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Maryland Considers Proposal to Extend "Millionaires Tax" to $100,000 Income Level

Tue, 15 May 2012 00:00:00 EDT

Earlier this year, Maryland Governor Martin O'Malley proposed a number of tax proposals, including increasing income taxes,[1] applying the sales tax to gasoline,[2] raising cigar taxes,[3] and doubling the "flush" tax, a septic system levy.[4]

Last month, despite the bevy of options that were suggested, the Maryland General Assembly failed to reach a revenue deal by a matter of minutes before the end of their session. What is traditionally a confetti- and balloon-filled final night celebration was replaced by a stern 1 AM press conference by Governor O'Malley.[5] Since then, O'Malley has called a special session to begin on May 14 to discuss an income tax hike which could affect all earnings over $100,000. While specific details are still scarce, we will here review some of the options that were on the table at the end of the regular session and discuss impacts on Maryland's fiscal situation and national competitiveness.

Budget "Cuts" and the Doomsday Fallacy

When the regular session ended without a new revenue deal, many onlookers feverishly decried the austerity of the "doomsday" budget that took effect instead, which would cut $500 million in expenses over the next year. However, these "doomsday" cuts are actually applied to planned spending increases, and even under this "doomsday" scenario the budget will still increase by $700 million, or 2 percent over last year.

Figure 1 shows Maryland's budget expenditures, which have grown steadily since 2004.

Figure 1

The editorial board of the Washington Post has argued that simply allowing the "doomsday" budget to proceed might be the most appropriate course of action, while a special session is likely to bring more complications than solutions:

The truth is that if lawmakers in the General Assembly were to stay home and skip the special sessions, the effect would be to cancel plans for a tax increase; spare the state a senseless expansion of casino gambling; eliminate some dubious spending programs; and ensure that Maryland's $35 billion budget still manages to grow by a respectable $700 million, about 2 percent.[6]

Income Tax Proposal

An income tax proposal was put forward on May 14 which would increase rates for singles earning above $100,000 and for joint filers earning above $150,000. This plan also phases out the exemption more aggressively than the current tax system, meaning that more income from high-income filers will be taxed, resulting in higher effective rates. Table 1 shows rates proposed under this plan.

Table 1: New Tax Rates Under Maryland Proposal

Single Filers
Bracket	Current Rate	Proposed Rate
>$0	2%	2%
>$1,000	3%	3%
>$2,000	4%	4%
>$3,000	4.75%	4.75%
>$100,000	4.75%	5%
>$125,000	4.75%	5.25%
>$150,000	5%	5.50%
>$250,000	5%	5.75%
>$300,000	5.25%	5.75%
>$500,000	5.5%	5.75%

Married Filing Jointly, Head of Household
Bracket	Current Rate	Proposed Rate
>$0	2%	2%
>$1,000	3%	3%
>$2,000	4%	4%
>$3,000	4.75%	4.75%
>$150,000	4.75%	5%
>$175,000	4.75%	5.25%
>$200,000	5%	5.5%
>$225,000	5%	5.75%
>$350,000	5.25%	5.75%
>$500,000	5.5%	5.75%

This proposal, though not a substantial increase from last year, could have palpable effects on the tax bills of high-income Maryland residents and businesses. Table 2 shows back-of-the-envelope calculations for a dual-earner, two child family with $250,000 in federal adjusted income living in Maryland, the District of Columbia, and Virginia. If enacted, they would pay $989 more in state income taxes:

Table 2: Two Child Family with $250,000 In Income

State	Currently	Under Maryland Proposal
Maryland	$16,786	$17,775
District of Columbia	$16,612	$16,612
Virginia	$11,651	$11,651

Before 2007, when Maryland first adopted a "millionaires tax," the state had a fairly flat income tax system, and this latest episode is just a continuation of a trend where the state is gradually tilting the income tax code to rely more heavily on high-income earners (See Table 3, below).

Table 3: Maryland Individual Income Tax Rates for Single Filers, 2007

*Bracket*	Rate
>$0	2%
>$1,000	3%
>$2,000	4%
>$3,000	4.75%

As we have seen at the federal level, progressive tax codes make for volatile revenue collections. High income earners are often businesses, which are especially sensitive to economic expansions and contractions.[7] Additionally, there is a negative incentive affect associated with high top marginal rates. In the long run, laborers are less likely to gain additional skills and aspire to higher wages if more of that potential income is taken by tax authorities.[8] So while income tax hikes on the wealthy are often popular with voters, because of the interconnectedness of the economy, the resulting decreases in labor productivity negatively affect everyone.

Sales Tax Proposal

Another potential tax increase proposal that might resurface in the special session is a one percent sales tax increase from 6 percent to 7 percent that was discussed mid-April.[9] If passed, the sales tax increase would tie Maryland for the second highest statewide sales tax rate in the country. Further, it would move Maryland out of step with its neighbors, particularly Delaware, which has no sales tax. Figure 2 shows sales tax rates around Maryland.

Figure 2

These disparate sales tax rates would instigate an increase in cross-border shopping, which would have a negative effect on revenue collections and hurt business activity in the state as consumers make purchases in neighboring states.[10]

New Jersey, which already has a 7 percent statewide rate, is well aware of this problem. In response to cross-border shopping, the state implicitly acknowledged that their sales tax rate is uncompetitive by halving the state sales tax rate in Salem County (on the Delaware border) from 7 percent to 3.5 percent.

Transparency

One of the problems with using a special session to make major tax and spending decisions is that the process tends to be opaque. Leading up to the special session, there was no formal tax plan that was available in writing. As of press time, a preliminary income tax bill has been released and we have done our best to analyze it here, but given the short time span of the session, it is difficult for citizens and commentators to keep up with the various bills' progress and voice opinions on legislation.

Conclusion

Maryland's latest income tax increase proposal fails to meet the criteria of sound tax policy. By opting to raise taxes on high-income earners, the proposal seeks to raise taxes in a politically expedient way, but one which will have distortive long-term effects. If a sales tax increase re-emerges as proposal, this too will make Maryland less competitive among its neighbors and in the nation.

[1] Joseph Henchman, Maryland Looking to Raise Income Tax on Middle-Earners, Tax Foundation Tax Policy Blog (Mar. 20, 2012), http://taxfoundation.org/blog/show/28059.html.

[2] David Hill, O'Malley springs sales-tax surprise on assembly, The Washington Times, Jan. 11, 2012, http://www.washingtontimes.com/news/2012/jan/11/omalley-springs-sales-tax-surprise-on-assembly/.

[3] General Assembly of Maryland, Department of Legislative Services, The 90 Day Report: A Review of the 2012 Legislative Session (Apr. 13, 2012), at B-13, http://mlis.state.md.us/2012rs/90-Day-report/The90DayReport.pdf.

[4] Joseph Henchman, Maryland Governor Proposing Increases in Income, Sales, Gasoline, Cigar, and 'Flush' Taxes, Tax Foundation Tax Policy Blog (Jan. 19, 2012), http://taxfoundation.org/blog/show/27903.html.

[5] Aaron C. Davis & John Wagner, Officials in Md. fail to vote on tax, casino bills, The Washington Post, Apr. 9, 2012, http://www.washingtonpost.com/local/md-politics/md-legislature-scrambles-in-closing-hours-to-finish-major-tax-and-casino-bills/2012/04/09/gIQAKBl66S_story.html.

[6] Editorial Board, Who's afraid of Maryland's 'doomsday' budget?, The Washington Post, Apr. 27, 2012. http://www.washingtonpost.com/opinions/maryland-lawmakers-should-go-easy-on-the-budget-fixes/2012/04/26/gIQA5HT0jT_story.html.

[7] R. Alison Felix, The Growth and Volatility of State Tax Revenue Sources in the Tenth District, Federal Reserve Bank of Kansas City Economic Review (2008), http://www.kansascityfed.org/Publicat/Econrev/PDF/3q08Felix.pdf.

[8] Edward C. Prescott, Why Do Americans Work So Much More than Europeans?, 28 Federal Reserve Bank of Minneapolis Quarterly Review 2-13 (2004), http://www.minneapolisfed.org/research/QR/QR2811.pdf.

[9] Scott Drenkard, Maryland Considers Raising Sales Tax Rate, Would Tie Second Highest in Nation, Tax Foundation's Tax Policy Blog (Apr. 12, 2012), http://taxfoundation.org/blog/show/28122.html.

[10] Mehmet Serkan Tosun & Mark Skidmore, Cross-Border Shopping and the Sales Tax: A Reexamination of Food Purchases in West Virginia (Working Paper, 2005), http://www.rri.wvu.edu/pdffiles/Tosunwp2005-7.pdf. See also Randolph T. Beard, Paula A. Gant, & Richard P. Saba, Border-Crossing Sales, Tax Avoidance, and State Tax Policies: An Application to Alcohol, 64 Southern Economic Journal 293-306 (1997).

Scholastic Books Faces State Tax Overreaching

Tue, 15 May 2012 00:00:00 EDT

Introduction

For decades, American schoolchildren have purchased books and other educational materials from Scholastic Book Club, Inc., which seeks to foster good reading habits and complement classroom education. However, courts in two states (Connecticut and Tennessee) have ruled this year that Scholastic owes back sales and use taxes, despite the fact that the company has neither property nor employees in those states, potentially disrupting Scholastic's mission.

The Scholastic cases reflect the ongoing debate about state tax authority, and the need for clearer rules on the proper extent of a state's power to impose tax obligations on out-of-state companies.

The Proper Scope of State Power to Tax: Physical Presence vs. Economic Presence

There exist two competing views of when states may properly assert the power to tax: physical presence nexus and economic presence nexus. Physical presence nexus means that the state can assert the power to tax on any individual or business that has a real, tangible presence in a state, such as with the presence of property or employees. Economic presence nexus proponents believe that states should have the power to tax any company that has customers in the state from which the company derives income.^{^[1]} Multistate companies, catalog sellers, and online retailers are the businesses most likely to be tripped up by unclear nexus rules.

While both presence standards have been argued before many courts, physical presence has evolved as the stronger standard. This can be attributed to the clarity of the argument: if a business is located in a jurisdiction, then it is liable for a tax. Economic nexus is difficult to know in advance because a company's out-of-state customers must demonstrate enough of a link to act as though the company were located in that area. However, as states increasingly seek to tax nonresidents, especially for Internet transactions, they are pushing for judicial adoption of the economic nexus standard.^{^[2]}

The U.S. Supreme Court has ruled on the tax treatment of remote sellers in key cases that frame the debate over Scholastic. The Court ruled in Scripto, Inc. v. Carson (1960) that a Georgia-based retailer (Scripto) had physical presence in Florida despite having no employees or property in that state. The Court found that Scripto's independent contractors were effectively salesmen and that their activities conducted on Scripto's behalf were more important than the fact that the contractors were not technically employees of Scripto.^{^[3]}

Scripto's rule-deeming independent contractors to be employees where their activities are essential for the maintenance of the out-of-state company's market in the state-is widely considered to be the furthest recognized extension of a state's taxing power. The Connecticut court did not limit its ruling to the confines of this rule, however, and actually suggested that their rule necessarily goes beyond Scripto: "[Scripto] was not necessarily intended to mean that a substantial nexus between the out-of-state retailer in the state could not be found in other, as of yet undefined circumstances."^{^[4]}

In National Bellas Hess, Inc. v. Ill. Dept. of Revenue (1967) and Quill Corp. v. North Dakota (1992), the U.S. Supreme Court affirmed the physical presence nexus standard for determining sales tax collection obligations of out-of-state retailers. Bellas Hess was a mail order company, incorporated in Delaware, that distributed catalogs to customers who would return order forms and then receive their items via common carrier. Illinois argued that any company soliciting customers in the state must collect sales tax but the Court rejected that approach. Finding that Bellas Hess had no physical presence in Illinois, they ruled no collection obligation existed. Quill reaffirmed this rule after North Dakota enacted a law similar to the one struck down in National Bellas Hess.

Connecticut Court: Teachers are Both Customers and Salespeople

In March, Connecticut's state supreme court ruled that Scholastic is "physically present" in the state for tax collection purposes despite having no property or employees there.

Two issues allowed physical presence to be established: (1) how books and products were distributed and (2) the role of those distributors. Scholastic Inc. is the parent company, based in Missouri, and makes educational products available through direct purchase or in retail stores. Scholastic Book Club (SBC) is a subsidiary that operates entirely through schools. SBC sends catalogs to voluntarily participating school teachers who can give them to their students. The students then give the catalogs or flyers to their parents, who may choose to purchase items and give the order back to the teacher. The teacher submits a bulk order to Scholastic and receives the items via common carrier (such as the U.S. mail or a private delivery service).

The catalog explicitly says that there is no agency relationship between the teacher and Scholastic.^{^[5]} While the teacher receives no monetary remuneration for collecting the sales from the parents, there is a bonus point system based on the number of books ordered each month. Teachers can earn points and redeem them for books or other items restricted to classroom use.

In 2007, the Connecticut Department of Revenue asserted that SBC must collect sales and use taxes on books sold in the state. Out-of-state businesses, however, are generally exempt from this obligation, and SBC does not own or lease any property, have employees, possess a phone or web address, or have a bank account in Connecticut. Revenue officials argued that teachers were operating as representatives of SBC and thus were effectively employees.

In 2009, the trial court ruled against the state: "As the teachers are not in-state 'order-takers' seeking to produce 'revenue' for themselves or SBC, the court concludes that Connecticut schoolteachers are not 'representatives' of SBC."^{^[6]} To have nexus in a state, a company must have a minimum link and the trial court did not believe the teachers as "representatives" argument established that link.

In its May decision, the Connecticut Supreme Court overruled the trial court and found it persuasive that teachers are the sole conduit for purchase and communication between SBC and the children's parents. While the court did recognize that teachers are also customers of SBC, they concluded that teachers could be both SBC customers and representatives. They pointed to teachers distributing flyers and catalogs of Scholastic products, collecting money for purchase, and mediating problems of sale. The final decision rested on redefining what constitutes a representative:

A representative is a person who is not an employee or an agent and who does not necessarily act through delegated authority for remuneration, as does a salesman, canvasser or solicitor, but who otherwise stands in the place of, or acts on behalf of, the out-of-state retailer "for the purpose of selling, delivering or taking orders" for the retailer's products.^{^[7]}

Some 14,000 teachers in Connecticut use SBC programs. Because Connecticut now deems all these individuals to be SBC representatives, the company must pay more than $3 million in back sales taxes and penalties. Connecticut's broad interpretation of "representative" moves away from the certainty of a bright line between "employee" and "non-employee." An independent representative that delivers or takes orders for a product can now establish nexus for the remote seller. In this case, educational products are being targeted but this precedent could theoretically be applied to any out-of-state company.

Tennessee Rule and Other States

Earlier in 2012, the Tennessee Court of Appeals also ruled against Scholastic, holding that the company owes over $5 million in back taxes and penalties.^{^[8]} There, the court set aside the question of whether the teachers are Scholastic agents, instead focusing on the fact that SBC effectively created a sales force through its teachers, thus developing a market in the schools. The court noted that SBC was using taxpayer services (public schools) to solicit and deliver its products, which demonstrates a benefit from collecting the sales tax.

The extent to which the Tennessee court decision rests on Scholastic's benefit from its sales in the state is problematically expansive. The opinion's discussion of Scholastic creating a market in the state is on firmer ground, but does not directly conclude that the teachers' activities amount to employee-like activity. An appeal to the Tennessee Supreme Court is pending.

Earlier state cases further illustrate this issue:

The California Court of Appeals ruled in Scholastic Book Clubs, Inc. v. State Board of Equalization (1989) that Scholastic had an obligation to collect tax because the teachers were SBC agents due to their activities in the SBC business operation and their remuneration with bonus points.^{^[9]}

The Kansas Supreme Court in Appeal of Scholastic Book Clubs, Inc. (1996) reached a similar result: "By Scholastic's accepting orders and payments and shipping merchandise to teachers for distribution to the student purchasers, the Kansas teachers are the implied agents of Scholastic."^{^[10]}

The Michigan Court of Appeals went the other way in Scholastic Book Clubs Inc. v. Michigan State Department of Treasury Revenue Division (1997). The Court found that "[t]he teachers are not a sales force that works for plaintiff. Rather, they are analogous to parents who order an item from a mail-order catalog for their children; no one would seriously argue that such parents are a "sales force" for mail-order vendors."^{^[11]}

The Future for Scholastic and Other Retailers

States are becoming increasingly aggressive about expanding nexus standards beyond their borders as budgets get tighter and the desire to find new revenue increases. Moreover, the precedent thus far in these Scholastic cases suggests a bleak future for remote sellers seeking to do business across state lines. With over 9,600 sales tax jurisdictions in the United States, each with a parochial and bewildering set of rates, rules, and bases, it is difficult for businesses to comply fully with these requirements, particularly since they are becoming less uniform and more complex each year. In Quill, the Supreme Court emphasized the importance of clarity to state tax authority and issues of interstate commerce, inviting Congress to substitute an alternative standard to physical presence if it desired.

A number of options exist, from a clear physical presence standard to several congressional proposals that would advance simplification while allowing states to collect additional revenue. Additionally, there are other ideas such as origin-based sales taxes, where the tax would be collected on where the seller is located (as is the case with brick-and-mortar businesses), not where the customer is located. Scholastic, incidentally, is headquartered in Missouri.

The rise of Internet retailers and economic integration generally means the costs of nexus uncertainty are more likely to burden and impede economic growth.^{^[12]} The Scholastic cases illustrate the inconsistency of courts in deciding state tax authority and the necessity for Congress or the courts to definitively resolve the problem. States' strong desire to shift the burdens of government from the voters and businesses that benefit directly from its services to unrepresented, remote taxpayers can only be checked by congressional or court action.

Jordan King is an Adjunct Scholar and Joseph Henchman is Vice President of Legal & State Projects at the Tax Foundation.

[1] See Chris Atkins, Does the Commerce Clause Protect Commerce or State Coffers?, Tax Foundation Tax Policy Blog (Dec. 12, 2006), http://www.taxfoundation.org/news/show/2083.html.

[2] See generally Joseph Henchman, Why the Quill Physical Presence Rule Shouldn't Go the Way of Personal Jurisdiction, 46 State Tax Notes 387 (2007).

[3] See Chris Atkins, Important Tax Cases: Scripto v. Carson and the Agency Theory of Nexus, Tax Foundation Tax Policy Blog (Aug. 25, 2006), http://taxfoundation.org/blog/show/1031.html.

[4] Carroll Waltreese, "Tax Professionals Split on Constitutionality of Scholastic Cases," Tax Analysts (Apr. 24, 2012).

[5] Grant Thornton LLP, Connecticut Supreme Court Holds Teachers Created Sales Tax Nexus for Out of State Book Distributor, (Apr. 3, 2012), http://www.grantthornton.com/staticfiles/GTCom/Tax/SALT_Alert_files/SALT_Alert_CT_nexus_books.pdf.

[6] Scholastic Book Clubs, Inc. v. Commissioner of Revenue Services, 2009 WL 1175675 (Conn. Super. Apr. 9, 2009).

[7] Scholastic Book Clubs, Inc. v. Commissioner of Revenue Services, 38 A.3d 1183, 1190 (Conn. 2012).

[8] Scholastic Book Clubs, Inc. v. Farr, 2012 WL 259979 (Tenn. Ct. App. Jan. 27, 2012).

[9] Scholastic Book Clubs, Inc. v. State Bd. of Equalization, 207 Cal.App.3d 734, 740 (Cal. Ct. App. 1989).

[10] Appeal of Scholastic Book Clubs, Inc., 920 P.2d 947, 956 (Kan. 1996).

[11] Scholastic Book Clubs, Inc. v. State, Dept. of Treasury, Revenue Div., 567 N.W.2d 692, 696 (Mich. App. 1997).

[12] Joseph Henchman, Dirk Gisebert, & Laura Lieberman, Ending the Nexus Guessing Game for Taxpayers: Lamtec Corp. v. Washington Department of Revenue, Tax Foundation Fiscal Fact No. 274 (Jun. 16, 2011), http://www.taxfoundation.org/news/show/27381.html.

Taxation of Online Travel Services: Lawsuits Generally Not Succeeding In Effort to Expand Hotel Taxes

Wed, 09 May 2012 00:00:00 EDT

Download a PDF of this report here.

Key Findings

Local officials in 25 states and the District of Columbia have sought to reinterpret hotel occupany tax ordinances to apply to amounts paid by consumers to online travel booking services, with limited success. OTCs have prevailed in cases in 18 states, while governments have prevailed in cases in 3 states and the District of Columbia. Cases are pending in 5 states.
In traditional hotel transactions, travelers book a room and pay a hotel tax based on the amount they pay to the hotel. Online travel companies (OTCs) facilitate such transactions between consumers and hotels, and keep part of what the consumer pays as a service fee.
OTCs neither operate hotels nor resell hotel rooms as wholesalers, placing them outside the proper scope of hotel occupancy taxes.
Most U.S. states and cities do not tax services, so taxing only Internet-based travel facilitation services (and doing so at a high rate) suggests that the real motivation is to shift tax burdens to nonresidents, burdening the free flow of interstate commerce.
Local governments should not expect easy revenue from pursuing such claims.

