Will West Virginia Reduce the Tax Burden on Manufacturing?

November 1, 2019

Here’s the good news: West Virginia’s tax structure ranks above average in our latest edition of the State Business Tax Climate Index, to the credit of bipartisan efforts of tax reform over several successive gubernatorial administrations.

And here’s the bad news: several sectors of the economy have been left behind by these reforms, subject to outmoded and uncompetitive taxes that make it hard for them to invest and grow in the Mountain State. That is particularly true of the manufacturing sector, due to the state’s taxation of machinery, equipment, and inventory, and, at the local level, an antiquated tax on business gross receipts that can hit manufacturers and distributors particularly heavily.

In fact, when we partnered with KPMG a few years ago to calculate the effective tax rates for different kinds of businesses (an industry-based model firms analysis) in each state, West Virginia ranked 43rd for its taxation of capital-intensive manufacturing and 47th for its taxation of labor-intensive manufacturing. Property taxes represented well more than half the tax liability for capital-intensive manufacturing operations, driven by the state’s taxes on machinery and equipment. The supply chain is also affected, with distribution centers facing effective tax rates of more than 30 percent.

Property taxes are part of the tax mix in all 50 states, but some states, like West Virginia, rely heavily on the taxation of tangible (as opposed to real) property, taxing things like business machinery and equipment, and in West Virginia’s case, inventory as well. West Virginia localities rely heavily on business tangible personal property taxes. Such taxes are not rare despite widespread recognition that they stand in the way of economic growth; what is unusual is just how important they are in West Virginia, where nearly a third of all property tax collections are derived from tangible personal property.

These taxes discourage investment, since new, undepreciated equipment has a higher taxable value than older equipment, even if its continued use is inefficient, and since it may be possible to locate some new capital investment in other states.

Extending the property tax to inventory, moreover, imposes high compliance costs for businesses and can create strong incentives for companies to locate inventory in states where they can avoid these harmful taxes. West Virginia is one of only 10 states which still tax inventory.

Both types of business property tax are highly distortionary and force companies to make decisions about production and distribution based on tax implications rather than sound business practices. They also impose high compliance costs, since these taxes are what is known as “taxpayer active.” That means that a company must track the acquisition price and depreciation of each piece of property, and the value and location of all inventory, along with the relevant assessment ratios and millages, and applicable credits, abatements, and refunds, to calculate and remit the tax.

Heading into the next legislative session, there appears to be some momentum behind the idea of repealing tangible property taxes on manufacturing machinery and equipment, as well as inventory. The idea is not new: similar or even broader proposals came out of the 1999 Commission on Fair Taxation, the 2006 Tax Modernization Project, and the 2018 Just Cut Taxes and Win proposal. But if West Virginia policymakers are interested in making the state more competitive, it may be an idea whose time has come.

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