Response to Professor Tannenwald’s Critique of the State Business Tax Climate Index

March 11, 2013

Note: This letter appeared in the March 11, 2013 edition of State Tax Notes.

To the Editor:

After each "State Business Tax Climate Index" release, the Tax Foundation attracts a few criticisms of the report, usually from states that score poorly. Most of those are hastily put together and don't reflect a full understanding of our method, or sometimes even tax policy. Robert Tannenwald's column ("Concerns About the Tax Foundation's State Business Tax Climate Index," State Tax Notes, Feb. 25, 2013, p. 601) was thoughtful and respectful of our work, but because it contained some critiques, we feel obligated to respond.

Criticism: The Index Weights Individual Income Taxes Too Heavily

Tannenwald's chief concern is that our weighting method gives the individual income tax component of the Indexthe highest weight. He reasons that property taxes are the primary tax cost paid by businesses, so they should be considered most heavily.

The main problem with that approach is that other taxes affect economic growth more than property taxes, because of their relative elasticity, and the effects of mobility. Such a weighting scheme would also reward states with low property taxes and high income taxes, which probably isn't anyone's idea of good tax policy. We couldn't stand behind such a method or recommendation, and we know David Brunori would never talk to us again.

In defense of the weights that our method yields, individual income taxes are generally one of the largest state revenue sources for state governments. "Passthrough" businesses like limited liability companies and S corporations pay taxes through the individual income taxes paid by their constituent members, representing 94 percent of business filers and approximately half of all business income nationally. Individual income tax compliance is one of the hardest things those businesses do each year or quarter. Individual income tax rates also matter for attracting and retaining high-skilled labor. While businesses may not be the ones cutting the check to the state treasury, their employees' interaction with the tax code matters to economic growth and location decisions.

Ultimately, any weighting scheme will be imperfect. Tannenwald highlights several drawbacks, but there are also several advantages to the way we do it. He challenges us to publish results under a variety of weighting schemes, but doing so would dilute the value of the Index, because each state's policy leadership would cite only the numbers that make them look best instead of striving for simpler, more sensible tax policy.

Criticism: The Tax Foundation Does Not Clarify the Differences in Its Studies

Tannenwald conjectures that policymakers do not have a firm grasp on how our "Location Matters" study (calculating the state-by-state tax bill for seven model firms) differs from the Index (how state tax systems are structured) or from our "State-Local Tax Burdens" report (how much residents pay in state and local taxes), and we sympathize. Even policy analysts at other organizations get them mixed up with each other and with similar reports from other organizations. We use every opportunity to explain our studies and clarify how they differ. Ultimately though, if there is more than one comprehensive state-by-state ranking out there (we alone at the Tax Foundation currently do three, not including smaller studies and reports), some confusion is going to occur.

We strive to be a good steward when talking to policymakers and reporters about what these studies say and how they are different. We often provide written descriptions of each to reporters after we talk. All of those studies tell different stories about tax policy and are worth publishing.

Suggestion: Do More Model Firm Studies

We would love to do more model firm studies! They are pricey, though. While we stretch our relatively small $300,000 annual budget and team of three quite a bit, more resources would be needed. We are currently seeking funding, so let us know if you know anyone who is interested.

Suggestion: Make the Index Raw Data Public

The last half of the report is actually pages and pages of tables containing all the data that goes into the Index. We're currently reformulating how this data is available on our website, and we hope those changes will make it even easier to access. And while we have discussed adding the Index model to our collection of online tax calculators at interactive.taxfoundation.org, we opt not to so that our branding would not be attached to a plan that we had no hand in. However, we frequently work with policymakers to estimate how a proposal will affect a state's Index ranking.

Suggestion: Work With Center on Budget and Policy Priorities, and
Don't Be so Reluctant to Cite Their Work

We haven't been afraid to cite CBPP when we think they're correct. Just a few weeks ago, we published "Tax Foundation and CBPP Agree: States Need Strong Rainy Day Funds," and Joe Henchman praised CBPP's report on the topic at the last Tax Analysts' roundtable. We'd be curious to see how frequently CBPP has favorably cited our work.

Both Tax Foundation and CBPP share a determination to make tax policy a key issue and provide important information, although we obviously disagree on many areas. But Nick Johnson and Henchman are frequently on panels together, and the two are already discussing a possible joint collaboration on an issue of agreement thanks to Tannenwald's prodding.

Finally, we'd like to wish Professor Tannenwald the best of success with his new column!

Scott Drenkard and
Joseph Henchman

Scott Drenkard is an economist and Joseph Henchman is vice president for state projects with Tax Foundation.


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