Introduction

A number of lawsuits have been filed recently by cities and counties claiming that online travel companies (OTCs, such as Expedia, Hotels.com, Orbitz, Priceline, and Travelocity) are in violation of their hotel occupancy tax ordinances.¹ The suits claim that hotel occupancy tax should be paid on the amount of hotel reservation transactions that accrues to the OTC, described variously as a facilitation fee, service fee, commission, markup, or difference between the "retail" and "wholesale" rates. Altogether, some 70 lawsuits have been filed in 25 states and the District of Columbia.

Put another way, the question is whether hotel occupancy taxes should be calculated based either (1) on the amount the hotel receives, or (2) on the amount the consumer pays. In the former case, hotel tax is imposed only on the hotel's charge for the accommodation. In the latter case, any money spent in procuring accommodations is conceivably subject to hotel tax, even if the money is spent on other services such as an online travel service, travel agent, personal assistant, or conference booking coordinator. In all but three states, services are generally exempt from sales taxation.²

City litigation efforts have also raised other serious questions by attempting to judicially enforce new interpretations of hotel occupancy tax statutes rather than pursuing legislative amendments, acting outside of established administrative procedures, and engaging in questionable oversight due to the hiring of private contingency-fee lawyers to pursue these lawsuits. In many cases, contingency lawyers seeking to litigate in this area actively encourage states and localities to pursue legislation designed to improve their chances of obtaining a favorable court judgment.

To date, judges have shown skepticism of the cities’ claims, with OTCs prevailing in 18 of the 25 states where lawsuits have been filed; cases in five states remain pending while the governments have prevailed, at least initially, in three states plus the District of Columbia. Many cities have backed off pursuing litigation as it became clear that easy revenue would not be forthcoming, contrary to proponents’ claims. Nevertheless, due to the continuation of this trend and the increasingly serious impact it has on interstate commerce (somewhere between 5 and 25 percent of hotel bookings are now done through OTCs³), federal legislation may be forthcoming to halt local hotel tax predation and preserve the status quo of hotel taxes based only on hotel occupancy.

Table 1
Status of Local Government Litigation Against Online Travel Companies as of March 2012

State	Litigation?	Disposition
Alabama	X	OTC services not taxable under hotel tax.
Alaska
Arizona
Arkansas	X	Government failed to exhaust administrative remedies.
California	X	OTC services not taxable under hotel tax.
Colorado
Connecticut
Delaware
Florida	X	OTC services not taxable under hotel tax.
Georgia	X	OTC services not taxable under hotel tax.
Hawaii	X	Case pending.
Idaho
Illinois	x	OTC services taxable.
Indiana	X	Government failed to exhaust administrative remedies.
Iowa
Kansas
Kentucky	X	OTC services not taxable under hotel tax.
Louisiana
Maine
Maryland	X	Case pending.
Massachusetts
Michigan	X	Case pending.
Minnesota
Mississippi
Missouri	X	OTC services not taxable under hotel tax.
Montana	X	Case pending.
Nebraska
Nevada
New Hampshire
New Jersey	X	Government lacked standing to pursue claim.
New Mexico	X	OTC services not taxable under hotel tax.
New York	X	OTC services not taxable under hotel tax.
North Carolina	X	OTC services not taxable under hotel tax.
North Dakota
Ohio	X	OTC services not taxable under hotel tax.
Oklahoma	X	OTC services not taxable under hotel tax.
Oregon
Pennsylvania	X	OTC services not taxable under hotel tax. Another case pending.
Rhode Island
South Carolina	X	OTC services taxable.
South Dakota
Tennessee	X	OTC services not taxable under hotel tax.
Texas	X	In two cases, OTC services not taxable under hotel tax. In one case, OTC services taxable.
Utah
Vermont
Virginia
Washington	X	Case voluntarily dismissed.
West Virginia
Wisconsin	X	Case dismissed.
Wyoming
District of Columbia	X	OTC services taxable.
Source: Tax Foundation review of litigation. See Appendix for detailed case information.

Booking a Hotel Room: The "Merchant" Model and Online Travel Services

If a traveler goes directly to a hotel's website and books a room, the calculation of the hotel tax is simple. The traveler stays at the hotel and pays the hotel a room charge plus a local hotel tax based on the room charge. If the amount paid by the traveler to the hotel for the accommodation is $100 a night, and the hotel tax is 15 percent, the tax owed is $15. No other parties are involved and no other amounts are paid by the consumer. The hotel keeps the room charge and forwards the tax money to the government. If a traveler books the room through a travel agent (the "agent" model), the hotel compensates the travel agent but this does not affect the amount received by the hotel from the customer, or the amount paid in tax.

When a traveler uses an online travel company to book the room (the "merchant" model), the traveler sorts through hotels on the OTC 's website and books the room there. Travelers pay one unified charge to the OTC, which encompasses the room rate agreed upon with the hotel (closely guarded, as hotels do not want other guests and competitors learning the amount of the discount given to OTC bookings), the taxes owed on that amount, and the remainder, which is kept by the OTC as a facilitation fee. After the hotel stay has occurred, the hotel bills the online travel company for the amounts owed, and the hotel is responsible for forwarding taxes to the government.

For example, assume the hotel agrees to a contract whereby it will receive only $70 a night for any OTC -facilitated rentals of the normally $100-a-night room (plus $15 in tax). Hotels agree to such contracts because they can reach a market through the OTC that they would not otherwise reach. If the traveler using the OTC website books the room at $90 a night inclusive of taxes and fees, $70 is forwarded to the hotel as a room charge, 15 percent of that amount ($10.50) is forwarded to the hotel to pay hotel taxes to the government, and the remainder ($9.50) is retained by the OTC as its service fee on the transaction.

A typical lawsuit claims, "[T]he internet travel sites negotiate room prices with hotels at a wholesale rate, then charge travelers who book through their websites a higher retail rate. However, the companies remit taxes only on the lower wholesale rate."⁴ It is a seductive argument that apparently won the day in the Texas case, as commentator Billy Hamilton describes:

The jury was told, 'if you buy a shirt at J.C. Penney, you pay tax on the total price of the shirt not some wholesale price with part of the price carved out from tax.' It's an interesting analogy, Cindy Ohlenforst, an attorney for one of the online booking companies, told me...

But suppose you hired a neighbor's teenager or a personal shopper to buy the shirt. Let's say the shopper found a shirt for $80 at Walmart and charged you $20 for her time. In that case, you haven't bought a shirt for $100. You've bought an $80 shirt and you've paid $20 for nontaxable services.⁵

In the online travel company context, there is no "wholesale" purchase followed by a "retail" sale, but rather one retail transaction that has a room rental component and a service component. This service provider or "merchant model" existed long before online service providers, in the form of bundled packages of hotel accommodations with other services.

Online Travel Services Are Generally Outside the Scope of Hotel Tax Statutes

While precise wording can vary, hotel tax statutes typically provide that hotel taxes are paid by hotel occupants based on the amount they pay to the hotel. Amounts paid by guests to others are not subject to the hotel tax. (Depending on what the transaction is, they may be subject to other taxes, and any company providing a service to a guest must pay income tax on the amount.)

While some cities (including New York City, South San Francisco, and Washington, D.C.) have legislatively changed their statutes to expand hotel taxes to amounts paid by the consumer to anyone connected with the hotel transaction, most cities have been reluctant to do so. Instead, they have filed lawsuits seeking to collect these amounts from OTCs, claiming that their activities fall under existing statutes as "hotel operators" or "hotel room wholesalers." Such broad statutes could encompass not only online travel companies, but also travel agents, advertisers, or even paid secretaries or co-workers who help book travel. The Washington, D.C. statute has already been criticized by a friendly judge as "impossible to reconcile any meaning out of the confusion."⁶

In most of the cases brought by the cities, courts have declined to extend the hotel tax statute to cover OTC services as beyond its plain meaning or intended scope. Even where a court has concluded that the statute could conceivably cover OTC services, they have generally declined to do so under the long-standing rule that ambiguous statutes with more than one possible interpretation should be resolved in favor of taxpayers.⁷

City Lawsuits Seek New Tax Revenue by Expanding Hotel Tax Base to OTC services

A properly structured tax on goods and services should apply to all goods and services once and only once. Goods and services primarily used by nonresidents should not be subject to higher, discriminatory taxes. Further, a well-designed, principled tax system does not attempt to micromanage consumer decisions. Such a system minimizes tax distortion of investment and production decisions and avoids discriminatory taxation of nonresidents who use fewer services than residents and have no democratic recourse.

Unfortunately, states stray from these principles. Whole categories of transactions, primarily services but also politically favored investment and consumer actions, are exempt from sales taxation. Business inputs are often taxed, resulting in multiple taxation. Nonresidents are made to bear a disproportionate share of the tax burden, through high taxes on items thought to be used primarily by them: restaurant meals, car rentals, and hotel rooms.

These two unprincipled efforts by states— exempting many goods and services from sales taxation while imposing high taxes on items thought to be used by nonresidents—have led directly to the online travel company disputes. State and local governments are loathe to tax services, like the service of booking a hotel room, in the belief that service providers are more likely to leave if taxation becomes excessive. But because officials want to extract more revenue from out-of-state travelers and out-of-state businesses, the result is an effort to tax only services provided by out-of-state and Internet businesses. As The Economist magazine recently summarized:

Business travelers are easy to tax. We dart in and out of town, we use easily taxable amenities like airports, hotels, and taxis, and, most important, we don't vote—at least not in our destination cities. Every business traveller has probably spent a night in a hotel where both state and local taxes are added to travellers' bills.⁸

Rather than correct or contain these misguided ideas, states and cities instead are looking for ways to expand them.

Many of the city lawsuits claim that the imposition of hotel tax on OTC services already exists and that they are simply attempting to collect tax amounts already owed. This is a disingenuous argument, since the collection of such taxes has not been expected prior to the lawsuits. In most cases, the hotel tax law is being amended or its interpretation dramatically changed, so it cannot reasonably be said that the taxes are owed yet "uncollected." Even if a new law is not required for the city to press for payment, businesses (and ultimately, consumers) will be paying a higher rate of taxes to the government than before, which makes it a tax increase.

Consequently, claims of "revenue losses" are misplaced. The revenue was never to have been gained, so it cannot have been lost. In any event, good policy analysis goes beyond merely evaluating whether a proposal raises revenue. An idea might raise millions of dollars in new revenue but it would be a bad policy if it did so in a damaging way. As one Nevada attorney said on the issue, "[T]he law doesn't change just because the economic times are tough right now."⁹ It is cynical to equate "might raise revenue" with "preventing revenue losses," as it assumes what the analysis is meant to figure out: whether the taxation is lawful and justified.

The mischaracterization that online travel companies have collected taxes (or disguised taxes as other charges¹⁰) but have not remitted them is similarly problematic, as it ignores the economic effects of taxation. Customers pay one total amount to the online travel companies, which then is divided among the hotel, the government, and the online travel company. The cities' claim is essentially that some portion of the profit kept by the online travel company is in reality "owed" taxes.

In any event, state and local governments have other revenue-raising options aside from discriminating against nonresidents by applying taxes to services primarily used by the nonresidents, or only to online versions of services. As one commentator pointed out, “If states or localities want to raise more revenue, they could just raise the rate rather than argue about which price to apply it to…. Whatever the solution, it should be a well thought-out, comprehensive approach, and not this case-by-case approach that is draining resources from the companies, the localities, and the courts.”¹¹

Cities’ Lawsuits Have Not Succeeded but Have Produced Extended Litigation and Negative Impacts on Tourism Industry

While the 70 related lawsuits filed in 25 states and the District of Columbia involve different statutes and different governments, there are commonalities. They generally involve claims by the local governments that online travel companies are in violation of their hotel occupancy tax ordinances due to a failure to pay the hotel occupancy tax on the amount of the transaction that accrues to the OTC, described variously as a facilitation fee, service fee, commission, markup, or difference between the “retail” and “wholesale” rates. The statutes in question usually do not explicitly speak to these services but the governments assert that the tax encompasses them.

Of those 70 cases, 26 cases have produced a judicial opinion on the merits. While there are cases pending or dormant, a review of the conclusions reached by judges weighing similar claims can be instructive. Two questions in particular come up with some frequency: (1) whether OTC s are “operators” of hotels and (2) what precisely the hotel occupancy tax taxes.

Court Rulings on Whether Online Travel Companies Are Hotel Operators

In 15 cases, judges specifically considered whether online travel companies are hotel “operators” for purposes of hotel occupancy tax statutes. The vast majority of the cases (12 out of 15) find that OTC s are not hotel operators.¹²

For example, in a case brought by Anaheim, California, the judge wrote:

OTCs do not control and run hotels...

The hotel controls the production of the product sold (the hotel room and accompanying amenities), the quantity of production, the quality of production, the channels of distribution of the product (i.e., whether and what quantity of rooms will be made available through a particular intermediary), and the pricing of the product (whether sold directly to the consumer or to an intermediary).¹³

Further, rejecting a claim that OTCs are operators because they take on some reporting responsibilities associated with the transaction, the judge stated: "One cannot logically conclude, however, that because a hotel operator is required to furnish a receipt specifying the amount of taxes, therefore any entity that furnishes a receipt of some sort to the consumer must be an operator."¹⁴

A Florida appellate court reached a similar conclusion:

The Defendants do not own, lease, operate or manage any hotels. They do not become involved in any of the myriad activities inherent in running a hotel business, from buying the property, to building or contracting the construction of the facilities, to staffing the various hotel operations or services, or to providing any hotel amenities. The individual hotels, not the online travel companies, register guests, establish check-in and check-out times and procedures, and set all the rules and procedures governing stays on that property…. Perhaps most importantly, the Defendants do not own or control the rooms for which they offer to obtain reservations. They do not rent a block of rooms in advance of booking, and then re-let those rooms to their customers; they are not obligated to make reservations for any minimum number of rooms; and there is no penalty if they do not assist in making a specific number of reservations.¹⁵

Similarly, the U.S. Court of Appeals for the Fourth Circuit, citing the Webster's Dictionary definition of "operator," concluded that "an online travel company is not a retailer because it is not a business of a type that is similar to a hotel, motel or tourist home or camp. As a result, an online travel company is not subject to the Pitt County occupancy tax."¹⁶The U.S. Court of Appeals for the Sixth Circuit also found that "OTCs are not like or similar to the listed types of businesses because they 'have neither ownership, nor physical control, of the rooms they offer for rent.'"¹⁷ The Kentucky Court of Appeals concluded that OTCs are "merely a broker" rather than a provider of accommodations.¹⁸ A federal judge in New Mexico found that OTCs are not "vendors" who furnish lodging, and instead "earn for their services, including providing their customers with the vast content on their websites…."¹⁹ The Texas Court of Appeals explained the element of hotel operation that OTCs do not possess:

The hotel offers occupancy in exchange for payment of the invoiced discounted rate. An OTC, on the other hand, does not have rooms or occupancy; as Houston concedes, the OTCs do not have the right to use or possess hotel rooms. Instead, the OTCs have websites and provide information. The content of a given OTC 's website includes material provided by the hotel, which may include photographs, descriptions, and listings of the amenities and services available onsite—but the OTC also provides information about the hotel's competitors. Visitors to the website can access maps, check room availability, and compare rates, ratings, and the reviews of other consumers... In sum, the OTC does not merely help the website visitor make a reservation; it also helps consumers make informed choices in spending their travel dollars, and to do so conveniently and efficiently. When the consumer pays the OTC, the payment includes compensation for these benefits.²⁰

The three cases that have found otherwise did not conclude that OTCs physically operate the hotel but rather exercise control of some level to fall within the statute's framework as a hotel operator. For example, the South Carolina Supreme Court found that the statute's limitation to entities that are "in the business of furnishing accommodations" applies to OTCs because they "directly or indirectly, provide hotel reservations to transients for consideration." ²¹ One justice dissented, claiming the majority defined the statute's two mentions of "furnish" in two different ways.²²

Similarly, a federal judge in Illinois focusing on the word "owner" found that while "[t]here is no dispute that defendants do not have an ownership interest in or conduct the operations of the hotels with which they do business," the word "owner" should be interpreted as encompassing "anyone who receives the 'consideration for the rental,'" such as OTCs.²³ Another federal judge, in the Western District of Texas, found "control" of hotels by OTCs, at odds with the Texas Court of Appeals and another federal judge from the Eastern District of Texas. In the class-action City of San Antonio v. Hotels.com, the judge found (relying on a jury verdict) that OTCs "control" hotels in that they step into the shoes of the hotel for the purpose of tax collection: "The OTCs have sole control over the decision to establish, change, or dissolve markups, services fees and/or surcharges as they wish."²⁴

These three decisions rely on legal sophistry, giving new meaning to words such as "own," "furnish," and "control" beyond their common understanding. In the vast majority of cases, courts correctly determined that OTCs are not akin to hotels and do not operate or control hotels.

Court Rulings on What Is Taxed by a Hotel Occupancy Tax

In twelve cases, courts focused on the scope of the hotel occupancy tax and what activities it is meant to tax. In nine of those twelve cases, the court concluded that OTC services are beyond the scope of the hotel occupancy tax.²⁵

For example, a New York appellate court ruled that "the plain meaning of [the statute] did not encompass the service fees charged by the travel intermediaries and the legislation may not be extended so as to permit the imposition of the tax in a situation not embraced by it."²⁶ The Missouri Supreme Court unanimously held that "the money [the OTC ] retains is compensation for facilitating a reservation, not providing a sleeping room," outside the scope of a tax on amounts paid by hotel guests.²⁷ A federal judge in New Mexico found that because only a portion of a hotel guest's payment ultimately goes to hotel operators, "[i]t would not make sense to interpret 'gross taxable rent' as the full amount charged by Defendants because only a portion of this amount is actually 'paid to vendors.'"²⁸

An Alabama circuit court judge concluded that OTCs perform facilitation services and are not in the business of renting or furnishing rooms:

The plaintiffs object to the use of the word 'facilitate' in defining the defendant's activities, but the undisputed facts show that that is what they do. They facilitate, or make easier, the making of such reservations... They provide a service to the public for which they are compensated by their customers. This compensation is not subject to the lodging tax.²⁹

Three cases reached a different conclusion. In Georgia, the State Supreme Court found that OTCs are not obligated to collect hotel occupancy taxes, but if they do, they must be applied to all amounts paid by a consumer for occupancy, including non-separately-stated OTC services.³⁰ A District of Columbia judge concluded that "[i]t is not the transaction between the hotel and the OTC that is the retail sale; rather, it is the subsequent sale to the ultimate purchaser..."³¹

A federal judge in the Western District of Texas (the same as above) chose to disregard a part of the statute in ruling against the OTCs:

The Cities assert that the words 'to the hotel' are mere surplusage, and the Court agrees. If a period were placed immediately after the phrase 'consideration paid by the occupant of the room,' the tax provision in the Dallastype ordinance would make perfect sense. Thus, there is every reason to disregard the words 'to the hotel' as surplusage because they are repugnant to the rest of the ordinance and would render the ordinances meaningless.³²

This decision is at odds with the federal judge in the Eastern District of Texas and the Texas Court of Appeals, both of whom found that the statute's requirement that only amounts paid "to the hotel" are taxable.³³

Court Rulings on Cities' Claim that Not Taxing OTC services Would Undermine the Hotel Occupancy Tax

Although more a public policy argument than a legal argument, some cities have argued that a court's unwillingness to permit taxation of OTC services under the hotel occupancy tax would undermine that tax as a whole. In the Anaheim case, the hearing officer reached that conclusion, as discussed by the judge who reversed him on this point:

The Hearing Officer concluded that an interpretation of the ordinance that bases the transient occupancy tax on the amount charged by the hotel would lead to absurd results. The Hearing Officer considered the following hypothetical: "[]A hotel or hotel chain [could establish] a wholly owned subsidiary corporation in a different municipality to handle all its reservation and booking inquiries. The hotel could then provide rooms to the subsidiary at an extremely cheap price and the subsidiary could sell them to consumers at a much higher rate. In this way, the Company would be able to provide accommodations to customers without having to charge the customers the…tax on the amount the customers actually pay for the room.³⁴

Similarly, the judge in the District of Columbia case upheld the law in part out of this worry, stating that government "is correct when it argues that under the OTC 's proposed interpretation, retail sales tax could be avoided altogether by a hotel simply by interposing a shell company between its customers and the hotel." ³⁵

This concern—the threat of hotel tax collections being disrupted unless OTC services are subject to the tax—arises only in the case of a poorly drafted hotel occupancy statute. If the statute is designed to tax amounts spent by the customer as part of transactions related to occupancy, then that is very broad and difficult to collect and enforce. Many different transactions are undertaken by travelers that are related to occupancy, such as online travel services, travel agents, personal assistants, conference booking coordinators, conference packages, transportation options, and so forth. If a jurisdiction wishes to tax all services under its sales tax, that is one thing, but there is no justification for subjecting only these services, or only OTC services, to the higher-rate hotel tax.

