RALEIGH – The questions started coming into our office the middle of last week, prompted by a press release from the office of Gov. Mike Easley.
Does North Carolina really have one of the lowest business-tax burdens in the United States? Do we really have the most favorable business climate in the Southeast? Does North Carolina really impose lower tax burdens than such famously fiscally conservative states as Wyoming, Montana, Alaska, and New Hampshire?
Yep, my JLF colleagues and I knew then that it was time for another round of tax-policy confusion, set off by the latest edition of a study by Ernst & Young for the Council on State Taxation (COST). Back in 2004, when the E&Y/COST report first made its appearance in North Carolina politics, we had patiently explained why it did not demonstrate what Easley and state lawmakers claimed at the time: that North Carolina’s tax policies were favorable to economic competitiveness and growth. Later, COST itself hastened to explain that its study was not intended to evaluate the effects of all state and local taxes on business decisions and economic competition. The study was simply a tallying up of the taxes that were the “statutory liability of businesses” instead of individuals. Because its methodology thus excluded most income and sales taxes, the study ended up essentially ranking states according to their reliance on the third leg of the state/local tax tripod: property taxes. That’s how North Carolina, which has relatively low property taxes, ended up at the bottom of the ranking.
Fortunately, we made some headway. State legislators and policy analysts became noticeably less confident about citing the COST study to advance absurdities such as the notion that Florida has a more adverse business-tax climate than do Michigan, New Jersey, and Ohio because it ranks “worse” in the COST study.
Still, not everyone got the memo. Case in point, the Easley administration. Last year, I used the term “metaphorical zombie” to describe the idea that North Carolina has an attractive business-tax climate. So, once again, let’s try a shotgun blast to its head.
First, legal tax liability and tax incidence are not the same thing. Many “individual” taxes can have significant effects on business decisions and bottom-lines, while many “business” taxes end up being borne primarily by consumers or workers rather than owners or shareholders. It is patently absurd to exclude all “individual” taxes from a calculation of the competitiveness of a state tax code, just as it would be absurd to suggest that raising “business” taxes will have no effect on individuals and households.
Consider capital-gains taxes. Whether you think they are currently too high, too low, or just right, you have to admit that at some level taxes on the receipt of dividends and capital gains will affect investor behavior. That, in turn, affects how easy it is for firms to raise capital. Similarly, industries such as cigarette manufacturers, alcohol distributors, and rental-car companies aren’t being irrational when they battle special excise or sales taxes on their products. While much of the cost of those taxes will be borne by the consumers who are legally liable for them, they also encourage some consumers to buy less, thus reducing sales revenue to the firms.
Tax incidence has a lot to do with whether consumers have lower-taxed alternatives. For example, back when the Bells enjoyed a near-monopoly in local phone service, virtually all of the cost of excise taxes and universal-service fees were passed along to the captive consumers. But as competing providers, cell phones and, later, Internet telephony came on the scene, the tax incidence began shifting to the Bells. Competition made it chancier for the landline companies to pass along the cost as higher prices, and eventually consumers could even purchase a substitute good (cell or Internet service). A mostly “individual” tax had become mostly a “business” tax.
The E&Y/COST study is fine if you want to know what percentage of each state’s tax code is legally attributable to businesses. But, contrary to Easley’s assertion, it reveals precisely nothing about whether North Carolina or any other state “offers an attractive business climate” when it comes to tax policy. For that, you need a more comprehensive measure that examines all major taxes, both marginal and effective tax rates, and the structure of the tax code (how broad the tax base is, for example, and the extent and effect of targeted exclusions and incentives). One useful measure is the State Business Tax Climate Index, published regularly by the Tax Foundation. The 2007 version ranks North Carolina an unattractive 40th, and places the likes of Wyoming, Montana, Alaska, and New Hampshire at or near the top of the list, where they belong.
That’s not to say that North Carolina has a broadly unattractive business climate. We’re only talking taxes here. Many other factors influence entrepreneurship, business decisions, and economic competitiveness. While punitive taxes may well have played a role in North Carolina’s relatively weak economic performance over the past decade or so, lots of folks are still working, prospering, and moving here. The point is, we could be doing better. Let me count the ways.
Hood is president of the John Locke Foundation.