This article reports the effective overall business tax rates by state from 1991 to 2002. Effective tax rates (ETRs) are more indicative of the true tax burden than nominal rates, because they implicitly take into account deductions, credits, and the effects of various tax rules. Moreover, overall rates take into account the total tax burden faced by a business: income, property, payroll, gross receipts, and other miscellaneous taxes.

Overall effective rates are computed as:
n
BETR_s,t = S_tx=1 tx_i,s,t / BGSP_s,t

where:
BETR_s,t   = business overall effective tax rate for state s in year t
tx_i,s,t       = business taxes of type i paid into state s in year t
BGSP_s,t   = business gross state product for state s in year t

Business gross state product is obtained from the U.S. Department of Commerce (Bureau of Economic Analysis). Business taxes are collected from a variety of sources, including Census and the Tax Foundation.

Overall effective business tax rates are shown in Table 1 on the next page. As can be seen, there is a high variance among states. Not surprisingly, the two states without corporate income taxes — Nevada and South Dakota — have among the lowest rates. The highest rates tend to be among East Coast states that must finance maintenance of aging infrastructures — for example, Delaware, New Hampshire, New Jersey, and New York. Other high-tax states are Arizona, Michigan, and West Virginia. A state with surprisingly low rates is Massachusetts, although there is a popular perception that it is a high-tax state.

A second observation is that overall ETRs appear to be increasing over time, which is supported by Figure 1 (p. 1017). This trend should come as no surprise given increasing cutbacks of federally sponsored programs and revenue sharing, which must be made up with increased revenues at the state and local levels.

One reason for the large variation in tax rates across the states is whether they have incentive programs in place. One of the most important incentive programs offered by states is location-specific, that is, if a firm locates in an Enterprise Zone (EZ). Table 2 (p. 1018) indicates which states offer these programs and whether the states offer wage credits, sales tax breaks, or property tax breaks for businesses locating in the zones. The last column shows whether the state requires preoperational approval to receive tax benefits (Prequal) or not (Nonprequal).

Figure 2 (p. 1019) shows the proportion of the total business effective rate, for 2002 and averaging across all states, that each type of tax contributes to the total. Easily, property taxes are the largest component at 37 percent, with corporate income taxes second at 30 percent. Note that because it is almost impossible to separate sales and use taxes into those paid by businesses, these taxes are not included anywhere in the analysis. Also, while Washington does not have a corporate income tax, its business and occupancy taxes are included as ‘‘occupation and business, NEC’’ here (as well as in all other tables and figures).

Finally, Table 3 (p. 1019) shows overall effective corporate income tax rates for 2002, grouping states by region. As shown, rates are highest in the Northeast and Mountain regions, and lowest in the Southeast and Midwest.

Table 4 (p. 1020) reports effective income tax rates of the states. States that tout lower statutory rates may be surprised at how high their effective rates are relative to others. Clearly, credits and incentives, rules on combined returns, deduction/ income rules, and other differences in the tax base have a dramatic impact.

Table 1

Overall Effective Business Tax Rates by State²

² Excluded from the analysis are Alaska, Montana, and Wyoming, whose enormous severance taxes yield a distorted effective tax rate.

Figure 1

Chart of United States Average Rates Over Time
 

 

Note that Texas’s franchise tax, which has elements of both a capital and an income tax, is classified as ‘‘occupation and business, NEC’’ here (as well as in all other tables and figures). Although South Dakota does not have a corporate income tax, I have included its financial institutions tax as a corporate income tax. Two states with very high rates are Michigan and New Hampshire. Michigan imposes the single business tax — which, unlike in other states, taxes corporate and noncorporate entities similarly. Although New Hampshire’s statutory rates are not severe, the state has very few credits and imposes a unitary taxing system that may act to apportion out-of-state income into New Hampshire.

Concluding Comments

The analysis in this article should be useful to state lawmakers who want to benchmark their state against nearby competing states. For example, if a state’s overall rates are much higher than those in adjoining states, its lawmakers may wish to lower rates to be more competitive in attracting or retaining businesses. For any particular business contemplating whether to locate in a state, this analysis provides a general snapshot of which states have more favorable tax climates. Of course, taxes faced by a particular firm will vary by industry, whether the firm locates in an EZ, the degree to which it is successful in negotiating tax reductions, and other factors.

Table 2

Enterprise Zone Benefits

Figure 2

Proportion Contributed to Overall Effective Rate by Type of Tax
 
 
 

Table 3

Overall Effective Tax Rates by Region, 2002

Table 4

Effective Income Tax Rates by State on Corporate Net Income, 2002

Charles W. Swenson, PhD, CPA, holds a joint academic appointment at the University of Southern California and Caltech. He can be reached at cswenson@marshall.usc.edu.