Further, not taxing OTC -hotel transactions does not threaten to undermine a city's ability to collect hotel taxes on amounts paid by travelers to hotels for rooming charges. As the judge in the Anaheim case explained:

Despite the Hearing Officer's concern, it is not necessary to skew the interpretation of the Anaheim ordinance in order to protect the City from the type of abuse suggested by the hypothetical. The hotel in the hypothetical is engaged in a collusive transaction with its subsidiary, charging 'an extremely cheap price' to the benefit of its subsidiary, not a price determined in an arms-length transaction. The abuse represented by the hypothetical is not that the hotel is marketing rooms through a third party, but that it is marketing rooms within its own corporate structure…. There is no evidence in the record that the prices charged by hotels to the OTCs are collusive prices. To the contrary, the Hearing Officer found that the prices charged by hotels to OTCs are set in negotiated transactions.³⁶

In the recent Tennessee case the judge concluded that "shell companies" are unlikely because "OTCs and the hotels are independent entities that negotiate in arms-length transactions [where] the hotel has every incentive to keep the net rate as high as possible and to reserve for direct booking as many rooms as it believes it can sell directly to consumers, without sacrificing any potential revenue to the OTCs."³⁷ The judge further emphasized that it is a legislative role, not a role of the courts, "to enact revenue statutes that clearly state the scope and application of the tax laws and, upon identifying any potential revenue shortfalls in their application, to address those perceived shortfalls by appropriate legislation."³⁸ The legislature is the one, the judge wrote, who must fix a statute that has "simply failed to keep up with the times."³⁹

Federal Action Could Bar Discriminatory Taxation, Similar to Other Precedents Restraining State Damage to Interstate Commerce

In economics, the idea that individuals should pay taxes in proportion to the government services they use is known as the "benefit principle." Since visitors use fewer services than residents, and never use the most expensive service (public schools), they should bear a smaller share of the tax burden. Taxes on restaurants, hotels, and car rentals can thus be considered a proxy for a tax on tourists (although there are tourists who stay with friends rather than in hotels, don't eat out, and don't rent cars). But the benefit derived from added economic activity from visitors and travelers probably exceeds the government services they use during their stay, undermining the basis for excessive hotel taxation.

Such taxes are often described as taxes on "them, not us." But we are all "them" to someone else; the net result is everyone paying high hotel taxes everywhere. These taxes can be considerable: The Global Business Travel Association estimates that these taxes alone on travelers can range from $21.49 to $40.99 per day.⁴⁰ Hotel taxes nationwide average about 14 percent, much higher than sales taxes on other goods and services.⁴¹

There is no principled basis for only taxing those services provided by Internet businesses. If state and local officials believe that online travel companies should pay sales or excise tax based on the services they provide, the payment should only occur as part of a general taxation of all services. A non-neutral tax system would apply the same tax rate to all services, and the democratic process can settle on a rate that raises needed revenue while minimizing economic harm. By singling out only services provided by Internet-based travel companies, state and local governments are demonstrating that their true motivation is gouging revenue from out-of-staters, not fairness.

Potential federal action could be justified to maintain settled practices in hotel occupancy taxation: Hotel occupancy taxes would be calculated by the amounts hotels receive in payment from the hotel occupant. Further, states could retain the option of taxing online travel booking services, as long as they tax services generally or at least do not discriminate by only taxing online travel booking services.

Such a proposal woud be in line with other federal actions that prevent parochial state government actions from damaging interstate commerce. The people of the United States adopted the Constitution in large part because their existing national government had no power to stop states from imposing trade barriers with each other, to the detriment of the national economy. As U.S. Supreme Court Justice William Johnson wrote in the seminal case of Gibbons v. Ogden, invalidating New York's stifling regulations on interstate water travel:

[States' power over commerce,] guided by inexperience and jealousy, began to show itself in iniquitous laws and impolitic measures..., destructive to the harmony of the States, and fatal to their commercial interests abroad. This was the immediate cause, that led to the forming of a convention.⁴²

Consequently, among the powers granted to Congress by the new Constitution was "[to] regulate Commerce... among the several States," a provision known today as the Commerce Clause.⁴³ Congress thus has the power to restrain state laws that discriminate against or otherwise burden the flow of interstate commerce.

Congressional actions under the Commerce Clause to remove or prevent state and local burdens on the travel industry are common and have previously been upheld.⁴⁴

City officials claim their motivations are not to burden interstate commerce, but rather to promote fairness and collect owed revenue from the "wholesale" service. In reality, existing tax laws are being contorted to extend to the online travel industry, taxing service transactions with no substantial nexus to the jurisdiction or to hotel occupancy.

The costs imposed in filing and defending these lawsuits are also passed along to taxpayers and travelers. These are magnified in places like California, which requires pre-payment of the disputed (and often enormous) tax amounts before a tax can be challenged in court.⁴⁵

It may be too much to ask that states only tax everything once and only once, and not design taxes to hit only nonresidents. The siren call of revenue (sometimes sold as costless and risk-free⁴⁶) is often tempting enough to override principles and sound policy. The Commerce Clause exists precisely for these situations, when states put tax parochialism ahead of the common national good.

It is in the nation's interest and the interest of each state and municipality to have a vibrant and dynamic travel industry. Unpredictable and unaccountable taxes are a hindrance to that, and perhaps only congressional action can move the states toward less harmful tax policy.

Conclusion

Aggressive and unjustified taxation of online travel companies is a cost, in that each community hopes to burden out-of-state travelers for its own benefit. Such a burden in one municipality is at best a bother. But when multiplied across the country, it can quickly become death by a thousand cuts.

If a state or local government wishes to tax nonresidents or services, that is acceptable. But if non-residents are taxed at a higher rate than residents, or if only services primarily used by nonresidents are taxed while everything else is exempt, the real motivation becomes clear: a "meddlesome, money-grabbing plan." When cities and states act in such a way toward one set of businesses, investment and economic growth can be chilled as other businesses take note.

It is important that our state and local governments collect revenue needed to provide the services demanded by their constituents. But that need does not justify impositions on interstate commerce, burdens on the national economy, or the corruption of sound tax principles.

Appendix: Cases

This section contains information on all OTC hotel tax cases that have issued a decision on the merits.

Six cases from six states, where the OTCs prevailed or where litigation is ongoing, are not included as they have not involved decisions on the merits, either due to a failure by the government to exhaust administrative remedies (Arkansas, California, Indiana, North Carolina, and Wisconsin) or where the government lacked standing to bring the case (New Jersey).⁴⁷ Pending cases in six states are not included as they have not reached merits decisions (Hawaii, Maryland, Michigan, Montana, Pennsylvania, Texas).

Federal Appellate Courts

U.S. Court of Appeals for the Fourth Circuit
January 14, 2009
Pitt County, North Carolina v. Hotels.com, L.P. ⁴⁸

Decision: OTC services not subject to hotel tax. Unanimous decision of 3-judge panel, affirming decision of the U.S. District Court for the Eastern District of North Carolina.

Statute: "Operators of hotels, motels, tourist homes, tourist camps, and similar type businesses and persons who rent private residences and cottages to transients are considered retailers under this Article. A tax at the general rate of tax is levied on the gross receipts derived by these retailers from the rental of any rooms, lodgings, or accommodations furnished to transients for a consideration…."⁴⁹

Analysis: "Online travel companies are not operators of the hotels whose rooms they offer to the public on the internet [citing Webster's Dictionary definition of "operator"]... We therefore conclude that under the plain meaning of § 105.164.4(a)(3), an online travel company is not a retailer because it is not a business of a type that is similar to a hotel, motel or tourist home or camp. As a result, an online travel company is not subject to the Pitt County occupancy tax."⁵⁰

U.S. Court of Appeals for the Sixth Circuit
December 22, 2009
Louisville/Jefferson County Metro Government v. Hotels.com, L.P. ⁵¹

Decision: OTC services not subject to hotel tax. Unanimous decision, affirming decision of the U.S. District Court for the Western District of Kentucky.

Statute: A tax on "the rent for every occupancy of a suite, room or rooms, charged by all persons, companies, corporations, or other like or similar persons, groups or organizations doing business as motor courts, motels, hotels, inns or like or similar accommodation businesses."⁵²

Analysis: "The district court reasoned that OTCs are not like or similar to the listed types of businesses because they 'have neither ownership, nor physical control, of the rooms they offer for rent.' According to the counties, this reading impermissibly adds the terms 'owner' and 'physical establishment' to the ordinances. We are unpersuaded by this argument, however, because the notions of ownership and physical control over the rooms for rent are simply shared characteristics of motor courts, motels, hotels, and inns. The district court thus properly applied the principle of ejusdem generis to the ordinances in question…. Furthermore, unlike in [hypotheticals suggested by the counties, of hotels forming subsidiaries and escaping taxation], none of the OTCs here are under common ownership with the physical establishments that control the rooms."⁵³

Other Courts

Alabama (City of Birmingham)
Alabama Circuit Court
November 18, 2011
City of Birmingham v. Orbitz, Inc.⁵⁴

Decision: OTC services not subject to hotel tax.

Statute: "There is levied and imposed, in addition to all other taxes of every kind now imposed by law, a privilege or license tax upon every person, firm or corporation engaging in the business of renting or furnishing any room or rooms, lodging or accommodations to transients in any hotel, motel, inn, tourist camp, tourist cabin, or any other place in which rooms, lodgings, or accommodations are regularly furnished to transients for a consideration," as calculated as a percentage "of the charge for such room, rooms, lodgings, or accommodations, including the charge for use or rental of personal property and services furnished in such room."⁵⁵

Analysis: "The plaintiffs object to the use of the word 'facilitate' in defining the defendant's activities, but the undisputed facts show that that is what they do. They facilitate, or make easier, the making of such reservations…. The plain language of the statute and the plaintiffs' ordinances compel the Court to the conclusion that the defendants in this case are not engaged in the business of renting or furnishing any room or rooms in any hotel…. These defendants are not hoteliers. They provide a service to the public for which they are compensated by their customers. This compensation is not subject to the lodging tax."⁵⁶

California (City of Santa Monica)
Superior Court for Los Angeles County
March 16, 2011
City of Santa Monica v. Expedia⁵⁷

Decision: OTC services not subject to hotel tax.

Statute: "[T]here is hereby imposed and levied on each and every transient a tax equivalent to fourteen percent (14%) of the total amount paid for room rental by or for any such transient to any hotel; which said tax shall be collected from such transient at the time and in the manner hereinafter provided…. [Room rental is t]he total charge made by any such hotel for lodging and/or lodging space furnished any such transient. ⁵⁸

Analysis: "If the 'commission' is a charge for some other service, and thus should be separately identified in the consumer's bill, it is not subject to transient occupancy tax."⁵⁹ "If a city decided to base a transient occupancy tax on the total amount paid by the transient for the hotel room (or for the hotel room and any 'commission' for the services of an intermediary) there seems to be no reason why such a tax scheme could not be drafted and considered. A new marketing methodology or other changed circumstances do not provide a basis for a court to rewrite a statute…."⁶⁰ "Santa Monica argues that excluding from taxation the amount paid to the OTC by the transient as an increment over and above the wholesale price of the room charged by the hotel operator lies outside the intent of the statute and deprives the Santa Monica ordinance of all serious purpose…. The fact that the Santa Monica ordinance does not tax the value of the service provided by the OTCs does not render the taxing scheme absurd. The fact that without the OTCs' services the hotels might themselves pay for alternative marketing arrangements does not render the transactions between the OTCs and the hotels a 'sham.'"⁶¹

California (City of Anaheim)
Superior Court for Los Angeles County
February 1, 2011
Expedia, Inc. v. City of Anaheim ⁶²

Decision: OTC services not subject to hotel tax.

Statute: "For the privilege of occupancy of space in any hotel, each transient is subject to and shall pay a tax in the amount of fifteen percent of the rent."⁶³ "'Rent' means the consideration charged by an operator for accommodations, including without limitation any (1) unrefunded advance rental deposits or (2) separate charges levied for items or services which are part of such accommodations including, but not limited to, furniture, fixtures, appliances, linens, towels, non-coin-operated safes, and maid service."⁶⁴ "'Operator' means any person, corporation, entity, or partnership which is the proprietor of the hotel, whether in the capacity of owner, lessee, sublessee, mortgagee in possession, debtor in possession, licensee or any other capacity. Where the operator performs its functions through a managing agent of any type or character other than an employee, the managing agent shall also be deemed an operator and shall have the same duties and liabilities as its principal."⁶⁵

Analysis: "OTCs do not control and run hotels…. "None of these facts comprise incidents of control of a hotel or give the OTCs the right to run the business of a hotel. The hotel controls the production of the product sold (the hotel room and accompanying amenities), the quantity of production, the quality of production, the channels of distribution of the product (i.e., whether and what quantity of rooms will be made available through a particular intermediary), and the pricing of the product (whether sold directly to the consumer or to an intermediary)."⁶⁶

"At most the Hearing Officer's findings would allow a conclusion that the OTCs are agents of the hotel for purposes of marketing a portion of the hotels' production (such portion having been determined by each hotel). But a mere agency relationship is not enough for shifting or sharing tax responsibilities under the Anaheim ordinance. Rather, the ordinance imposes such responsibility only on managing agents, agents who have been delegated sufficient discretion to allow them to make corporate policy..."⁶⁷

"The Hearing Officer considered the following hypothetical: 'A hotel or hotel chain could establish a wholly owned subsidiary corporation in a different municipality to handle all its reservation and booking inquiries. The hotel could then provide rooms to the subsidiary at an extremely cheap price and the subsidiary could sell them to consumers at a much higher rate. In this way, the Company would be able to provide accommodations to customers without having to charge the customers the tax on the amount the customers actually pay for the room.' Despite the Hearing Officer's concern, it is not necessary to skew the interpretation of the Anaheim ordinance in order to protect the City from the type of abuse suggested by the hypothetical. The hotel in the hypothetical is engaged in a collusive transaction with its subsidiary, charging 'an extremely cheap price' to the benefit of its subsidiary, not a price determined in an arms-length transaction. The abuse represented by the hypothetical is not that the hotel is marketing rooms through a third party, but that it is marketing rooms within its own corporate structure…. There is no evidence in the record that the prices charged by hotels to the OTCs are collusive prices. To the contrary, the Hearing Officer found that the prices charged by hotels to OTCs are set in negotiated transactions."⁶⁸

Florida (Leon County)
Circuit Court, 2nd Judicial Circuit, Leon County, Florida
April 19, 2012
Leon County v. Expedia, Inc. ⁶⁹

Decision: OTC services not subject to hotel tax.

State Statute: "It is declared the intent of the Legislature that every person who rents, leases, or lets for consideration any living quarters or accommodations in any hotel, apartment hotel, motel… for a term of 6 months or less is exercising a privilege which is subject to taxation under this section [unless otherwise exempt]."⁷⁰ The TDT "shall be due on the consideration paid for occupancy in the county . . . ."⁷¹ The TDT "shall be charged by the person receiving the consideration for the lease or rental, and it shall be collected from the lessee, tenant, or customer at the time of payment of the consideration for such lease or rental."⁷²

Analysis: "[The statute says the tax] shall be collected from the lessee, tenant, or customer at the time of payment of consideration. And I don't think you can get around that language, because when it goes on to the customer's credit card, that's the payment." ⁷³ "Arguing fairness, if property is going to be taken by the state, and that's what a tax is, the tax statutes have to be strictly construed..."⁷⁴

Florida (Orange County)
Circuit Court, 9th Judicial Circuit, Orange County, Florida
January 20, 2011
Orange County v. Expedia, Inc. ⁷⁵

Decision: OTC services not subject to hotel tax.

State Statute: “It is declared the intent of the Legislature that every person who rents, leases, or lets for consideration any living quarters or accommodations in any hotel, apartment hotel, motel… for a term of 6 months or less is exercising a privilege which is subject to taxation under this section [unless otherwise exempt].”⁷⁶ The TDT “shall be due on the consideration paid for occupancy in the county….”⁷⁷ The TDT “shall be charged by the person receiving the consideration for the lease or rental, and it shall be collected from the lessee, tenant, or customer at the time of payment of the consideration for such lease or rental.”⁷⁸

Analysis: “The difficulty arises not from the language chosen by the Legislature and the local authorities, which are reasonably plain when viewed in isolation, but from application of these laws to a type of internet business transaction which was undoubtedly not contemplated at the time the TDT was initially drafted and enacted, and has apparently never been amended to directly address these circumstances.”⁷⁹

"The Defendants do not own, lease, operate or manage any hotels. They do not become involved in any of the myriad activities inherent in running a hotel business, from buying the property, to building or contracting the construction of the facilities, to staffing the various hotel operations or services, or to providing any hotel amenities. The individual hotels, not the online travel companies, register guests, establish check-in and check-out times and procedures, and set all the rules and procedures governing stays on that property…. Perhaps most importantly, the Defendants do not own or control the rooms for which they offer to obtain reservations. They do not rent a block of rooms in advance of booking, and then re-let those rooms to their customers; they are not obligated to make reservations for any minimum number of rooms; and there is no penalty if they do not assist in making a specific number of reservations."⁸⁰

"Clearly, a net amount of rent accepted by the hotels themselves is properly subject to tax. The remainder of the charges to the hotel customers, however, reasonably can be viewed as separate fees or profits made by the online travel companies in exchange for the services they provide in informing customers about hotel accommodations, or in sending customers to hotels…. The Court finds that the TDT was not crafted to include within it the income earned by the online travel agencies in the transactions at issue in this case..."⁸¹

Georgia (City of Atlanta)
Supreme Court of Georgia
May 16, 2011
City of Atlanta v. Hotels.com ⁸²

Decision: OTC services not subject to hotel tax. Unanimous

Statute: "There is levied and assessed and there shall be paid a tax of seven percent of the rent for every occupancy of a guestroom in a hotel in the city."⁸³ Rent is defined as "the consideration received for occupancy valued in money..."⁸⁴ Further, "Every person occupying a guestroom in a hotel in this city is liable for the tax levied in this article."⁸⁵

Analysis: "Under the statute and ordinance the tax is on the consumer. The statute and ordinance do not tax any transaction between a non-occupant such as an OTC and the hotel. Thus, reading the ordinance in toto and in pari materia to the Enabling Statute, the amount that is taxable is the retail amount paid for occupancy by someone who will occupy the room. Since the consumer cannot obtain the right to occupy the room without paying the retail room rate charged by the OTC, it is the retail room rate that is the taxable amount or 'rent' under the City's ordinance."⁸⁶

Georgia (City of Columbus)
Supreme Court of Georgia
June 15, 2009
Expedia, Inc. v. City of Columbus ⁸⁷

Decision: OTCs are not operators of hotels and are not obligated to collect taxes, but must remit any taxes they collect. 4-3 decision.

Statute: Imposes "an excise tax in the amount of seven percent of the charge to the public upon the furnishing for value of any room or rooms or lodging or accommodations furnished by any person licensed by or required to pay business or occupation taxes to Columbus for operating a hotel within the meaning of this article."⁸⁸ "Any tax levied… in this Code section is also imposed upon every…entity who is a hotel or motel guest and who receives a room…. The person or entity collecting the tax from the hotel or motel guest shall remit the tax to the governing authority imposing the tax…."⁸⁹

Analysis: "Due to a lack of evidence regarding the amount of the facilitation fee, no one can discern which portion of the room rate is allegedly for Expedia's facilitation fee. Since Expedia has chosen to represent the room rate to the public as the price a customer must pay to secure his right to occupy the room, the City has no choice, under a clear and unambiguous reading of its ordinance, but to tax the customer for the published room rate demanded by Expedia."⁹⁰

"As borne out by the facts of the case, Expedia, by virtue of its contracts with City hotels, elects of its own accord to collect hotel occupancy taxes. It may change its business practices at any time and any injunction should reflect this fact."⁹¹

Dissent (Hunstein): "As the majority acknowledges, neither it nor the trial court has found Expedia to be an innkeeper or operator under the City's 'Hotel-Motel Occupancy Excise Tax' ordinance. Accordingly, when Expedia sells to persons who ultimately occupy motel or hotel rooms in the City, Expedia does so not as an innkeeper but as a private party who, under the plain language of the ordinance, is not subject to the ordinance's terms…. Expedia is not different from the tourist who, after renting a room, hands the keys over to a traveler in the parking lot in exchange for reimbursement and a fee. The City's ordinance simply does not govern transactions between a non-innkeeper entity like Expedia and the users of the rooms, who occupy the rooms but do not pay the hotel and instead pay Expedia."⁹²

Dissent (Melton, Hunstein, Hines): "[T]he trial court granted equitable relief [an injunction] despite the fact that a motion for a declaratory judgment, an adequate remedy at law, was pending at the same time. By longstanding principles, the grant of equitable relief in this situation was improper."⁹³

Illinois (Village of Rosemont)
U.S. District Court for the Northern District of Illinois, Eastern Division
October 14, 2011
Village of Rosemont, Illinois v. Priceline.com, Inc. ⁹⁴

Decision: Transactions with OTCs are subject to tax, as they are not services but the rental of property by an "owner," defined as "anyone who receives the 'consideration for the rental.'"

