate sales that occur in the course of production. This leads to tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. , where taxes are embedded in the final product (or service) multiple times over. Tax pyramiding raises the costs of production, and many of these increased costs are borne by consumers (albeit in a nontransparent way) in the form of higher prices.
One of the most significant economic consequences of applying the sales tax to business inputs is its non-neutrality across businesses and industries. Companies that have long supply chains or low profit margins must pay special attention to which states tax the inputs they rely on and which states do not. Of the 16 model firms in our study, the mature data center has the greatest sales tax exposure, with sales taxes responsible for an average of 41 percent of the firm’s overall state and local tax burden. Currently, data center equipment is fully or partially subject to sales taxes in more than half the states, significantly increasing the upfront costs associated with building a new data center. Similarly, manufacturing machinery is subject to the sales tax in a number of states, raising the costs of production.
As policymakers consider ways to improve their tax structure to encourage business investment and promote economic growth, corporate income tax rate reductions are a crucial part of that conversation, but they shouldn’t be the only consideration. Most states have significant room for improvement in how they structure their property and sales taxes, and much progress can be made by excluding tangible property from the property tax base and refraining from applying the sales tax to business inputs.
Note: This is the second of a four-part series highlighting key takeaways from our Location Matters report. To view the report in full, or examine any particular state or industry, click here.
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