When it comes to taxes, location matters. The US may be one country, but each of its 50 states, driven by various political and economic conditions, handles state and local taxes differently.
Foreign investment is highly sought after by state and local governments keen to attract capital and increase job opportunities in their area. While site selectors admit corporate tax rates and incentives are not a top priority in making a location decision, they can fall within the top 10 criteria when considering investment, according to Gene DePrez, founding partner of New Jersey-based business and economic development consultancy Global Innovation Partners.
“For the vast majority of publicly held companies looking comprehensively at all factors affecting a location decision, whether making the selection themselves or with the assistance of independent, objective and experienced location consultants, the drivers will have more to do with meeting their access and workforce needs at a reasonable overall cost, with taxes playing a secondary role,” he says.
With the US coming out of a deep recession, some states are raising taxes to cover budget deficits and pay for infrastructure and services, while others are cutting taxes to make their state more competitive for business.
Michigan, which has suffered the worst economic contraction of any state in the US over the past five years, as well as the largest net population loss, is now replacing its cumbersome and distortionary gross receipts tax with a flat 6% corporate income tax that is largely free of special tax preferences. Meanwhile, in neighbouring Wisconsin, the state's governor has just approved a tax reduction that gets rid of income tax rates, improves business treatment of net operating losses and pares back targeted tax credits.
On the other side of the country in New Mexico, a significant business tax reduction has been approved. The corporate tax rate will decrease over time from 7.6% to 5.9% and a jobs tax credit will be tightened. “New Mexico has a long way to go, but policy-makers there are determined to have their state open for business,” says Joseph Henchman, vice-president for legal and state projects at the Tax Foundation, a non-profit, non-partisan tax research organisation based in Washington, DC.
In other states, the reaction has been to increase taxes. The Minnesota legislature recently passed a bill to raise $2.1bn by increasing taxes on top earners and cigarettes. Governor Mark Dayton says that he aims to use the additional revenue largely for expanding early childhood education programmes and freezing tuitions at state universities, as well as for closing the state’s budget deficit and funding job initiatives and property tax refunds.
In California, business owners are facing huge retroactive bills, while the state's governor, Jerry Brown, projects a budget surplus of $1.1bn. Mr Brown proposes to save the surplus for a rescue fund. The last time that the state had a budget surplus, in the early 2000s, the capital was spent on higher spending and tax breaks.
Best and worst
In its 2013 edition of the State Business Tax Climate Index, the Tax Foundation found that the top 10 US states ranked by the attractiveness of their tax environment were Wyoming in the top position, followed by South Dakota, Nevada, Alaska, Florida, Washington, New Hampshire, Montana, Texas and Utah. According to the index, the absence of one major tax is the dominant factor contributing to the attractiveness of many of these states.
While property taxes and unemployment insurance taxes are levied in every state, several states do without one or more of the major taxes: the corporate tax, the individual income tax or the sales tax. Wyoming, Nevada and South Dakota have no corporate or individual income tax; Alaska has no individual income or state-level sales tax; Florida has no individual income tax; and New Hampshire and Montana have no sales tax.
“The lesson is simple: a state that raises sufficient revenue without one of the major taxes will, all things being equal, have an advantage over those states that levy every tax in the state tax collector’s arsenal,” the report states.
The 10 lowest ranked states according to the index are, in descending order, Maryland, Iowa, Wisconsin, North Carolina, Minnesota, Rhode Island, Vermont, California, New Jersey and, in bottom place, New York. “The reason New York scores very poorly is because it has a very progressive income tax on the individual side but, additionally, gives away a host of special credits to certain companies for engaging in preferred activities,” says Scott Drenkard, an economist at the Tax Foundation.
Many states offer incentives such as tax cuts to companies that relocate within their boundaries. These rewards are often pegged to the amount being invested and the number of jobs that will be created, with additional credit given for research and development activity.
In recent decades, Alabama has been known for offering huge tax incentives for attracting companies. Determined to land investment from aircraft manufacturer Airbus, the state contributed $158m in cash, tax breaks and other incentives toward the company's first US-based manufacturing project, according to the Alabama Department of Commerce. That included $125m in state incentives plus $33m from city and county governments. Airbus is constructing a $600m aircraft assembly plant in the Alabaman city of Mobile, which will be the European company's first on US soil.
Twenty years earlier, Alabama aggressively courted and landed car manufacturer Mercedes by offering the company approximately $300m in incentives, most in the form of deferred taxes. Officials claim that Mercedes has since contributed more than $1.5bn to the state's economy each year since vehicle production began in 1997.
The question concerning the Tax Foundation is whether a business state tax code adheres to the principles of a sound tax policy. “The bread and butter of good tax policy is having a broad base that applies a low rate to all activities and does not pick winners or losers in business,” says Mr Drenkard.
According to the Tax Foundation, all types of business – small and large – tend to locate where they have the greatest competitive advantage. “The states with the best tax systems are the most competitive in attracting new businesses and most effective at generating economic and employment growth,” says the Tax Foundation's report.
While much of the focus is on corporate taxes, Mr Drenkard says that taxes on individual income are also important for businesses in an indirect way. “While corporate taxes are paid directly by a corporation, about 50% of all business income is filed through the individual income tax,” he says. “Even if a state does not cut the individual income tax, it has to compete for labour in an increasingly global market as well.”
For instance, while employees living in New York City have to contend with both a very high cost of living and the seventh highest state individual income tax in the country, their counterparts in Charlotte, North Carolina, are about to be relieved of their individual income tax, when the state reforms its tax code.
“It is very expensive to live in the New York City area,” says Mr Drenkard. “Real estate costs there are high, and then there are additional tax costs. While taxes are not the only thing that is going to impact individual behaviour, it will play a large role by margins. The margins are where the decisions are.”
When it comes to FDI, Global Innovation Partners' Mr DePrez maintains that taxes play a more important role in the minds of privately held companies, especially smaller ones where the owner is more directly affected.
“We hear a lot about taxes, but usually from local companies and business groups that are threatening to leave, or are trying to get their taxes lowered. Often these are more threat than real,” he says. “The emergence of tax consultants, and earlier by the tax practices of accounting and legal firms doing `site selection work’, but often focused on incentives and tax considerations, has also had impact of more emphasis on taxes because of the interests and specialised expertise of those firms. Often the way they are compensated drives their approach.”
The Tax Foundation insists that taxes do matter to businesses. “Even in our global economy, states’ stiffest and most direct competition often comes from other states,” it says in its report. It goes on to say that state law-makers create tax deals under the banner of job creation and economic development. “But the truth is, if a state needs to offer such packages, it is most likely covering for a woeful business tax climate."