Statute: A tax upon "the privilege of renting a hotel or motel room within the Village of Rosemont [at a rate of ] 7% of the room rental rate [excluding] taxes or other non-room rental charges added to the hotel bill."⁹⁵ Paid by the rentor (customer who "seeks the privilege occupying the hotel or motel room," but it is the duty of "the owner of every hotel or motel to secure the tax from the rentor…and to pay over to the Village Collector the tax."⁹⁶ Owner is defined as any person (a) having "an ownership interest in [a hotel]," (b) "conducting the operation of a hotel," or (c) "receiving the consideration for the rental of such hotel or motel room."⁹⁷

Analysis: "Because the customer cannot access the hotel room unless and until he pays the OTC 's entire charge, the OTCs are owners who receive 'consideration for…rental[s],' within the meaning of the ordinance."⁹⁸

"The term 'owner' is defined by the Ordinance to include anyone who receives the 'consideration for the rental'... A classification for taxation purposes carries a strong presumption of validity, and it will survive a challenge on equal protection grounds unless the party asserting the challenge negates every conceivable basis for the classification."⁹⁹

Kentucky (City of Bowling Green)
Court of Appeals of Kentucky
April 29, 2011
City of Bowling Green v. Hotels.com ¹⁰⁰

Decision: OTC services not subject to hotel tax. Unanimous.

Statute: A tax on "the rent for every occupancy of a suite, room, or rooms, charged by all persons, companies, corporations, or other like or similar persons, groups, or organizations doing business as motor courts, motels, hotels, inns, or like or similar accommodations businesses."¹⁰¹

Analysis: "In construing statutes, we must give them a literal interpretation unless they are ambiguous and if the words are not ambiguous, no statutory construction is required…. The OTCs do not provide physical accommodations within the City of Bowling Green…. [A provider of temporary corporate apartments is different from OTCs] because it had an actual physical presence within the county and was not merely a broker of the rooms."¹⁰²

Missouri (St. Louis County)
Supreme Court of Missouri
June 28, 2011
St. Louis County v. Prestige Travel, Inc. ¹⁰³

Decision: OTC services not subject to hotel tax. Unanimous en banc.

Statute: A tax on "the amount of sales or charges for all sleeping rooms paid by the transient guests of hotels and motels situated within St. Louis County, Missouri." ¹⁰⁴

Analysis: "When read in context, it is clear the obligation to file the tax was placed solely on those 'engaged in the business of operating a hotel or motel.' This supports the finding that Prestige was not liable for the tax. Furthermore, because taxing statutes must be construed strictly, and taxes are not to be assessed unless they are expressly authorized by law, this Court will not read a tax obligation into the law where one was not clearly expressed." ¹⁰⁵

New Mexico (City of Gallup)
U.S. District Court for the District of New Mexico
March 1, 2010
City of Gallup v. Hotels.com ¹⁰⁶

Decision: OTC services not subject to hotel tax.

Statute: "There is hereby imposed an occupancy tax of revenues of five percent (5%) of gross taxable rent for lodging paid to vendors on and after August 1, 1998. Every vendor providing lodging shall collect the tax thereon on behalf of the city and shall act as a trustee therefor."¹⁰⁷

Analysis: "It would not make sense to interpret 'gross taxable rent' as the full amount charged by Defendants because only a portion of this amount is actually 'paid to vendors'…. Plaintiffs have not established that Defendants collected taxes over and above what they have remitted to the vendors." ¹⁰⁸

New York (City of New York)
New York Supreme Court, Appellate Division, First Department
November 29, 2011
Expedia, Inc. v. City of New York Department of Finance ¹⁰⁹

Decision: OTC services not subject to hotel tax. Unanimous 5-0.

Statute: Imposes on a hotel occupant a tax on the rent or charge per day for each hotel room. ¹¹⁰

Analysis: "[T]he plain language of the enabling legislation did not clearly and unambiguously provide the City with broad taxation powers with respect to imposing a hotel occupancy tax. Rather, it permitted the City to impose the tax on 'hotel occupants.' Given the well-established rule that a statute that levies a tax 'must be narrowly construed' and 'any doubts concerning its scope and application are to be resolved in favor of the taxpayer,' the plain meaning of this phrase did not encompass the service fees charged by the travel intermediaries and the legislation may not be extended so as to permit the imposition of the tax in a situation not embraced by it." ¹¹¹

Ohio (City of Findlay)
U.S. District Court for the Northern District of Ohio
June 26, 2006
City of Findlay v. Hotels.com, L.P. ¹¹²

Decision:OTC services not subject to hotel tax. To the extent OTCs collected what they indicated to consumers were taxes, they are obligated to remit them to the City.

Statute: "The transient guest tax…shall be paid by the transient guest to the vendor, and each vendor shall collect from the transient guest the full and exact amount of the tax payable on each taxable lodging. The tax required to be collected under this chapter shall be deemed to be held in trust by the vendor until paid to the [City]." ^113/sup>

Analysis: "The plain definition of 'vendor' in the City's ordinance is too narrow to reach Defendants, who are not alleged to own or operate any hotels…. [E]ven if the exception clause in the City's definition section created an ambiguity regarding whether Defendants are 'vendors,' the Ohio Supreme Court maintains that when it finds statutes defining subjects of taxation to be ambiguous, it resolves the ambiguity in favor of the taxpayer."¹¹⁴

Ohio (City of Columbus)
U.S. District Court for the Northern District of Ohio
October 14, 2009
City of Columbus v. Hotels.com, L.P. ¹¹⁴

Decision: Court rejected City's claim that OTCs are engaged in criminal or fraudulent activity.

Analysis:"[N]othing has been presented which would justify a finding that its conduct in attempting to influence legislation and related activities could be classified as fraudulent or criminal." ¹¹⁶

Oklahoma
District Court of Oklahoma County
March 11, 2011
State v. Priceline, Inc. ¹¹⁷

Decision: OTC services not subject to hotel tax.

Statute: Tax on the gross receipts of each sale of "[s]ervice of furnishing rooms by hotel, apartment hotel, public rooming house, motel, public lodging house, or tourist camp." ¹¹⁸

Analysis: The Court granted the OTCs' motion to dismiss the case after considering the briefs.

Pennsylvania (County of Lawrence)
Commonwealth Court of Pennsylvania
August 3, 2011
County of Lawrence, Pennsylvania v. Hotels.com, L.P. ¹¹⁹

Decision: Trial to proceed on the question of whether "the Companies take title to the hotel rooms before renting them out to patrons," and if so, whether the statute is applicable to the companies. Other claims by County dismissed.

Statute: County commissioners authorized to "impose an excise tax on the consideration received by each operator of a hotel, as defined by this section, from each transaction of renting a room or rooms to accommodate transients. If levied the tax shall be collected by the operator from the patron of the room and paid over to the county."¹²⁰ An operator is a person or persons "who maintain, operate, manage, own, have custody of or otherwise possess the right to rent or lease overnight accommodations in a hotel to the public for consideration." ¹²¹

Analysis: "We note that the County has alleged that the Companies take title to the hotel rooms at issue before renting them out to patrons…. We note that these allegations are strenuously contested by the Companies, but if they are proven, it would present common pleas with a viable question whether these activities are sufficient to make the Companies hotel 'operators' within the meaning of the ordinance. We express no opinion on this at this premature stage..."¹²²

Note: The Court was reviewing an order from a trial judge who dismissed the case but passed away before issuing a written opinion. The Court notes that his transcripted remarks suggested a finding of fact against the County, but further proceedings are needed to produce a written opinion. The trial judge, addressing his remarks to the County, had said: "I think they're [the Companies] right on the exhaustion. I think they're right on the ordinance itself. I think you jumped the gun. Go to the legislature and get what you need from them, they write the statute and go to the county and get the ordinance. You're trying to pull yourselves up by your own bootstraps. And it isn't going to work."¹²³

Pennsylvania (City of Philadelphia)
Commonwealth Court of Pennsylvania
February 2, 2012
City of Philadelphia v. City of Philadelphia Tax Review Board ¹²⁴

Decision: OTC services not subject to hotel tax.

Statute: Operator collects tax from a hotel patron; operator is "a person or entity that maintains, operates, manages, owns, has custody of, or otherwise possesses the right to rent or lease overnight accommodations in any hotel to the public for consideration."¹²⁵

Analysis: "[T]he booking of a reservation through Expedia does not provide a customer with the use or possession of a room or the right to the same. Rather, this booking merely establishes the expectation that a room will be available to a customer at a set point in time in the future. Additionally, as Expedia notes, hotels typically permit cancellations and changes in itineraries, and it would be illogical to assess a tax on a future event which may never occur. In the end, the record supports the Board's determination that '[i]t is not until an individual has registered at a hotel facility and has obtained and paid for a room, that the actual rental has occurred...'"¹²⁶

Note: A prior court decision in this case included a 2005 admonishment of the City's failure to follow administrative procedures. "This court is troubled by the fact that it does not appear that the City has ever performed an audit, provided notice or attempted to collect the Tax from Defendants, other than by filing the instant lawsuit. It is the function of the court system to resolve legal disputes; its role is not to levy or collect taxes (absent an appeal)." ¹²⁷

South Carolina
Supreme Court of South Carolina
January 18, 2011
Travelscape, LLC v. South Carolina Department of Revenue ¹²⁸

Decision: OTC services are subject to hotel tax, as OTC is "engaged... in the business of furnishing accommodations." The tax raises no constitutional concerns because no two states can tax the same OTC transaction. 4-1 decision with written dissent.

Statute: A tax on "the gross proceeds derived from the rental or charges for any rooms…furnished to transients by any…place in which rooms, lodgings, or sleeping accommodations are furnished to transients for consideration."¹²⁹ "Gross proceeds of sale" is defined as "the value proceeding or accruing from the sale, lease, or rental of tangible personal property…without any deduction for…the cost of materials, labor, or service."¹³⁰ The tax is imposed "on every person engaged or continuing within this State in the business of furnishing accommodations to transients for consideration."¹³¹

Analysis: "In our view, the fees charged by Travelscape for its services are subject to sales tax under the plain language of section 12-36-920(A) as gross proceeds…. [Gross proceeds] includes the value obtained from the rental of accommodations without deduction for the cost of services." ¹³²

"Travelscape's argument ignores the antecedent language in (E) that it applies to all persons 'engaged… in the business of furnishing accommodations.'… Accordingly, we find the context of 'furnish' as it appears in subsection (E) demonstrates that it encompasses the activities of entities such as Travelscape who, whether directly or indirectly, provide hotel reservations to transients for consideration."¹³³

Dissent: "The question before us is whether the legislature intended the statutory seven percent sales tax to reach the separate fee charged by Travelscape for the service it provides. I do not believe the statute unambiguously answers this question.… As the majority acknowledges, the word 'furnished' as used in subsection (A) connotes physically providing accommodations to customers, which Travelscape does not do. Thus, in order to find Travelscape to be in the business of 'furnishing accommodations,' the majority imposes a different meaning of the word 'furnish' in subsection (E)…. In my opinion, giving the term 'furnish' a different meaning in subsection (A) than is given in subsection (E), is in contravention to the rule of statutory construction that the same terms or words in a statute should be given the same meaning."¹³⁴

Tennessee (City of Goodlettesville)
U.S. District Court for the Middle District of Tennessee
February 21, 2012
City of Goodlettesville v. Priceline, Inc. ¹³⁵

Decision: OTC services not subject to hotel tax.

Statute: A tax "upon the privilege of occupancy in any hotel of each transient in an amount equal to three percent (3%) of the consideration charged by the operator."¹³⁶

Analysis: "Contrary to the allegations set forth in the Complaint, the evidence demonstrates that OTCs do not purchase or take title to hotel rooms and do not pay the hotels before a booking is made. Instead, the evidence shows that OTCs contract for the right to market an allotment of rooms, in return for the hotel's promise to reimburse the OTCs at the negotiated net rate for any rooms sold, with no payments made until after a booking occurs and with no penalty for unsold rooms.[...]

"Although the City is correct that, under Tennessee law, the court should not adopt a statutory interpretation that renders a revenue statute a "virtual nullity," the court's interpretation here has no such effect. Under the existing statutory framework, the City and the other class members have collected and will continue to collect substantial occupancy tax revenues on the consideration local hotels receive at the net rate. Furthermore, as several courts have found, it is not "absurd" for localities to collect tax revenue on the net rate.[...]

"Moreover, the OTCs and the hotels are independent entities that negotiate in arms-length transactions. In those transactions, the hotel has every incentive to keep the net rate as high as possible and to reserve for direct booking as many rooms as it believes it can sell directly to consumers, without sacrificing any potential revenue to the OTCs." ¹³⁷

Texas (City of Houston)
Texas Court of Appeals (Houston, 14th Dist.)
October 15, 2011
City of Houston v. Hotels.com ¹³⁸

Decision: OTC services not subject to hotel tax.

Statute: "There is hereby levied within the corporate limits of the city a tax upon the cost of occupancy of any room furnished by any hotel where such cost of occupancy is at the rate of $2.00 or more per day, such tax to be equal to seven percent of the consideration paid by the occupant of such room to such hotel." ¹³⁹

Analysis: "This is a reasonable reading of the ordinance, as can be seen by comparing the products or services of hotels and OTCs to the defined term occupancy. Simply stated, a hotel has rooms and the concomitant right to use or possess those rooms; to express this right in the terms defined in the resolution, a hotel has occupancy. The hotel offers occupancy in exchange for payment of the invoiced discounted rate. An OTC, on the other hand, does not have rooms or occupancy; as Houston concedes, the OTCs do not have the right to use or possess hotel rooms. Instead, the OTCs have websites and provide information. The content of a given OTC 's website includes material provided by the hotel, which may include photographs, descriptions, and listings of the amenities and services available onsite—but the OTC also provides information about the hotel's competitors. Visitors to the website can access maps, check room availability, and compare rates, ratings, and the reviews of other consumers. In many instances, visitors to an OTC 's website have the additional opportunity to combine the OTC 's services in booking a hotel room with its similar services in arranging cruises, flights, and ground transportation. In sum, the OTC does not merely help the website visitor make a reservation; it also helps consumers make informed choices in spending their travel dollars, and to do so conveniently and efficiently. When the consumer pays the OTC, the payment includes compensation for these benefits." ¹⁴⁰

"If Houston's interpretation of the ordinance is also reasonable, then the ordinance is ambiguous and the trial court could have properly granted summary judgment on the ground that the ordinance is ambiguous and therefore must be strictly construed against Houston and in the OTC 's favor."¹⁴¹

Texas (City of Orange)
U.S. District Court for the Eastern District of Texas
September 21, 2007
City of Orange v. Hotels.com ¹⁴²

Decision: OTC services not subject to hotel tax.

State Statute: Municipalities are authorized to impose "a tax on a person who, under a lease, concession, permit, right of access, license, contract, or agreement, pays for the use or possession or for the right to the use or possession of a room that is in a hotel, costs $2 or more each day, and is ordinarily used for sleeping..." ¹⁴³

City Statute: "[A] tax upon the occupancy of any room or space furnished by any hotel or motel...paid by the occupancy of such room or space to such hotel or motel..." ¹⁴⁴

Analysis: "Plaintiff does not, and of course, cannot allege that Defendants are 'hotels' or 'motels.' Plaintiff admits that it properly receives the 7% tax based on the negotiated room rate that is actually paid to the hotels…. The Ordinance clearly states that the tax is imposed only on the amount received by the hotel in consideration for occupancy of the room." ¹⁴⁵

Texas (City of San Antonio)
U.S. District Court for the Western District of Texas
July 1, 2011
City of San Antonio v. Hotels.com ¹⁴⁶

Decision: OTCs "control" hotels in that they step into the shoes of the hotel for the purpose of tax collection. Tax is imposed on consumer for amounts paid to secure hotel accommodation, and statutory reference of "to the hotel" should be disregarded.

Statute: Case is a class action involving 173 Texas cities. The statutes are very similar to the other Texas statutes listed above.

Analysis: "[T]he only contract or agreement at the time hotel occupancy tax is being assessed and collected is between the OTC and the consumer…. There is no contract between the consumer and the hotel until some later date when the occupant actually checks into the hotel."¹⁴⁷ "The OTCs have sole control over the decision to establish, change, or dissolve markups, services fees and/or surcharges as they wish."¹⁴⁸ "[The margin kept by OTCs] is clearly part of the retail cost that the consumer must pay for the right to occupancy."¹⁴⁹

"The OTCs concede that they currently make enough revenue through their markup and service fee to charge taxes on the margin and still make a considerable profit."¹⁵⁰

"The Cities assert that the words 'to the hotel' are mere surplusage, and the Court agrees. If a period were placed immediately after the phrase 'consideration paid by the occupant of the room,' the tax provision in the Dallas-type ordinance would make perfect sense. Thus, there is every reason to disregard the words 'to the hotel' as surplusage because they are repugnant to the rest of the ordinance and would render the ordinances meaningless."¹⁵¹

"Based on the jury's finding that Defendants are 'controlling' hotels, and the Court's findings and conclusions herein, the Court finds that the OTC 's have a legal duty to collect and remit hotel occupancy taxes imposed under the Cities' ordinances."¹⁵²

Wisconsin (City of Madison)
Dane County Circuit Court
October 12, 2011
City of Madison v. Expedia, Inc. ¹⁵³

District of Columbia (City of Washington)
Superior Court of the District of Columbia
October 12, 2011
District of Columbia v. Expedia, Inc. ¹⁵⁴

Decision: OTCservice is taxable because statute's purpose is to tax any payments made by ultimate purchaser, including for any services as part of the sale.

Statute:Tax imposed on "the gross receipts from the sale of or charges for any room or rooms, lodgings, or accommodations furnished to a transient by any hotel…or other place in which rooms, lodgings, or accommodations are regularly furnished to transients."¹⁵⁵ Gross receipts are defined as "the total amount of the sales prices of the retail sales."¹⁵⁶

Analysis: "Both interpretations are reasonable. Both the Defendant and the District read the statute in the manner a well-informed person might. Because the plain meaning of the statute is open to two reasonable, yet opposing, interpretations, it is necessary under Acme to turn to other tools of reasonable statutory interpretation in order to discern the purpose of the statute and avoid absurd results."¹⁵⁷

"It is not the transaction between the hotel and the OTC that is the retail sale; rather, it is the subsequent sale to the ultimate purchaser…. The statute is designed to ensure taxation applies to the entirety of the services being taxed…. The District of Columbia is correct when it argues that under the OTCs' proposed interpretation, retail sales tax could be avoided altogether by a hotel simply by interposing a shell company between its customers and the hotel."¹⁵⁸

New Law: In April 2011, the District of Columbia enacted a new law explicitly imposing hotel tax on "the net sale or net charges received from the transient by the room remarketer," defining net sale and net charges as "the gross receipts from the sale of or charges for any room or accommodations received by a retailer from a room remarketer."¹⁵⁹ Thus, confusingly, the taxable amount is the "net" amount paid to an OTC, defined in turn as the "gross" amount received by the hotel. As the judge in this case noted, "[l]ooking at the two statutory provisions together, it is impossible to reconcile any meaning out of the confusion."¹⁶⁰ However, the judge nevertheless upheld the tax on OTCs: "Despite its unnecessarily ambiguous plain language, the court holds that the amended sales tax statute would apply to the OTCs transactions with transients prospectively."¹⁶¹

