RALEIGH – Here we go, again.
House Speaker Joe Hackney, Senate leader Marc Basnight, and other defenders of the status quo are citing the Council on State Taxation’s study of the business-tax burden as evidence of North Carolina’s fiscal attractiveness. The COST study, conducted by Ernst & Young, has been misunderstood and misquoted for years. If you think it’s likely that New Hampshire is a high-tax state and New Jersey a low-tax state, you might be inclined to take the COST report seriously as a guide to state economic-development policy, because that’s what its rankings suggest. Ditto if you think the capital-gains tax has no effect on business-investment decisions, the retail sales tax has no effect on retail sales, and the personal-income tax has virtually no effect on entrepreneurial activity or business-location decisions. These are the assumptions you must hold if you try to use the COST report to prove something about relative tax burdens on business activity.
If, on the other hand, you live in Reality Land, you should ignore North Carolina’s ranking in the COST report. It is not a useful guide to the economic effects of state tax policy.
Keep in mind that businesses are contractual relationships between individuals. A business is a nexus of contracts. It is not a person. To levy a tax on a business is actually to levy a tax on the business activities of individuals who use the business to conduct trade.
In reality, all the COST report does is attempt to quantify the total state and local taxes that are legally attributable to business tax filers. That’s not the same task as quantifying the incidence of state and local taxes – that is, what group of individual taxpayers truly bears the bulk of the cost of a given tax in the form of lower incomes.
For example, legally it is the consumer who is obligated to pay a tax on the purchase of a taxable good. But in practice, sometimes business owners or workers have to take the income hit instead because they can’t afford to charge the price they would have charged in the absence of the tax. Similarly, half of the federal payroll tax for Social Security and Medicare is legally attributable to employers. The other half is legally assigned to employees. In economic terms, this is a distinction without a difference. Depending on market conditions, somewhere between most and all of the incidence of a payroll tax is borne by employees in the form of lower compensation.
Tax incidence is a complex subject. Hard numbers are hard to generate. But just to make this plain, no one with any sense believes that all corporate-income taxes are borne by owners of corporate stock, or that all sales or excise taxes are borne by consumers. Taxes on business translate into taxes on business owners, employees, vendors, and customers. The relative proportions depend on the situation. From an economic perspective, it doesn’t make much sense to refer to some taxes as being paid by “businesses” and other taxes being paid by “individuals.”
As a political matter, of course, it does matter. For one thing, there’s a good case to be made that using businesses as tax collectors is inefficient and obscures the true tax burden (which is what COST is trying to get at, actually). As far as politicians are concerned, they play around with these tax-burden categories precisely because they want to obscure or mislead.
There is no perfect assessment of the relative economic efficiency of state and local tax burdens. But the Tax Foundation’s annual study of the business-tax climate is the most-comprehensive analysis available. Rather than pretend that capital-gains taxes, for example, have no effect on business activity or tax competitiveness – a pretense that would get you laughed out of corporate boardrooms or university economics departments within minutes – the Tax Foundation weighs the effects of all the major sources of state and local tax revenue. While the COST report more or less translates into a state-by-state comparison of the property tax, on which North Carolina will certainly rank low, the Tax Foundation’s study yields broader tax-burden rankings that comport with real-world experience. New Hampshire ranks high in fiscal competitiveness (7th), as everyone knows it should rank. New Jersey ranks low (49th), which also comes as no surprise.
And North Carolina ranks 40th. When it comes to taxing overall business activity, North Carolina is unattractive. If you’re a big corporation able to wrangle an incentive deal, North Carolina looks a bit better. Why isn’t the state’s economy is worse shape, given the tax penalty? Because taxes aren’t the whole story. Relatively inexpensive land and low levels of unionization are strong pluses, among others.
I know that Hackney, Basnight, and other politicians will continue to cite the COST report, despite its manifest flaws. But now you know why you should laugh at them for doing so.
Hood is president of the John Locke Foundation.