Endnotes

^[Back] OTCs are sometimes referred to as third-party intermediaries (TPIs), accommodations intermediaries, travel intermediaries, or travel booking facilitators.
^[Back] States that impose sales tax on services generally are Hawaii, New Mexico, and South Dakota.
^[Back] See Billy Hamilton, Shirt Tales and Online Travel Companies, 54 State Tax Notes 661, 664 (2009).
^[Back] Judy DeHaven, Lyndhurst is suing travel websites for its local hotel tax, New Jersey Star-Ledger, Jun. 25, 2008. See also Jon Ralston, Weighing the pros and cons of Clark County suing Web sites for room tax revenue, Las Vegas Sun, Aug. 2, 2009 (“The issue, which has been percolating for years, is starting to bubble up again on Grand Central Parkway as county commissioners may soon be asked to sue Internet travel sites to recoup room tax revenue lost because of a differential between what Expedia & Co. pay for blocks of rooms and what they sell them for to customers. That is, the companies buy blocks of rooms for $100 each, sell them for, say $150, and pay the room tax only on the $100.”).
^[Back] Hamilton, at 661.
^[Back] District of Columbia v. Expedia, No. 2011-CA-002117-B at *20 (D.C. Sup. Ct. Oct. 12, 2011).
^[Back] See, e.g., Hassett v. Welch, 303 U.S. 303, 314 (1938) (“[I]f doubt exists as to the construction of a taxing statute, the doubt should be resolved in favor of the taxpayer . . . .”); Bowers v. New York & Albany Lighterage Co., 273 U.S. 346, 350 (1927) (“The provision is part of a taxing statute; and such laws are to be interpreted liberally in favor of the taxpayers”); Leavell v. Blades, 141 S.W. 893, 894 (Mo. 1911) (“When the tax gatherer puts his finger on the citizen, he must also put his finger on the law permitting it”); United States v. Merriam, 263 U.S. 179, 188 (1923) (“If the words are doubtful, the doubt must be resolved against the Government and in favor of the taxpayer”). For complete list of federal and state cases holding this rule, please see Tax Foundation, How Is the Money Used? Federal and State Cases Distinguishing Taxes and Fees (forthcoming 2012).
^[Back] Duluth vs. Expedia: Suing for Sales Tax, Economist, May 21, 2011.
^[Back] Todd Bice quoted in Scott Wyland, County won’t sue online firms to get room taxes, Las Vegas Review-Journal, Nov. 18, 2009.
^[Back] See, e.g., Dan Bucks, Guest opinion: Online travel firms should pay state taxes like Montana businesses do, Billings Gazette, Nov. 19, 2010, http://billingsgazette.com/news/opinion/guest/article_6d615934-19a0-5ad2-943b-46118d8e3056.html (“We believe that Travelocity, Priceline, Orbitz and Expedia have been collecting this tax from Montana visitors, but keeping a part of it for themselves and shortchanging us.”).
^[Back] Weissman, supra note 2.
^[Back] Twelve supporting cases: Pitt County, N.C. v. Hotels.com, L.P., 553 F.3d 148 (4th Cir. 2009); Louisville/Jefferson County Metro Government v. Hotels.com, L.P., 590 F.3d 381 (6th Cir. 2009); City of Birmingham v. Orbitz, Inc., No. CV 09-3607 (Ala Cir. Ct. Nov. 18, 2011); Expedia, Inc. v. City of Anaheim, No. JCCP 4472 (Sup. Ct. Los Angeles Co. Feb. 1, 2010); Orange County v. Expedia, Inc., No. 48-2006-CA-2104-O (Cir. Ct. Orange County, Florida Jan. 20, 2011); Expedia, Inc. v. City of Columbus, 681 S.E.2d 122 (Ga. 2009); St. Louis County v. Prestige Travel, Inc., No. SC 91228 (Mo. Jun. 28, 2011); City of Findlay v. Hotels.com, L.P., 441 F. Supp.2d 855 (N.D. Ohio 2006); City of Philadelphia v. City of Philadelphia Tax Review Board, No. 216 CD 2011 (Pa. Cmwlth. Feb. 2, 2012); City of Goodlettesville v. Priceline.com, Inc., No. 3:05-cv-00561 (M.D. Tenn. Feb. 21, 2012); City of Houston v. Hotels.com, No. 14-10-00349-CV (Tex. Ct. App. Oct 25, 2011); City of Orange v. Hotels.com, 2007 WL 2787985 (E.D. Tex. Sep. 21, 2007).
^[Back] City of Anaheim, at 14-15 (internal quotations omitted).
^[Back] City of Anaheim, at 23.
^[Back]Id. at 18-19.
^[Back]Pitt County, 553 F.3d at 313-14.
^[Back]Louisville/Jefferson County Metro Government, 590 F.3d at 388-89.
^[Back]City of Bowling Green, at *2.
^[Back]City of Gallup, at part III.
^[Back]City of Houston, at IV.A.
^[Back]Id. at 34.
^[Back]Id. at 39-40 (Pleicones, J., dissenting).
^[Back]Village of Rosemont, at 4-5.
^[Back]Op. at ¶ 80.
^[Back]See City of Birmingham v. Orbitz, Inc., No. CV-09 3607 JSV (Ala. Cir. Ct. Nov. 18, 2011) (finding compensation for facilitation services not encompassed by tax); City of Santa Monica v. Expedia, No. SC108568 (Cal. Sup. Ct. Los Angeles Mar. 16, 2011) (finding OTC commission not subject to hotel tax); Orange County v. Expedia, Inc., No. 48-2006-CA-2104-O (Jan. 20, 2011) (finding that tax ordinance does not include OTC services); St. Louis County v. Prestige Travel, Inc., No. SC 91228 (Mo. Jun. 28, 2011) (finding no OTC tax obligation in the statute); City of Gallup v. Hotels.com, No. CV 07-644 JC/RLP (D.N.M. Mar. 1, 2010) (finding that gross taxable rent in the statute refers to the amount received by the hotel); City of Philadelphia v. City of Philadelphia Tax Review Board, Mar. Term 2010 No. 00764 (Phila. C.P. Jan. 14, 2011) (finding the transaction occurs when the consumer obtained the right to use and occupy the room, not when the reservation was made); City of Houston v. Hotels.com, No. 14-10-00349-CV (Tex. Ct. App. Oct. 25, 2011) (finding that a consumer’s payment to the OTC is distinct from hotel occupancy); City of Orange v. Hotels.com, 2007 WL 2787985 (E.D. Tex. Sep. 21, 2007) (finding the statute only covers amounts received by the hotel). But see Expedia, Inc. v. City of Columbus, 681 S.E.2d 122 (Ga. 2009) (finding that tax is amount paid by consumer, including to OTC, if OTC chooses to collect it); City of San Antonio v. Hotels.com, No. 5:06-cv-00381 (W.D. Tex. Jul. 1, 2011) (finding that statute’s language limiting tax to amounts paid “to hotel” is “surplusage”); District of Columbia v. Expedia, Inc., No. 2011-CA-002117-B (D.C. Sup. Ct. Oct. 12, 2011) (finding tax encompasses any payments made by ultimate purchaser).
^[Back]City of New York Department of Finance.
^[Back]St. Louis County, at 6.
^[Back]City of Gallup, at part III.
^[Back]City of Birmingham.
^[Back]Id. at 129.
^[Back]Id. at 14-16.
^[Back]Op. at ¶ 155.
^[Back]City of Houston, at IV.A; City of Orange, 2007 WL 2787985 at *6 (E.D. Tex. Sep. 21, 2007).
^[Back] City of Anaheim, at 25.
^[Back] District of Columbia, at 14-16.
^[Back] Id. at 24-25.
^[Back] City of Goodlettesville v. Priceline.com, Inc., No. 3:05-cv-00561 (M.D. Tenn. Feb. 21, 2012), at *29.
^[Back] Id. at *28.
^[Back] Id. (internal citations omitted).
^[Back] Global Business Travel Association, Lodging, Rental Car, and Meal Taxes on Travelers in the Top 50 U.S. Cities, Aug. 2009, http://www2.gbta.org/foundation/resourcelibrary/Pages/sept09article2.aspx.
^[Back] Roger Yu, Taxes on hotel rooms are rising, USA Today, Apr. 5, 2010, http://www.usatoday.com/money/industries/travel/2010-04-05-1Ahoteltax05_ST_N.htm.
^[Back] Gibbons v. Ogden, 22 U.S. 1, 224 (1824) (Johnson, J., concurring).
^[Back] U.S. Const. art. I, sec. 8, cl. 3.
^[Back] See Heart of Atlanta Motel, Inc. v. United States, 379 U.S. 241 (1964) (upholding congressional action prohibiting state and local statutes that interfered with use of hotels by interstate travelers); Katzenbach v. McClung, 379 U.S. 294 (1964) (same with restaurants used by interstate travelers); the Internet Tax Freedom Act, P.L. No. 105-277 (prohibiting state and local taxation of Internet access); 49 U.S.C. section 40116 (prohibiting state and local taxation of the sale of air transportation); 49 U.S.C. section 14505 (prohibiting state and local taxation of the sale of motor carrier transportation).
^[Back] See, e.g., Expedia, Inc. v. City and County of San Francisco, No. JCCP 4472 (Sup. Ct. Los Angeles June 19, 2009).
^[Back] In several instances, private contingency-fee lawyers have sought to be hired by a city to sue the online travel companies on the city’s behalf with no up-front cost, with the agreement that they get a cut of any amounts collected. The city’s oversight is often lax, resulting in abuses when private sector individuals are given governmental authority to pursue the collection of disputed taxes. A similar program at the federal level has been canceled due to rampant abuse. The Tax Foundation filed a friend-of-the-court brief opposing giving tax collection powers to private contingency-fee lawyers in a case currently on appeal to the California Supreme Court. See Joseph Henchman and Justin Burrows, The Dangers of Privatizing Tax Collection: Priceline.com, Inc. v. City of Anaheim, June 25, 2009, http://www.taxfoundation.org/research/show/25286.html.
^[Back] Failure to exhaust administrative remedies: See City of Fayetteville v. Hotels.com, L.P., No. CV 07-567-01 (Ark. Cir. Ct. Washington County Jul. 25, 2008); City of Oakland, California v. Hotels.com, LP, No. 07-17258 (9th Cir. Jul. 16, 2009); Lake County Convention and Visitors Bureau v. Hotels.com, L.P., No. 2:06-cv-00207-JVBAPR (N.D. Ind. Mar. 30, 2010); Wake County, et al. v. Hotels.com, LP, No. 06-CVS-16256 (N.C. Gen. Ct. Nov. 19, 2007) (case ongoing); City of Madison v. Expedia, Inc., No. 2007-cv-004488 (Wis. Dane County Cir. Ct. Jul. 24, 2008). Improper standing: Lyndhurst, N.J., Township v. Priceline.com, Inc., 657 F.3d 148 (3d Cir. 2011).
^[Back]553 F.3d 308 (4th Cir. 2009).
^[Back]N.C. Gen. Stat. § 105.164.4(a)(3).
^[Back]Pitt County, 553 F.3d at 313-14.
^[Back]590 F.3d 381 (6th Cir. 2009).
^[Back]Ky. Rev. Stat. § 91A.390(1).
^[Back]Louisville/Jefferson County Metro Government, 590 F.3d at 388-89.
^[Back]No. CV 09-3607 JSV (Ala. Cir. Ct. Nov. 18, 2011), aff’d, No. 1100874 (Ala. Apr. 13, 2012).
^[Back]Ala. Code § 40-26-1 et seq.
^[Back]City of Birmingham.
^[Back]No. SC108568.
^[Back]Santa Monica Mun. Code § 6.68.020; Santa Monica Mun. Code § 6.68.010(d).
^[Back]City of Santa Monica, at 8.
^[Back]Id. at 10.
^[Back]Id. at 12-13.
^[Back]No. JCCP 4472 (Feb. 1, 2010).
^[Back]Anaheim Mun. Code § 2.12.010.
^[Back]Anaheim Mun. Code § 2.12.005.080.
^[Back]Anaheim Mun. Code § 2.12.005.050.
^[Back]City of Anaheim, at 14-15 (internal quotations omitted).
^[Back]Id. at 20.
^[Back]Id. at 24-25.
^[Back]No. 2009-CA-4319 (Apr. 19, 2012).
^[Back]F.S. 125.0104.
^[Back]F.S. 125.0104(2)(a).
^[Back]F.S. 125.0104(f).
^[Back]Leon County, at 6.
^[Back]Leon County, at 8.
^[Back]No. 48-2006-CA-2104-O (Jan. 20, 2011).
^[Back]F.S. 125.0104. See also Orange County Ordinances 25-136 et seq. (identical language).
^[Back]F.S. 125.0104(2)(a).
^[Back]F.S. 125.0104(f). See also Orange County Ordinances 25-137(a) (identical language).
^[Back]Orange County, at 14.
^[Back]Id. at 18-19.
^[Back]Id. at 20-22.
^[Back]No. S11A0508; S11X0509; S11A0510; S11X0512 (Ga. May 16, 2011).
^[Back]Atlanta Ordinance § 146-79.
^[Back]Atlanta Ordinance § 146-77.
^[Back]Atlanta Ordinance § 146-80.
^[Back]City of Atlanta, at 5.
^[Back]681 S.E.2d 122 (Ga. 2009).
^[Back]Columbus Ordinance § 19-111.
^[Back]Ga. Code § 48-13-51(a)(1)(B)(ii).
^[Back]City of Columbus, 681 S.E.2d at 128.
^[Back]Id. at 129.
^[Back]Id. at 129 (Hunstein, P.J., dissenting).
^[Back]Id. at 130 (Melton, J., dissenting).
^[Back]No. 09-C-4438 (E.D. Ill. Oct. 14, 2011).
^[Back]Rosemont Ordinance § 10-23(a).
^[Back]Rosemont Ordinance § 10-23(b)-(c).
^[Back]Rosemont Ordinance § 10-22.
^[Back]Village of Rosemont, at 4-5.
^[Back]Id. at 17-18.
^[Back]--- S.W.3d ----, 2011 WL 1600505 (Ky. App. Apr. 29, 2011).
^[Back]Ky, Rev. Stat. 91A390(1).
^[Back]City of Bowling Green, at *2.
^[Back]No. SC 91228 (Mo. Jun. 28, 2011).
^[Back]St. Louis County Rev. Ordinances § 502.500.
^[Back]St. Louis County, at 6.
^[Back]No. CV 07-644 JC/RLP (D.N.M. Mar. 1, 2010).
^[Back]Gallup Ordinance § 3-2C-4; Gallup Ordinance § 3-2C-7(A).
^[Back]City of Gallup, at part III.
^[Back]No. 6174 650761/09 (N.Y. Ct. App. Nov. 29, 2011).
^[Back]See Uncons Laws of NY ch 288-C, § 1.
^[Back]City of New York Department of Finance.
^[Back]441 F.Supp.2d 855 (N.D. Ohio 2006).
^[Back]Findlay Ord. § 195.06.
^[Back]City of Findlay, 441 F.Supp.2d at 859-60.
^[Back]Case No. 3:07cv2117 (N.D. Ohio Oct. 14, 2009).
^[Back]Id.
^[Back]No. CJ-2010-8952 (Mar. 22, 2011).
^[Back]Okla. Stat. § 68-1354(A)(6).
^[Back]No. 2541 (Pa. Cmwlth. Ct. Jun. 6, 2011).
^[Back]16 P.S. § 1770.6(a). See also Lawrence County Ordinance No. 317 (identical language).
^[Back]16 P.S. § 1770.6(f). See also Lawrence County Ordinance No. 317 (identical language).
^[Back]County of Lawrence, at 8.
^[Back]Id. at 3, citing Reproduced Record at 1180-81.
^[Back]No. 216 CD 2011 (Pa. Cmwlth. Feb. 2, 2012), aff’g Mar. Term 2010 No. 00764 (Phila. C.P. Jan. 14, 2011).
^[Back]Phila. Code § 19-2401.
^[Back]No. 216 CD 2011 (Pa. Cmwlth. Feb. 2, 2012).
^[Back]City of Philadelphia v. Hotels.com, No. 0106023, 122014 (Phila. C.P. May 25, 2006) at 3.
^[Back]705 S.E.2d 28 (S.C. 2011).
^[Back]S.C. Code § 12-36-920(A).
^[Back]S.C. Code § 12-36-90(1)(b)(ii).
^[Back]S.C. Code § 12-36-920(E).
^[Back]Travelscape, 705 S.E.2d at 33.
^[Back]Id. at 34.
^[Back]Id. at 39-40 (Pleicones, J., dissenting).
^[Back]No. 3:05-cv-00561 (M.D. Tenn. Feb. 21, 2012).
^[Back]Goodlettesville City Code § 5-502.
^[Back]City of Goodlettesville, at *16.
^[Back]No. 14-10-00349-CV (Tex. Ct. App. Oct. 25, 2011).
^[Back]Houston, Tex. Code of Ordinances § 44-102.
^[Back]City of Houston, at IV.A.
^[Back]Id.
^[Back]2007 WL 2787985 (E.D. Tex. Sep. 21, 2007).
^[Back]Tex. Tax Code § 351.002.
^[Back]Orange, Tex., Code of City Ordinances § 1.604 (2006).
^[Back]City of Orange, 2007 WL 2787985 at *6 (E.D. Tex. Sep. 21, 2007).
^[Back]No. 5:06-cv-00381 (W.D. Tex. Jul. 1, 2011).
^[Back]Op. at ¶ 51-52.
^[Back]Op. at ¶ 80.
^[Back]Op. at ¶ 108.
^[Back]Op. at ¶ 118-120.
^[Back]Op. at ¶ 155.
^[Back]Op. at ¶ 206.
^[Back]No. 2007-cv-004488 (Dane Co. Cir. Ct. Jul. 24, 2008) (case dismissed).
^[Back]No. 2011-CA-002117-B (Oct. 12, 2011).
^[Back]D.C. Code § 47-2002 (repealed 2011).
^[Back]D.C. Code § 47-2001(h) (repealed 2011).
^[Back]District of Columbia, at 10.
^[Back]Id. at 14-16.
^[Back]D.C. Code § 47-2001 et seq.
^[Back]District of Columbia, at 20.
^[Back]Id. at 21.

Americans Paying More in Taxes than for Food, Clothing, and Shelter

Thu, 03 May 2012 00:00:00 EDT

In 2012, Americans will pay approximately $4.041 trillion in taxes, which is $152 billion, or 3.9 percent, more than they will spend on housing, food, and clothing.[1] Through looking at contemporary data and examining the trend of tax collections and expenditures on housing, food, and clothing, we can compare the costs of government with the necessary costs individuals incur every year. Relative to the basic cost of living, taxes have increased considerably in recent decades. In turn, a greater share of essential private expenditures are now funded through government outlays.

Historical Perspective: Tax Growth Exceeds Spending Growth

Between 1929 and the early 1980s, aggregate tax collections were less than total expenditures on housing, food, and clothing (see chart). From 1929 to 1980, tax liabilities grew from $10 billion to $751 billion, while expenditures on housing, food, and clothing grew from $41.6 billion to $775.7 billion. In 1982, total tax collections exceeded expenditures on those items. The gap between tax collections and expenditures on essential goods reached a maximum in 2000, when Americans gave 19 percent more to the government than they spent on these items. The growth in tax collections has halted due to economic contractions, such as the collapse of the "dot-com bubble" in 2001 and the 2007-2009 financial crisis.[2]

Other Costs to Consider

Food, clothing, and housing represent the bare minimum that individuals need. However, adding in healthcare and transportation represents a more complete account of the basic cost of living.

Government Handouts: A Growing Share of Spending on Essential Goods

Transfer payments, or government social benefits, have grown to represent a substantial portion of money spent on living expenses, encompassing housing, food, clothing, healthcare, and transportation.[3] This means that the government is picking up an increasing portion of the tab for these essential goods. For instance, in 1929 transfer payments represented only 0.5 percent of private expenditures on housing, food, clothing, healthcare, and transportation. By 1965, when Medicare began, this percentage had grown to about 11 percent. Today it stands at close to 35 percent. While some money spent on transfer programs is spent on other items besides healthcare, food, clothing, transportation, and housing, the strong prevalence of in-kind benefits, or government transfer payments for a specific item or service, keeps this as a small fraction of overall expenditures.

Limitations to This Data

There are some restrictions inherent in comparing tax costs to expenditures on essential goods. As mentioned, a large share of tax revenues today are spent on transfer payments, which private individuals then spend on essential goods. That is, the consumption data, which comes from the Bureau of Economic Analysis, includes private consumption that is paid for with government transfer payments from assistance programs such as Medicare. This leads to double counting, as the taxes that finance these programs and the increased consumption that those taxes fund are included in both tax and consumption figures, respectively. Despite these limitations, the comparison of tax costs to the basic cost of living provides a useful illustration of the growing cost of government.

Table 1 (in billions)

Year	Total Taxes	Total Transfers to Persons	Food, Clothing and Housing	Cost of Living
1929	$10.1	$0.8	$41.6	$53.0
1930	$9.5	$0.9	$38.4	$48.2
1931	$8.5	$1.9	$33.4	$41.6
1932	$7.8	$1.3	$26.8	$33.5
1933	$8.6	$1.3	$25.5	$32.0
1934	$9.4	$1.3	$28.9	$36.3
1935	$10.3	$1.6	$31.3	$39.4
1936	$11.9	$2.7	$34.4	$43.7
1937	$14.2	$1.6	$36.8	$46.6
1938	$13.6	$2.1	$36.1	$44.9
1939	$14.2	$2.2	$37.1	$46.8
1940	$16.2	$2.4	$38.8	$49.5
1941	$23.4	$2.3	$44.1	$56.4
1942	$30.9	$2.3	$52.1	$61.9
1943	$46.7	$2.1	$59.8	$69.9
1944	$47.9	$2.7	$65.2	$76.1
1945	$48.7	$5.1	$71.5	$83.7
1946	$48.6	$10.1	$81.4	$100.3
1947	$54.5	$10.4	$89.0	$112.3
1948	$56.5	$9.9	$94.2	$121.3
1949	$52.6	$10.9	$94.0	$124.1
1950	$65.3	$13.4	$98.1	$132.5
1951	$81.2	$10.5	$109.6	$144.2
1952	$85.8	$11.0	$116.8	$152.3
1953	$90.0	$11.7	$121.6	$161.4
1954	$85.2	$13.7	$126.0	$166.1
1955	$95.9	$14.8	$131.4	$178.5
1956	$103.4	$15.6	$138.2	$185.7
1957	$109.2	$18.1	$145.1	$196.8
1958	$107.4	$22.2	$151.6	$202.8
1959	$121.7	$22.9	$159.5	$217.1
1960	$131.0	$24.4	$165.7	$226.3
1961	$135.5	$28.1	$171.6	$231.7
1962	$146.6	$28.8	$179.4	$246.3
1963	$157.6	$30.3	$186.0	$258.7
1964	$162.0	$31.3	$197.6	$276.7
1965	$175.1	$33.9	$210.9	$297.7
1966	$196.9	$37.5	$227.2	$319.6
1967	$210.5	$45.8	$237.4	$335.1
1968	$243.4	$53.3	$257.4	$368.5
1969	$274.3	$59.0	$278.2	$400.7
1970	$277.3	$71.7	$300.0	$428.5
1971	$293.9	$85.4	$319.9	$466.8
1972	$336.0	$94.8	$348.1	$511.2
1973	$377.5	$108.6	$384.2	$566.2
1974	$415.2	$128.6	$424.6	$621.2
1975	$425.0	$163.1	$468.8	$690.4
1976	$486.3	$177.3	$512.0	$771.2
1977	$546.7	$189.1	$562.6	$857.3
1978	$615.4	$203.2	$626.8	$953.9
1979	$689.4	$227.1	$699.1	$1,069.2
1980	$751.1	$270.8	$775.7	$1,189.1
1981	$858.3	$307.2	$854.4	$1,322.5
1982	$867.9	$342.4	$913.3	$1,408.6
1983	$917.7	$369.9	$978.2	$1,529.6
1984	$1,016.4	$380.4	$1,051.9	$1,663.8
1985	$1,100.3	$402.6	$1,124.8	$1,797.7
1986	$1,167.4	$428.0	$1,196.0	$1,899.9
1987	$1,282.0	$447.4	$1,268.2	$2,021.9
1988	$1,369.7	$475.9	$1,361.3	$2,187.7
1989	$1,480.2	$519.4	$1,454.0	$2,345.2
1990	$1,561.0	$572.7	$1,545.5	$2,507.4
1991	$1,597.1	$648.2	$1,611.0	$2,597.3
1992	$1,679.2	$729.5	$1,673.2	$2,749.4
1993	$1,778.6	$776.7	$1,745.7	$2,892.2
1994	$1,917.0	$813.1	$1,834.7	$3,056.1
1995	$2,030.3	$860.2	$1,905.4	$3,192.3
1996	$2,180.9	$901.2	$1,990.0	$3,355.3
1997	$2,356.2	$929.8	$2,076.8	$3,522.8
1998	$2,529.7	$951.9	$2,172.5	$3,685.3
1999	$2,695.2	$987.6	$2,291.3	$3,897.7
2000	$2,903.6	$1,040.6	$2,427.0	$4,159.7
2001	$2,887.2	$1,141.3	$2,546.5	$4,372.7
2002	$2,736.5	$1,247.9	$2,621.4	$4,536.9
2003	$2,796.9	$1,316.0	$2,731.8	$4,753.7
2004	$3,003.6	$1,398.6	$2,873.2	$5,028.7
2005	$3,375.1	$1,482.7	$3,075.0	$5,381.9
2006	$3,680.5	$1,583.6	$3,257.9	$5,659.1
2007	$3,858.2	$1,687.9	$3,403.3	$5,932.7
2008	$3,703.5	$1,842.4	$3,526.6	$6,114.9
2009	$3,321.1	$2,099.9	$3,546.1	$6,053.3
2010	$3,560.6	$2,242.9	$3,631.9	$6,289.0
2011	$3,742.6	$2,296.8	$3,760.3	$6,602.6

[1] William McBride, Tax Freedom Day 2012, Tax Foundation Special Report 198 (Apr. 9, 2012), http://www.taxfoundation.org/files/sr198.pdf.

[2] National Bureau of Economic Research, U.S. Business Cycle Expansions and Contractions (Apr. 23, 2012), http://nber.org/cycles/cyclesmain.html.

[3] Bureau of Economic Analysis, Transfer Payments (May 6, 2003), http://www.bea.gov/regional/pdf/lapi2001/transfer.pdf.

Movie Production Incentives in the Last Frontier

Thu, 26 Apr 2012 00:00:00 EDT

Key Findings

Film tax credits cost states revenue and require either higher taxes or lower government spending elsewhere.
At best, film tax incentives largely shift production from one sector to another without producing a net increase in economic activity or employment.
However, the program is unlikely to produce a self-sustaining state film industry.
Content restrictions raise concerns about censorship.

Introduction

State film tax incentives have exploded in popularity in the last decade.[1] In 2000, only three states offered the subsidies. By 2010, the number of states offering incentives peaked had peaked at 40. As in many states, film subsidies in Alaska have been credited with bringing to the state the economic activity spurred by several productions.[2] However, the commonly cited benefits of film subsidies are often overstated and fail to take into account offsetting economic effects. This paper will examine the common arguments for film incentives, focusing both on general arguments and arguments specific to Alaska. We will address the following questions:

Can the program make the industry able to sustain itself in the long-term, even when subsidies are cut?
Do the subsidies distort the economy?
Does the program reduce unemployment, contribute to economic output, and add revenues to the Treasury?
Is the program consistent with free speech and an unhampered marketplace of ideas?

Film incentives

The program

Film incentives can be in the form of tax credits, tax rebates, grants, or exemptions. Alaska's subsidy is structured as a tax credit, a type of tax benefit which reduces a company's tax liability dollar for dollar. Production companies typically must spend at least a certain amount in the state to qualify. In many states, the tax credits are refundable, meaning that if the credit exceeds the liability the state pays companies the difference between the amount of their credit and their tax liability. In some states, including Alaska, the credits are transferable, meaning that credits earned by film production companies can be sold to another company, which can then claim the credit against its tax liability.

Although the program was originally established and expired in the 1990s, Alaskan lawmakers reinstated the program in 2008. Of the 35 states that offer incentives to movie producers,[3] Alaska's is among the most generous, with a credit rate ranging from 30% to 44% of expenses.[4] Production companies can receive tax credits only for films with qualified expenditures of at least $100,000. They receive a base rate of 30% of expenditures, and additional credits for spending on wages to Alaskan residents (10%), filming in rural locations (2%), and for filming in the off-season (2%). The credits are transferable, as long as the purchasing company has a tax liability of least $100,000. Credits are not refundable. The state's Film Office considers tax credit applications, serves as an information clearinghouse for individuals in the film industry, and certifies internship programs.[5] The Film Office is currently authorized to disburse up to $100 million between 2008 and 2013. As of Jan. 13, 2012, over $14 million in credits had been issued. The film industry has indeed boomed in recent years, with spending rising from about $745,000 in 2010 to more than $54 million in 2012, the number of movies and TV shows rising from 1 and 3, respectively, in 2008 to 4 and 10, respectively, in FY2010 and 2011.[6]

New Proposals

Alaska lawmakers recently passed a bill, waiting for the governor's approval, to renew the program to run through June 2023. The bill makes several changes to the program: (1) It caps the budget at $200 million; (2) institutes a third-party audit and requires the Film Office to disclose information about its criteria in considering applications; (3) increases credits for spending in rural areas to 6%. (4) provides a one-time credit for the first episodic script of a television production; (5) transfers the Film Office to the Department of Revenue; and (6) establishes the Alaska Film Review Commission. For "above the line" positions (directors, writers, and other select categories), the production company gets a standard credit of 5 percent, plus a 50 percent credit on all wages paid to Alaskan workers and to all expenditures on Alaskan businesses. For "below the line" positions, the production company gets a standard credit of 30 percent, plus a 20 percent credit on all wages paid to Alaskan workers (no mention of businesses).[7]

The Debate

The bill's supporters make several claims. They argue that the program creates positive publicity and boosts tourism. Further, supporters assert that renewal would prevent the industry from collapsing and making the film infrastructure and workers' skills worthless. Some argue that since several other states are scaling back their programs, Alaska can defend its industry at low cost. Others argue the program must be renewed for the long-term to reassure investors. Many claim the program increases total tax revenue for the state, stimulates economic activity, and creates jobs.[8]

Skeptics of the program's merits claim that it doesn't increase revenues and does little to stimulate local economic activity and employment.[9] Rep. Mike Hawker notes that while "[i]t's great for people that want to look at superstars walking down the street in the state of Alaska[,] what is it doing for in-state jobs?" Some claim that it has subsidized films that give the state negative publicity; others, that it picks winners and losers.[10] Still others point to the disadvantage of hiding incentives in the tax code rather than showing them in the budget. Hawker says, "If we're going to offer basically just free access to the treasury, we should just have the courage to stand up and write the check."

Developing a self-sustaining film industry and a diversified economy?

Alaska's economic activity is highly concentrated in resource extraction. The state also taxes these industries heavily, with nearly 77% of state tax revenues coming from severance taxes on resource extraction. [11 ]As a result, some have argued that the state is sensitive to uncertain world market conditions. Robin Kornfeld, the head of a production services company, expressed the widespread concern that Alaska's economy is unsustainable: "We have fishing. We have tourism. We have oil. We had timber. [W]e can't count on those industries being here for us forever." [12] It is tempting to argue, then, that the state can and should try to create economic diversity by developing and supporting the nascent film industry until it can sustain itself without subsidies, and that extending the incentives program's life for an additional ten years will accomplish this.

Unfortunately for Alaskans, this strategy is unlikely to work. To understand why, a few principles of economic analysis must be understood. First, states with film tax credits invariably end up paying for some productions that would have occurred anyway. Second, states are currently locked in a race to the bottom with each other (not to mention other nations) that virtually ensures that Alaska will never be able to ensure that no other state can lure away their productions. Third, lawmakers have neither the specialized knowledge nor the power to dictate what the market will demand, which would be required to be able to pick the right industries.

The "But-For" Problem

For some productions, Alaska is the most attractive filming location, with or without the subsidies. Any subsidy for these productions, which would locate in Alaska anyway, is wasted. This problem is sometimes called the "but-for" problem: it is not possible to know what each production would have done but for the incentive. Anecdotal evidence suggests that some producers choose to film in Alaska not because of the subsidies but rather because Alaska's landscape and local industries make it an ideal location. [13] For example, because much of the genre of reality television focuses on local industries, some, such as the popular Deadliest Catch, which predates the incentives program, would likely continue to film in Alaska even without the incentives.[14] Indeed, the incentives are often not considered in deciding whether to launch a series, as an executive at The History Channel notes of his own company: "The show has to stand on its merits."[15] When producers receive tax credits for films that they would produce even without subsidies, the credits do little but transfer wealth from taxpayer to production companies.

Runaway Productions and the Race to the Bottom

However, it is possible that Alaska would be the preferred filming location if not for other states luring films away with subsidies.[16] Proponents refer to the phenomenon as ‘runaway production'[17] and argue that Alaska should offer subsidies at least as generous as other states until those states kill their subsidies. One problem with this argument is that it holds Alaska's policy hostage to other states' policies by explicitly engaging in an arms race of subsidies. Other states may keep their subsidies indefinitely. Further, every state that accepts this argument will increase its subsidies to outdo Alaska and other states. In a spiraling "race to the bottom," states have already increased their subsidies from a modest $4 million in 1999 to a hefty $1.4 billion in 2010.[18] Lawmakers should not be fooled into thinking that other states will not continue to try to outbid them.

The Infant Industry Argument

Film tax credits are also sometimes defended as a means of temporarily protecting an infant industry until it becomes competitive on its own. A film producer of a major film, for one, claims that producers are reluctant to produce in Alaska because its film infrastructure is less developed than elsewhere.[19] This argument supposes that production costs are high and that they would fall if the industry reached a large enough scale.[20] In this argument, the Alaskan industry needs temporary protection until it reaches a point where it becomes a self-sustaining industry that no longer requires subsidization.

However, in practice, lawmakers do not have the knowledge by which to anticipate which industries will thrive. Economists generally agree that lawmakers have had little to no success at creating a business cluster where one doesn't already exist.[21] As Joseph Cortright writes, "it is virtually impossible to say what it takes to successfully create a new industry cluster in a particular place."[22] A study by B.L. Weinstein and T.L. Clower finds limited potential for growth outside of Canada and New York.[23]

The infant industry argument is further weakened by the fact that even Hollywood is having trouble maintaining its status as the center of the film industry.[24] Greg Elmer and Mike Gasher note that film production has transformed "from an exclusive and centralized base to a global network of production sites."[25] If production is no longer concentrated in Hollywood, it is unlikely that it would concentrate in Alaska. Not only is production dispersed, production companies are highly mobile, with some economists comparing production companies to floating factories.[26] Clearly the film industry has undergone significant changes, and Alaska would have a long way to go to become a center of film production. After discussing all the government action she believed would be needed to help support the film industry in Alaska, Susan Bell, commissioner of the Department of Commerce, Community, and Economic Development notes that "These are not 'just add water' accomplishments."[27] Obviously there is substantial reason to doubt that the film industry can be permanently anchored even with permanent, ever-expanding tax credits, let alone temporary ones.

Counting the Cost of Film Tax Credits

Supposing, though, that the industry would be viable at a larger scale, it still doesn't follow that subsidies can be justified as a means of attempting to reach that scale. In order to justify the subsidies, proponents would have to show that the price of subsidies in term of lost revenue is lower than the benefit received, and that the opportunity costs of the subsidies do not outweigh the benefits. Yet neither of these assertions is supported by the evidence.

One common misconception must be addressed at the start. Although some studies purport to show that film tax credits increase government revenue, more thorough and comprehensive studies indicate otherwise. It is often claimed that film tax credits do not cost states revenue because the induced economic activity ripples through the economy and increases revenues from taxes such as income and sales taxes. However, it cannot be credibly claimed that the film tax credit does not cost Alaska revenue. For one, some productions would likely be subsidized that would have located in Alaska anyway. Additionally, because Alaska's credit is a function of production costs (as opposed to tax liability) and is transferable, the value of the credit is not limited to a production's actual tax liability. The Alaska Film Office even notes on their website that "most film and TV productions will owe little or no taxes to the State of Alaska, so producers need to sell their tax credit to a business that has an Alaska tax liability."[28] This means that it cannot be claimed that the program only forgives tax liability that would not have existed anyway.

Realistic, comprehensive studies show that film production incentives cost the treasury much more than they bring in for a number of reasons. Some of the most important reasons are that states invariably subsidize activity that would have occurred anyway; much of the spending on film productions ultimately flows to out-of-state residents; many analyses neglect long-run economic adjustments, and misunderstand the structure of production; and policy makers overlook the opportunity cost of spending and taxes.

The best evidence shows that film incentives cost the treasury more than they recoup from taxes on induced economic activity. A study in South Carolina found that film incentives returned 19 cents for each dollar paid out in tax rebates.[29] Surveying the literature, we found that aside from studies paid for by economic development authorities and the Motion Picture Association of America, an industry trade association, almost every other study has found film tax credits generate less than 30 cents for every $1 of spending:

Arizona's Department of Commerce calculated 28 cents on the dollar.
Connecticut's Department of Economic Development found a 7 cent return on every $1 spent.
Two studies in Louisiana found between 13 and 18 cents on the dollar.
Massachusetts' Department of Revenue found it got 16 cents on the dollar.
Michigan's Senate Fiscal Agency found 11 cents on the dollar.
New Mexico's Legislative Finance Office found 14 cents on the dollar.
Pennsylvania's Legislative Budget & Finance Committee found 24 cents on the dollar.

As Joseph Henchman noted in his Tax Foundation commentary in 2011, "of the above studies, only Massachusetts's study did not assume that all film and television production occurred because of the credit. So all the other numbers should be considered on the high end."[30]

Put another way, the Massachusetts study, for example, found that the treasury lost $88,000 for each new job for residents.[31]

One reason why the programs lose revenue is that states often do not have ancillary taxes to recoup revenues from induced economic activity.[32] Alaska in particular has no state sales tax or personal income tax. Most state revenues come from a tax on production of oil and gas,[33] which doesn't increase with spending on film production. A second, and more important, reason that programs lose revenues is that the resources employed in the industries that support film production, such as restaurants and trailers, would have been employed, and taxed, even without the subsidy.

In addition, not all of the economic impact of the spending from a given film will stay in state. This is true in Alaska because many of the highly specialized workers needed for film production will not be Alaska residents. Information released by Alaska's Film Office suggests that the bulk of the outlays of subsidized productions do not go to wages for residents: out of $74.7 million in total qualified expenditures from 2010 through 2012, $44.1 million was spent on wages to non-residents and $7.7 million on wages for residents.[34] As a representative example, one film, Beyond, paid just 5% of qualified expenses as wages to Alaskans, while paying much of the rest to cast and crew from out of state. To be sure, Alaskans transfer resources to out-ofstate residents every time they purchase goods from outside the state, and this benefits them through mutually advantageous trades. But transfers to outof- state film producers differ from other transactions in that they provide Alaskans with neither goods and services nor a return on investments. One improvement in the recent film tax credit legislation is to reduce the credit available for wages paid to some out of state workers. While this might be an improvement, it still holds that not all the economic benefit of film productions can be counted as a benefit to the state.

There is also a cost to the state and its taxpayers when a film company locates in a state and consumes state government services but pays no taxes. Police and fire protection, road systems, and other critical services consumed by film productions are not free. Other taxpayers are left to pay the tab, either through increased strain on those services or increased taxes to make sure the services keep up with demand.

Opportunity Costs

Because film tax credits cost the state revenue, lawmakers must account for the opportunity costs of that foregone revenue. This lost revenue must be made up somewhere, either by higher taxes elsewhere or fewer government services. Production companies that receive the credits gain, as might businesses closely associated with those projects. But all other taxpayers that pay higher tax or face reduced services lose, as do the businesses that lose the patronage of those taxpayers. Both of these results would have offsetting economic effects that would ripple through the economy, offsetting to some degree the economic effects of film productions.

Similarly, instead of subsidizing film production, the state could use the same revenue to subsidize a different industry, potentially one with more economic impact and room for growth than film production. Just like film productions, each of these subsidized industries would have economic effects that would ripple through the economy. If Alaska lawmakers believe that subsidizing industry is an effective economic development strategy, they would need to determine which industry is the best to subsidize. Without accounting for these opportunity costs, studies that look at the film industry's economic impact are really only looking at one half of the picture, namely the benefits and not the costs.

Economic Distortions

Film incentive programs result in distortions to the economy. For example, they distort the overall pattern of production and shift risk from production companies and investors to taxpayers. Film subsidies distort the overall pattern of production by causing the film industry to expand beyond what consumers of films would support in an unhampered market. Alaska's resources go toward developing know-how and capital equipment that government officials, rather than consumers, value. Expansion of the film industry consumes resources and leaves less room for expansion of other industries: instead of more fishing trawlers and oil rigs, Alaska gets sound stages. Instead of training to be oil workers and fishermen, workers train to be stagehands or key grips.[35] Studies show that distortions caused by special incentives such as film incentives harm growth and reduce production of private and public goods.[36]

Beyond distortion to the overall Alaskan economy, the film subsidy program protects investors against losses. Generally, risk plays an important role in the market, making sure that resources are put to the best use and ensuring that resources are not overly invested in excessively risky activities. Film tax credits reduce this risk for film producers. Taxpayers must effectively absorb the risk of a film's losses by guaranteeing investors a better return on their investment, as film industry professionals recognize. [37] New Integrity Films informs investors about how film incentives can reduce their risk and boost return: "Tax rebates and incentives [...] allow an investor to greatly minimize his or her risk on what would ordinarily be considered a risky investment. [...] In today's economy this type of investment assurance is hard to come by." One case of this can be found in the film The Curious Case of Benjamin Button. Despite initially finding the film to be "too risky," the production companies eventually produced the film partly because tax incentives in Louisiana reduced some of the risk.[38]

Issues with Estimating Economic Impact

Beyond the failure to fully count the costs, economic impact estimates may overestimate the benefits of the incentivized film industry. Some economists have argued that input-output models in general, including the IMPLA N model used by the McDowell Group in its impact analysis of Big Miracle, overstate or inaccurately estimate the regional multiplier in the film industry for several reasons.[39] First, the models assume that jobs and businesses created in response to spending in the film industry are permanent. But as studies in Louisiana and Michigan show, many of these jobs are temporary. Failure to account for the temporary nature of many film jobs leads to vastly overstated job creation estimates.[40] The models also implicitly assume that spending will increase output by drawing unemployed workers into the film industry. But production may go to areas with low unemployment and production companies need specialized skills and equipment that may need to be imported from outside the state, thus leading the models to overestimate the effect on output and employment.[41] The models further implicitly assume that businesses and workers employed in the film industry do not abandon other productive activity by entering the industry. But while subsidized productions and their suppliers produce more as a result of the incentives, they draw resources away from all other businesses, which thereby have to produce less than before the credit was spent. Thus, the multiplier overestimates the economic impact. Finally, input-output models make arbitrary assumptions about how businesses respond to increases in spending that may not hold, especially when an industry is in the development stages within a state.

Subjectivity and Censorship

The marketplace of ideas—the exchange of ideas in society—is free when all individuals promote their ideas on equal terms, without government hindrance or subsidy. The Supreme Court in 1952 recognized the importance of films in the marketplace of ideas: "It cannot be doubted that motion pictures are a significant medium for the communication of ideas. They may affect public attitudes and behavior in a variety of ways [including] the subtle shaping of thought which characterizes all artistic expression."[42] The statute governing the film program in Alaska specifies guidelines and restrictions on content. The film office must "determine that the production is not contrary to the best interests of the state." These guidelines require officials to consider:

the effect of the production on both the immediate and long-term prospects for the film industry in Alaska;
the effect of the production on the employment of Alaska residents; and
the effect of the production on the economy of the state.[43]

In addition, legislation currently before the governor further instructs the Film Office to consider "the public perception of state policy on the utilization and development of the natural resources of the state."[44]

These guidelines are fairly subjective and give officials leeway to interpret them to deny funding for films that they believe are unfavorable to the state in one way or another. For example, one lawmaker, Rep. Anna Fairclough would have the program deny credits to films that are unfavorable to the state's resource development industries. She has noted that she is "very concerned about film credits being used by people to shut down Alaska and resource development." [45] But where one official may interpret a film as an unfavorable depiction of legitimate Alaskan industry, another may interpret the same film as accurate and necessary. Although film-goers may sympathize with one perspective or the other, the content will be skewed when officials influence what films get made.

Officials also tend to deny funding for films that portray political officials, the government, or its policies unfavorably. When a film in Texas seemed to portray the state's anti-illegal immigration law in a negative light, for instance, conservatives pressured the commission to deny the production's application for funding.[46]

The idea that Alaska's film commission can distort the marketplace of ideas is not mere speculation, as experience in other states confirms. In Texas, the film commissioner told the makers of a film about the Waco raid that they need not apply for funding, as he saw it as inaccurate.[47] Utah openly states that it has rejected films for their content. As the director of the Utah Film Commission said, "all the states will be looking at this [limiting funds based on content] as they begin to tighten their belts."[48]

The state's choice whether to subsidize such a film will always favor one group's view over another's. When the state taxes all film productions, and then returns that tax in the form of subsidies only to certain productions, those subsidized messages are made cheaper to produce and disperse, and all others are made relatively more expensive. In this way, a subsidy for some film content is an implicit penalty on the content of all other films. This is essentially a form of censorship: the power to approve or deny applications for film productions carries with it the power to distort the marketplace of ideas. Taxpayers and lawmakers should be wary of this type of government control of public discourse.

By using the film program for this and other purposes, the film program protects the content of films favored by the administrators against the judgments of film-goers. The alternative is to let films fail or thrive on their merits as judged by film-goers. If producers see value in portraying Alaska unfavorably, let them see whether film-goers agree. The more Alaska actually has to be proud of, the more successful the films that demonstrate those attributes will be. Fred S. Siebert expressed the merits of leaving the source of revenue to the consumer of media such as film: "Let all with something to say be free to express themselves. The true and sound will survive. The false and unsound will be vanquished. Government should keep out of the battle and not weigh the odds in favor of one side or the other."[49]

Conclusion

There are certainly many reasons to be wary of the value of film incentives in general and in Alaska specifically. Film incentives generally serve to only shift economic activity and jobs from one area to another. They result in a net revenue loss for states (i.e. a film tax credit does not "pay for itself ") and require higher taxes or lower government spending elsewhere. The incentive is unlikely to create a self-sustaining film industry in Alaska. And film incentives interfere with the free market of ideas.

What can be done to fix these problems? Some argue, with some merit, that the federal government should step in to stop destructive competition between states to attract businesses with tax incentives. [50] Others suggest that states might be able to commit to pacts barring them from using selective incentives to attract businesses.[51] Aside from these pacts, though, Alaska would establish the conditions for long-term sustainable growth if it unilaterally adopts a principle of neutrality, letting industries grow or shrink without the use of subsidies and selective taxes.

Endnotes

1. Will Luther, Movie Production Incentives: Blockbuster Support for Lackluster Policy, Tax Foundation Special Report No. 173, Jan. 2010.

2. For a succinct statement of the perceived benefits and accomplishments of the program, see Susan Bell, Lights and Cameras of Hollywood Bring Opportunity for Alaskans, Alaska Dispatch, Jan. 6, 2011.

3. As of June 2, 2011. Joseph Henchman, More States Abandon Film Tax Incentives as Programs' Ineffectiveness Becomes More Apparent, Tax Foundation, June 2, 2011.

4. State Film Production Incentives and Programs, National Conference of State Legislatures, Jan. 2011.

5. Alaska Stat. § 44.33.231 (2011).

6. As of February 24, 2012. Bill Popp, Film industry pours money into the state, Anchorage Daily News, Feb. 24, 2012.

7. Russell Stigall, Film, oil and gas taxes mashed into single bill, Juneau Empire, April 17, 2012. See also Alaska Senate Bill 23.

8. Kyle Hopkins, Wooing Hollywood, Anchorage Daily News, Feb. 28, 2011.

9. Pat Forgey, State film incentive program gets plaudits, but also has critics, Juneau Empire, June 15, 2011.

10. Rachel D'Oro, Film Industry: Extend Alaska Production, Anchorage Daily News, Jan. 1, 2012.

11. Tax Foundation calculations based on United State Census Bureau, State Government Tax Collections 2011, available at http://www.census.gov/govs/statetax/. Alaska's Department of Revenue's Tax Division projects that 88 percent of General Purpose Unrestricted Revenue through FY2021 will come from oil revenue. See Revenue Sources Book: Fall 2011 (Dec. 2011).

12. Nick Goundry, Alaska filming incentives cover third of costs on whale drama Big Miracle, The Location Guide, Feb. 15, 2012.

13. A. H. McDonald, Through the Looking Glass: Runaway Productions and Hollywood Economics, Journal of Labor and Employment Law, 919-922 (2006).

14. Film tax credit ramps up productions in Alaska, NECN.com, Feb. 19, 2011.

15. Hopkins, Wooing Hollywood.

16. A. H. McDonald perhaps helpfully distinguishes between three types of advantages one location has over another: It may suit the subject matter of the production better ('artistic'); it may offer greater protection ('artificial'); and it may have lower costs ('natural'). A. H. McDonald, Down the Rabbit Hole: The Madness of State Film Incentives as a Solution to Runaway Production, University of Pennsylvania Journal of Business Law (2011).

17. A. H. McDonald, Through the Looking Glass: Runaway Productions and Hollywood Economics, Journal of Labor and Employment Law, 919-922 (2006).

18. Henchman, More States.

19. Sean Cockerham, Alaska movie premieres in Washington, McClatchey Newspapers, Jan. 27, 2012.

20. Carolyn Robinson, owner of a film production services company, expressed the idea: "This is a very young industry that is just starting to walk. [...] The more movies we

get here, the more locals we'll get trained and move up the food chain of production." Hopkins, Wooing Hollywood.

21. See sources cited in in P. T. Calcagno and F. Hefner, "South Carolina's Tax Incentives: Costly, Inefficient and Distortionary," in Unleashing Capitalism: A Prescription for Economic Prosperity in South Carolina, Peter Calcagno et al., eds. (Columbia, SC: 2009, 124).

22. Joseph Cortright, Making Sense of Clusters: Regional Competitiveness and Economic Development, A Discussion Paper Prepared for the Brookings Institution Metropolitan Policy Program, p. 48 (2006).

23. B. L. Weinstein & T. L. Clower, Filmed Entertainment and Local Economic Development: Texas as a Case Study, Economic Development Quarterly (2000).

24. Richard Verrier, Iowa film tax credit program racked by scandal, Los Angeles Times, Jan. 29, 2011.

25. Greg Elmer & Mike Gasher, "Introduction: Catching Up to Runaway Productions," in Contracting Out Hollywood, Greg Elmer & Mike Gasher, eds., 2005.

26. Isaiah A Litvak, Hollywood Movie Production Industry: Floating Factories, AIB-SE (USA) 2006 Annual Meeting: Clearwater Beach, FL, Feb. 25, 2009.

27. Bell, Lights and Cameras.

28. Alaska Film Office, Information and Resources, http://www.film.alaska.gov/business/index.html.

29. Frank Hefner, Impact Analysis for Film Production in South Carolina, S.C. Coordinating Council for Economic Development, April 29, 2008.

30. Joseph Henchman, Motion Picture Association Attacks Tax Foundation Critique of Film Tax Subsidies, June 29, 2011. For the studies cited, see this commentary, available at http://www.taxfoundation.org/news/show/27410.html.

31. Robert Tannenwald, State Film Subsidies: Not Too Much Bang for Too Many Bucks, Center on Budget and Policy Priorities, Dec. 9, 2010.

32. Will Luther, Movie Production Incentives: Blockbuster Support for Lackluster Policy, Tax Foundation Special Report No. 173, Jan. 2010.

33. Alaska's Department of Revenue's Tax Division projects that 88 percent of General Purpose Unrestricted Revenue through FY2021 will come from oil revenue. See Revenue Sources Book: Fall 2011 (Dec. 2011).

34. FY2010 - FY2012, as of Feb. 6, 2012. Alaska Film Office, 2012 Report to the 27th Legislature, http://www.film.alaska.gov/reports/index.html.

35. Markusen 2007 argues that policymakers rarely consider the opportunity cost of incentives programs. Ann Markusen, ed. (2007), Reining in the Competition for Capital. (Kalamazoo, MI: W.E. Upjohn Institute for Employment Research), cited in Calcagno and Hefner 2009: 143.

36. See references cited in Calcagno and Hefner 2009: 133, fn. 4 and 7.

37. New Integrity Films, http://besttaxbreak.net.

38. Gary Perilloux, State film industry growing, The Advocate, Mar. 7, 2007, cited in Luther (2010).

39. Frank Hefner, Using input-output models to measure local economic impacts, International Journal of Public Administration (1997); Cletus C. Coughlin & Thomas B. Mandelbaum, A Consumer's Guide to Regional Economic Multipliers, Federal Reserve Bank of St. Louis Review (1991).

40. Michigan's study, for example, found that each job in its state lasted 23 days. David Zin, Film Incentives in Michigan, Michigan Senate Fiscal Agency, p. 19, Sept. 2010.

41. Kurt Schuler, Missing from the debate on multipliers, FreeBanking.org, Jan. 19, 2012.

42. Joseph Burstyn, Inc. v. Wilson , 343 U.S. 495 (1952).

43. Alaska Stat. § 44.33.231 (2011).

44. Susan Harrington, Changes needed for Alaska business, Alaska Business Monthly, Jan. 2012. See also Alaska Senate Bill 23.

45. Forgey, State film.

46. Michael Cieply, State Backing Films Says Cannibal Is Deal-Breaker, New York Times. June 14, 2010.

47. Ibid.

48. As of June 15, 2010, Michigan's commission had denied 160 out of 320 applications, to a great extent because of content. Cieply, State Backing.

49. Fred S. Siebert, et al., Four Theories of the Press (University of Illinois Press, Oct. 1, 1963).

50. Burstein & Rolnick, Congress.

51. Lawrence Reed, Time to End the Economic War Between the States, Mackinac Center, April 4, 1986.

Testimony on the Proper Role of Congress in State Taxation

Wed, 25 Apr 2012 00:00:00 EDT

(Download PDF of written statement here.)

Oral Statement

The Proper Role of Congress in State Taxation: Preventing Harm to the National Economy

Joseph Henchman

Vice President, Legal & State Projects, Tax Foundation

Hearing on "Tax Reform: What It Means for State and Local Tax and Fiscal Policy”

Committee on Finance, U.S. Senate

April 25, 2012

Mr. Chairman, Mr. Ranking Member, and Members of the Committee:

Thank you for the opportunity to testify to you today on the role that Congress plays in state tax policy. In the 75 years since our founding, the Tax Foundation has monitored tax policy trends at the federal and state levels, and our analysis is guided by the principles of economically sound tax policy: simplicity, neutrality, transparency, stability.

The main question I want to answer for you is: what is Congress’s role in state tax policy? After all, to be American is to be a believer in federalism, and that means Congress has its areas and the states have their areas. Most of the time, Congress should let the states do their thing, even if it’s bad policy. But in a few very important situations, Congress has the power and the responsibility to get involved in state tax policy. Two situations, in fact.

The first is to preserve the power of the federal government. States cannot tax the Federal Reserve, for instance, and there are federal laws banning state taxes on nonresident members of Congress and nonresident members of the military.

The second situation goes to the reason why we adopted the Constitution in the first place. States went wild under the Articles of Confederation: port states punitively taxed commerce going to interior states, and vice versa. Tariff wars proliferated. So the Constitution was adopted, giving Congress the power to restrain states from enacting laws that harm the national economy by discriminating against interstate commerce.

In short, states will put their own interest ahead of the federal interest every time. They have an incentive to shift tax burdens from physically present individuals and businesses, to those who are beyond their borders, nonvoters. When this behavior is not prevented by Congress or the courts, the results can be taxpayer uncertainty, incompatible standards, and harm to national economic growth.

As one example, take a multistate corporation with operations in 5 states. If each of those 5 states imposes a state corporate income tax, the company’s profit must be divvied up, or apportioned, among the 5 states. That’s so no state taxes more than fair share and no multiple taxation occurs. States game this, bending their apportionment rules to tax profits that were earned in other states. Congress recognized this problem, and set up the Willis Commission in 1959 to adopt one uniform apportionment standard. That threat got the states to adopt one on their own, although without congressional force backing it up, the states began drifting away from it soon afterward. Today, only 11 states stick with the uniform apportionment rule. The rest have abandoned it to grab revenue from other states.

There are similar situations today which cry out for a uniform standard, which I describe in detail in my written statement. Just to highlight one problem, this is BNA’s Survey of State Tax Departments, a compilation of state questionnaire results on nexus-creating activities. According to the survey results, 13 states will tax you if you have a website hosted on another entity’s server in the state. 1 state and DC will tax you if you send employees to attend a seminar even if you engage in no sales activity. This volume, while the best source for businesses asking when they can be subject to tax, is littered with footnotes, exceptions, and “depends” notations, reinforcing the lack of clarity the states have imposed on those engaged in interstate commerce. We get calls all the time from taxpayers, caught in a trap by an aggressive state nexus standard. The same is true with individual income tax on business travelers and with sales tax, and with many other state taxes.

The states cannot solve these problems themselves. Congress told the states to adopt a uniform apportionment standard in 1959, and we’re still waiting. Sales taxes, despite the work of the Streamlined project, are getting more complex and more numerous each year. On income tax on business travelers or cell taxes, the states aren’t budging.

Today, with new technologies, even the smallest businesses can sell their products and services in all fifty states. Business travel is easier than ever before. The temptation is great to treat interstate commerce like a golden goose to be squeezed. This temptation can only be countered by well-thought-out uniform rules imposed at the federal level.

Thank you.

Written Statement
(download PDF)

The Proper Role of Congress in State Taxation:
Preventing Harm to the National Economy

Joseph Henchman

Vice President, Legal & State Projects, Tax Foundation

Hearing on "Tax Reform: What It Means for State and Local Tax and Fiscal Policy"

Before the Committee on Finance,

U.S. Senate

April 25, 2012

Mr. Chairman, Mr. Ranking Member, and members of the Committee:

I appreciate the opportunity to testify today on the role that Congress plays in state tax policy. In the 75 years since our founding in 1937, the Tax Foundation has monitored tax policy trends at the federal and state levels, and our data and research is heavily relied upon by policymakers, the media, and the general public. Our analysis is guided by the idea that taxes should be as simple, neutral, transparent, and stable as possible, and as a 501(c)(3) non-profit, non-partisan organization, we take no position on any pending legislation.

We hope that the material we provide today will be helpful in the Committee's consideration of these issues.

The Constitution Empowers Congress to Limit States' Power to Shift Tax Burdens to Non-Residents

What you have before you is not a new issue. Absent guidelines from Congress or the courts, states have an incentive to shift tax burdens from physically present individuals and businesses, to those who are beyond their borders. Indeed, it was the states' unchecked behavior in this regard that led to the Constitutional Convention in the first place. Under the Articles of Confederation, states with ports taxed commerce bound for interior states, tariff wars proliferated, and the national economy was imperiled. As Justice Johnson described in 1824, these actions were "destructive to the harmony of the states, and fatal to their commercial interests abroad. This was the immediate cause that led to the forming of a convention."[1]

And so the Constitution was adopted, and through that document, the Congress was granted the power to restrain states from enacting laws that harm the national economy by discriminating against interstate commerce.[2] James Madison noted that these powers would check the "clamors of impatient avidity for immediate and immoderate gain" that drive state legislation discriminating against non-residents.[3] Justice Story later praised the "wisdom and policy in restraining the states themselves from the exercise of [taxation] injuriously to the interests of each other. A petty warfare of regulation is thus prevented, which would rouse resentments, and create dissensions, to the ruin of the harmony and amity of the states."[4]

So strong was this concern that the rule for a century and a half was that states could not tax interstate commerce at all.[5] This eroded in the 1950s and 1960s as it was recognized that those engaged in interstate commerce do enjoy benefits in states where they are present, so it is not unfair to have them support those services with taxes. The complete ban on state taxation of interstate commerce was abandoned in 1977, replaced by a recognition that resident businesses engaged in interstate commerce should pay for the fair share of the state services they consume. In Complete Auto Transit, Inc. v. Brady, the U.S. Supreme Court held that states may tax interstate commerce if the tax meets a four part test:[6]

nexus, a sufficient connection between the state and the taxpayer;
fair apportionment, the state cannot tax beyond its fair share of the taxpayer's income;
nondiscrimination, the state must not burden out-of-state taxpayers while exempting in-state taxpayers;
fairly related, the tax must be fairly related to services provided to the taxpayer.

Before and since Complete Auto, the courts have routinely exercised this power to restrain state tax infringements on interstate commerce, and these decisions are one of the more non-controversial aspects of constitutional law.[7] Congress has also been active in this area, legislating limits on state tax power where states are incapable of achieving a simplified, uniform system that restrain each state from claiming more than its fair share of taxes on interstate commerce.[8] These have included prohibiting state taxes on food stamps, Federal Reserve banks, interstate airline and bus travel, satellite services, and nonresident members of the military and nonresident members of Congress.[9] Congress has also banned discriminatory state taxes on federal employees, interstate electricity transmission, and interstate railroads.[10]

This power-to limit state tax authority-is not a power to use lightly. There are many components of state tax systems that, frankly, are none of Congress's business, even if they are good or bad public policy. Those aspects of state tax systems that are neither motivated by protectionism nor have the effect of raiding revenue from out-of-staters should be left alone as part of our commitment to fifty simultaneous laboratories for policy experiments, to paraphrase Justice Brandeis.[11] If bad state policy can be corrected by the political pressure of voting resident taxpayers or by the economic pressure of the out-migration of people and dollars, it ought to be left to the states to handle.

However, there are situations where it is vital that Congress use this power, where the alternative is the problem we experienced as a young country under the Articles of Confederation. While everyone is for simple taxes and fair taxes, in practice states look for any advantage or opportunity to shift tax burdens from voting residents to non-voting non-residents, to benefit in-state businesses and individuals by adopting tax policies that discriminate against out-of-state businesses and individuals. For all the discussion about how nonresident companies benefit from state services, the real issue usually is shifting tax burdens away from voting residents to someone else. As Professor Daniel Shaviro has put it, "Perceived tax exportation is a valuable political tool for state legislators, permitting them to claim that they provide government services for free."[12] Without court intervention or congressional action (or the threat of congressional action), efforts to get states to solve interstate tax issues have historically failed, because as soon as a state thinks they can get a bigger share of the pie by breaking the agreement, they do so, and the whole thing unravels.

As one example, the threat of congressional action by the Willis Commission in 1959 led to the adoption of uniform state corporate income tax apportionment rules. This standardization, however, only lasted twenty years before Iowa deviated from it to gain an advantage for itself. Many other states have followed, and today, only 11 states still adhere to the uniform rule. The trend continues to move away from uniformity, not towards it, despite the existence of voluntary organizations like the Multistate Tax Commission (MTC) and the Federation of Tax Administrators (FTA) that exist to advance uniformity in such rules.

Nexus Based on Physical Presence

We at the Tax Foundation have monitored the increasing use of tax policy by states to do precisely what I have described: shift tax burdens from out-of-state businesses and individuals to benefit in-state businesses and individuals, through discriminatory tax policy. These generally involve disputes over "nexus" standards: the proper scope of state tax power over non-resident individuals and businesses.

Generally, the historical standard is that states may tax those physically present in the jurisdiction, and may not tax those not physically present. This is premised on a view known as the "benefit principle": that the taxes you pay should roughly approximate the services you consume. State spending overwhelmingly, if not completely, is meant to benefit the people who live and work in the jurisdiction. Education, health care, roads, police protection, broadband access, etc.: the primary beneficiaries are state residents. The "benefit principle" thus means that residents should be paying taxes where they work and live, and jurisdictions should not tax those who don't work and live there. A physical presence standard for state taxation would be in line with this fundamental view of taxation.

Developments have arisen in the three major state tax areas (corporate income tax, individual income tax and sales tax), as well as with some other state taxes (such as telecommunications taxes, taxes on digital goods, car rental taxes, and so forth). Bills have been introduced in the Congress that seek to address some of the problems that have been identified in these areas.

Recent Developments in State Corporate Income Tax

Businesses throughout our nation's history have plied their trade across state lines. Today, with new technologies, even the smallest businesses can sell their products and services in all fifty states through the Internet and through the mail. If such sales can now expose these businesses to tax compliance and liability risks in states where they merely have customers, they will be less likely to expand their reach into those states. Unless a single nexus standard is established, the conflicting standards will impede the desire and the ability of businesses to expand, which harms the nation's economic growth potential.

Frequent and ambiguous alterations of tax codes and the confusion they cause are a key source of the growing tax compliance burden. These costs are especially relevant for interstate businesses, both large and small. Nonetheless, many states have sought to impose business activity taxes on remote entities under the general heading of economic nexus without regard to lack of physical presence. While a rule premised on the physical presence of employees or business property can be demarcated with predictability, this is not the case with economic nexus. Scholars disagree sharply on what the term even means, with many definitions involving case-by-case, defendant-specific, multi-factor inquiries that leave businesses generally incapable of foreseeing whether a particular activity will create nexus in a given state.

The complexities imposed by states' steadily expanding their nexus standards beyond the bright-line physical presence rule can be illustrated with a review of current nexus standards. Each year, tax publisher BNA produces the Survey of State Tax Departments, a compilation of questionnaire results on nexus-creating activities submitted to state taxing authorities. For each scenario, the state responds as to whether a particular activity creates nexus. For example:

· Merely having a phone number listed in a telephone book is treated as sufficient nexus-creating activity in 9 states.

· Having a website hosted on another entity's server in the state creates nexus in 13 states.

· Sending employees to attend a seminar but engaging in no sales activity creates nexus in 1 state and the District of Columbia.

· While shipping products in non-returnable containers is protected by Public L. 86-272, shipping products into a state in returnable containers creates nexus in 26 states.

While this thick volume remains the best comprehensive guidance for interstate business, it is littered with footnotes, exceptions, and "depends" notations, reinforcing the lack of clarity the states have imposed on those engaged in interstate commerce. For example, 10 states (primarily those with aggressive nexus rules) requested that BNA note that they (the states) do not consider any of their answers to be binding guidance if the particular situation were actually to arise.

With the increasing level of economic integration we have today, the economic costs of nexus uncertainty burden and impede the economy much more than ever before. As some states follow the physical presence rule and others follow some iteration of economic nexus (roughly half the states taking each approach at present for business activity taxes), compliance costs for business engaged in interstate commerce will increase. Businesses that expand their sales into states following economic nexus will have to file tax returns and understand the local tax base, applicable tax rates, available tax incentives, and differing apportionment formulas. Many taxpayers will have to guess about what approach a state will follow for their situation, leaving them taking a chance on whether or not to file taxes.

In 2010, for instance, the State of Washington adopted a new standard for "engaging [in business] within this state."[13] Under this definition, a person is engaged in business in Washington when the "person generates gross income of the business from sources within this state, such as customers or intangible property located in this state, regardless of whether the person is physically present in this state."

The apportionment formula applicable to a multistate taxpayer with putative "substantial nexus" adopts a cascading set of principles that ask the taxpayer, first, to determine (and keep records on) where the customer "received the benefit of the taxpayer's service," or where the customer "used the taxpayer's intangible property."[14] If the taxpayer believes this occurred in more than one state in the customer's operations, the taxpayer is asked to determine where the benefit was "primarily received" or the intangible property was "primarily used."[15] In an integrated national economy, these tests superimpose a challenging subjective analysis on a high-volume accounting process. The taxpayer has the burden of showing these tests are not reasonably answerable, of course, before it may move on to the other five possible allocation rules under the statute.

Additionally, the Respondent Department of Revenue has adopted emergency rules that, for example, allocate to Washington receipts paid by a business customer for a service-if it is not related to real or tangible personal property-if the service "relates to the [customer's] business activities in this state."[16] Under the emergency rule, an out-of-state entity with no property or employees in Washington can be found to have putative "substantial nexus" with Washington if the services it performs for a client are deemed to be "relate[d] to [the client's] business activities in" Washington and if the fees from this client and/or similar clients exceed $250,000 in a tax year.

The Washington example shows how economic nexus exacerbates the uncertainties and compounds the burdensome recordkeeping that attend doing business with customers in other states. Why, you may ask, did Washington adopt this? Tax exportation was one explicit reason. The Department of Revenue summarized the prospective impact of Washington's 2010 legislation as requiring tax payments from "out-of-state businesses [that] currently do millions of dollars in business with the state but pay zero tax because they lack physical nexus."[17] At the same time, they write, "[m]any Washington-based businesses will see reduced taxes" (emphasis original).[18]

A physical presence standard for business activity taxes would halt these growing state efforts to export tax burdens. A physical presence standard would also have the benefit of focusing states on raising their tax revenue from those who work and live in the jurisdiction.

Recent Developments in State Individual Income Tax

Half the states require nonresident employees to set up individual income tax withholding for their first day of travel into the state.[19] 16 more states also require withholding after a certain point. And that's just withholding, not the obligation to file a return or pay taxes.[20]

A few years ago, we got a call from a woman in Ohio. Her son was a semi-professional soccer goalie and he had earned $28,000. Spread across this woman's kitchen table were 10 state income tax returns, divvying up the tax on $28k. States are becoming more aggressive with nonresident income taxes, hunting schedules via Twitter, demanding travel vouchers, generally imposing a colossal compliance burden that is a net revenue wash, transferring tax dollars from low-tax, low-expense states to the states with the highest tax burdens.[21] We regularly receive reports of state tax departments demanding access to business travel records.

Traditionally imposed only on athletes and entertainers, increasing availability of public schedules is enabling states to reach further down into the business traveler community. Current state practices of expanding individual income tax nexus standards to more professionals and business travelers threaten to disrupt interstate commerce and falsely suggest that business travelers earn their income in traveling states and not from the home office. In recent hearings, members of the House of Representatives have shown their outrage at these state practices.

Tax systems should aim to treat like transactions alike, whether the seller is remote or in-state. Income tax should be paid by those who work or live in a jurisdiction. However, the economy incurs enormous deadweight loss if income tax obligations kick in at minimal levels of activity. One proposed standard is restricting states' power to tax individuals who work in a state for less than 30 days, which would shield de minimis activity while affirming state power to tax those who are genuinely working in the state for extended periods. An alternative income-based standard would be difficult to implement in practice and would be less effective at allowing businesses and their employees to foresee tax liability in a state.

Recent Developments in State Sales Tax: Background

There are a number of proposals to reverse a series of U.S. Supreme Court decisions (most recently the Quill decision of 1992) that prohibit states from imposing sales tax collection obligations on businesses with no property or employee in the state. This "physical presence" standard is meant to prevent states from shifting tax burdens to non-residents away from residents who are the primary beneficiary of state services, while also protecting the free flow of interstate commerce from the compliance costs of non-uniform and numerous (9,600+) sales tax jurisdictions in the United States.

The steadily increasing growth of Internet-based commerce has however led to frustration with this standard, primarily due to disparate sales tax treatment of similar goods within states that has no economic basis. This can be addressed while also ensuring that some standard exists to restrain states from engaging in destructive behavior, such as tax exporting to non-voters or imposing heavy compliance costs on interstate businesses, that the Congress is empowered to prevent. Further, because economic integration is greater now than it has ever been before, the economic costs of nexus uncertainty are also greater today and can ripple through the economy much more quickly.

Substantial progress has been made in recent months toward possible solutions that could (1) simplify sales tax systems and avoid discriminatory compliance costs, (2) eliminate non-neutral tax rates on similar products sold by online and brick-and-mortar businesses, (3) limit taxation in a state to those residents who enjoy the benefits of state services, (4) prevent multiple taxation of interstate commerce, and (5) prevent unconstitutional and fragmented state attempts to impose such tax burdens in a destructive manner.

These actions are only the latest chapter in a long saga over the proper tax treatment of sales made over the Internet, and an even longer saga over the proper scope of state taxing authority. At its core is a dispute over which is more important: limiting state power to tax nonresidents and thus harm the national economy, or ensuring that some transactions do not escape tax because they are conducted online. Discussions following a recent compromise in California suggest that there are policy options that could achieve both ends.

Recent Developments in State Sales Tax: Quill

What is nexus for a remote seller? In 1967, the U.S. Supreme Court held that a business does not have nexus with a state if the business has no retail outlets, solicitors, or property in the state, and communicates with customers only by mail or common carrier as part of a general interstate business.[22] Otherwise, the Court concluded, states could "entangle National's interstate business in a virtual welter of complicated obligations to local jurisdictions with no legitimate claim to impose a fair share of the cost of the local government." This decision was reaffirmed after the Complete Auto test was announced in 1977.[23]

During the 1980s, some academics and many states criticized National Bellas Hess as archaic, formalistic, and outmoded. Officials were encouraged to ignore the decision, and some state courts disregarded it, even as the number of sales taxes rose from 2,300 to 6,000. Different murky definitions of economic nexus have been proposed:

· Engaged in exploiting the local market on a regular, systematic, large-scale basis.

· Presence of intangible property or affiliates

· Number of customers in state, value of assets or deposits in the state, and receipts attributable to sources in the state

· Analysis of frequency, quantity, and systematic nature of taxpayer's economic contacts with the state

· Derivation of economic benefits from state's residents

Defying the Court rulings, North Dakota enacted a law requiring the out-of-state Quill Corp. to collect sales tax on its sales to 3,000 in-state customers. Any state that advertised three times in the state was liable. In the case, the U.S. Supreme Court reaffirmed National Bellas Hess and Complete Auto.[24] There they stated that the physical presence rule "firmly establishes the boundaries of legitimate state authority to impose a duty to collect sales and use taxes and reduces litigation concerning those taxes." Justice Byron White dissented, arguing two points that continue to be made today: (1) injustice that some sales escape taxation and (2) arguing that technological change had made discriminatory compliance costs no longer burdensome.

Recent Developments in State Sales Tax: Efforts to Change Quill

Today, there are over 9,600 state and local sales tax jurisdictions in the United States. There are different rates on different items, they change frequently, and are not even aligned to 9-digit zip codes. States are reluctant to cooperate on even basic rules and definitions.

The Streamlined Sales Tax Project (SSTP) was launched in 2000 with the mission of getting states to adopt changes to their sales taxes to make them simple and uniform. SSTP then hopes to convince Congress or the courts to overrule Quill and allow use tax collection obligations on out-of-state companies ("Main Street Fairness Act").

However, the SSTP has abandoned simplification efforts and any attempt to reduce the number of sales tax jurisdictions, instead focusing on uniformity efforts. In many cases, the Project has enabled state sales tax complexity by permitting separate tax rates for certain goods. States generally are reluctant to yield parochial advantages, even with the possibility of online sales tax revenue in return, undermining their argument to Congress as part of the Main Street Fairness Act that they have succeeded in their mission. Large states have generally avoided the SSTP, and membership has been stuck at 20-something states for some time.

This in turn has led to impatience from states and others.

Recent Developments in State Sales Tax: Efforts to Defy Quill

In 2008, New York adopted an "Amazon" tax, nicknamed after the Internet retailer as the most visible target. The law held that a person or business with no physical presence in the state nevertheless has nexus if it (1) enters into agreement with in-state resident involving commissions for referring potential customers; and (2) has gross receipts from sales by out-of-state company from referrals within the state are more than $10,000 in a 12-month period.

Amazon.com & Overstock.com responded by terminating affiliate programs in New York, and Amazon.com filed a lawsuit in state court. The law was upheld by a trial judge (New York's trial courts are called the "New York Supreme Court," causing confusion about who upheld the Amazon tax as constitutional); the judge concluded that Amazon.com's in-state affiliates are necessary and significant to establishing and maintaining out-of-state company's market in the state. But because they make up only 1.5% of sales, that was the basis for the appeal. The New York Supreme Court, Appellate Division ruled in late 2010 that law is not facially unconstitutional but may be unconstitutional for Amazon. The case was remanded to the lower court, but Amazon is appealing to state's highest court, the New York Court of Appeals. The case is ongoing.

In 2009, Rhode Island and North Carolina adopted identical New York-style laws. Neither has seen any revenue and Rhode Island has actually seen revenue loss due to reduced income tax collections from terminated in-state affiliates. Laws were also passed in California and Hawaii but vetoed.

In 2010, Colorado considered the same law but faced opposition from in-state affiliates. Instead it adopted a law (H.B. 10-1193) designed to push Amazon into collecting use taxes without explicitly requiring it. Any out-of-state retailer that is part of "a controlled group of corporations" with at least one member with physical presence in Colorado, all the retailers in the group have nexus with Colorado. However, the "only" obligation with this nexus is notification:

"[N]otify Colorado purchasers that sales or use tax is due on certain purchases made from the retailer and that the State of Colorado requires the purchaser to file a sales or use tax return." Penalty of $5 per failure per customer, plus criminal penalties
"[Notify] all Colorado purchasers by January 31 of each year showing such information as the Colorado Department of Revenue shall require by rule and the total amount paid by the purchaser for Colorado purchases made from the retailer in the previous calendar year. Such notification shall include, if available, the dates of purchases, the amounts of each purchase, and the category of the purchase, including, if known by the retailer, whether the purchase is exempt or not exempt from taxation." Must be sent separately from other shipments and be by first-class mail. CC to State. Penalty of $10 per failure per customer, plus criminal penalties.

Amazon.com terminated affiliate programs in Colorado, and the Direct Marketing Association filed lawsuit in federal court. In January 2010, a federal judge stayed the law stayed as probably unconstitutional on First Amendment grounds, and the law was thrown out completely in April 2012.[25]

North Carolina followed Colorado by adopting regulation with similar/notification requirements. They demanded out-of-state companies provide them with all customer purchase information dating from 2003, by April 19, 2010. Amazon.com and the ACLU filed lawsuit in federal court, arguing that "[e]ach order of a book, movie, CD or other expressive work potentially reveals an intimate fact about an Amazon customer." Examples of purchases by North Carolina residents:

Bipolar Disorder: A Guide for Parents and Families
He Had It Coming: How to Outsmart Your Husband and Win Your Divorce
Living with Alcoholism: Your Guide to Dealing with Alcohol Abuse and Addiction While Getting the Alcoholism Treatment You Need
What to Do When You Can't Get Pregnant: The Complete Guide to All the Technologies for Couples Facing Fertility Problems
Outing Yourself: How to Come out as Lesbian or Gay to Your Family, Friends, and Coworkers
Lolita (1962)
Brokeback Mountain (2005)
Fahrenheit 9/11 (2004)

A federal judge struck down the North Carolina regulation as violating First Amendment in October 2010.

In 2011, Illinois and Arkansas enacted New York-style laws. California enacted one but after a possible repeal referendum was proposed, the state and Amazon.com reached an agreement whereby Amazon.com will develop a physical presence in the state (i.e., build warehouses).

Recent Developments in State Sales Tax: Possible Solutions

Florida "iStart" Proposal. This state legislative proposal would require the State of Florida to create software ("Internet Sales Tax Automated Revenue Tracking") to enable one-stop sales tax calculation and payment. The state would make it available to retailers selling in Florida and under license to other states. The state would also pay compensation to vendors who collect, and the law prohibits disclosure of purchase information. When revenue from the software exceeds $5 billion per year, the state sales tax is automatically reduced by 1 percentage point.

Origin-Based Taxation. This proposal is premised on the benefit principle, the idea that the taxes one pays are a rough approximation for the government services consumed. State spending overwhelmingly, if not exclusively, is meant to benefit those who live and work in the jurisdiction. Education, health care, roads, police: the primary beneficiaries are in-state residents. Thus, individuals and businesses should pay taxes where they work and live; jurisdictions should not tax those who don't work and live there. In practice for sales tax, Amazon.com would collect Washington sales tax on all transactions. Amazon employees use Washington state services. Resident-purchasers of Amazon products pay other taxes to their states. This solution is in line with brick-and-mortar practice: tax based on where business is, not where customer is from. It levels playing field (as opposed to the Main Street Fairness Act or "Amazon" taxes, where brick-and-mortar comply only with taxes where they are physically present while online companies must comply with thousands).

While some may criticize origin-based taxation as enabling Internet-based businesses to "escape" taxation by locating in states that do not tax sales, individuals do not all congregate in states with no income tax and corporations do not all congregate in states with no corporate income tax. States compete not only over taxes but over state services, transportation, education, weather, and other factors.

National Online Sales Tax. If states are unwilling to simplify their tax systems to prevent complexities from being imposed on those engaged in national online commerce, another option would be to implement a single default national sales tax to be imposed on online transactions, with the revenue distributed among the states. This could be on its own or distinct from other options and would eliminate much of the disparity between goods purchased in brick-and-mortar stores and goods purchased online. Ideally, implementation should be revenue-neutral, with the revenue collected used to reduce other taxes.

Marketplace Fairness Act/Marketplace Equity Act Proposals. Two recent proposals would eliminate the physical presence rule but otherwise make advances towards ensuring that states reduce the burdens associated with collecting their sales taxes. Example provisions include requirements that states have a single state-level agency that administer all sales tax rules, offer one tax return and audit for the entire state, require one uniform tax base for the entire state, provide software that identifies the applicable tax rate for a sale, including local rates and hold sellers harmless for any software errors or mistakes by the state, provide 30 days notice of any local sales tax rate change, and exempt sellers with a de minimis level of collections. Effective simplification is a necessity for any federal proposal.

Recent Developments in Other State Taxes

Other proposals are pending in the Congress regarding discriminatory state taxes in other state tax areas. One bill, for example, would adopt a uniform rule on which state may tax a digital purchase. At present, where a resident of State A could easily access the Internet in State B to download a purchase from a business in State C from its servers in State D, a system that works out which state may tax the transaction is crucial.

Other proposals focus on new targeted state taxes on products primarily used in interstate commerce or by out-of-state travelers, such as cell phone taxes and car rental taxes. These are most similar to past congressional actions prohibiting discriminatory taxation of interstate railroad property and prohibiting new targeted taxes on Internet access, both of which have been successful at restraining state tax policy from harming interstate commerce.

Conclusion

Businesses throughout our nation's history have plied their trade across state lines. Today, with new technologies, even the smallest businesses can sell their products and services in all fifty states through the Internet and through the mail. Business travel is easier than ever before. If such sales, travel, or activity can now expose these businesses to tax compliance and liability risks in states where they merely have customers, they will be less likely to expand their reach into those states. Interstate commerce is not a golden goose that can be squeezed without adverse effects on economic growth. Unless a single uniform nexus standard is established, the conflicting standards will impede the desire and the ability of businesses to expand, which harms the nation's economic growth potential.

We at the Tax Foundation track the numerous rates, bases, exemptions, credits, adjustments, phaseouts, exclusions, and deductions that litter our federal and state tax codes. Frequent and ambiguous alterations of tax codes and the confusion they cause are a key source of the growing tax compliance burden. We have several staffers as well as computer-based and publication subscriptions dedicated to being up to date and accurate on the frequent changes to the many taxes in our country, but even we have trouble doing it. It would be extremely difficult for individuals and businesses who are in business to sell a good or service, not to conduct tax policy research.

Congress can obtain evidence from interested stakeholders and take political and economic factors into consideration when developing new rules of taxation. The Supreme Court, by contrast, must develop broad doctrine in a case-by-case fashion, based on the facts of the particular case before them. (Additionally, the Court seems to have an aversion to tax cases.) This is why congressional action, which can be more comprehensive and accountable than judicial action, and can better address issues of transition, retroactivity, and de minimis exemptions, may now be the best vehicle for preventing burdens to interstate commerce. It is up to Congress to exercise its power to protect interstate commerce.

We now live in a world of iPods, telecommuting, and Amazon.com. It is a testament to the Framers that their warnings about states' incentives to hinder the national economy remain true today.

Some may argue that faster roads and powerful computers mean that states should now be able to tax everything everywhere. While some constitutional principles surely must be revisited to be applied to new circumstances, the idea that parochial state interests should not be permitted to burden interstate commerce remains a timeless principle regardless of how sophisticated technology may become.

About the Tax Foundation

The Tax Foundation is a non-partisan, non-profit research institution founded in 1937 to educate taxpayers on tax policy. Based in Washington, D.C., our economic and policy analysis is guided by the principles of sound tax policy: simplicity, neutrality, transparency, and stability.

About the Center for Legal Reform at the Tax Foundation

The Tax Foundation's Center for Legal Reform educates the legal community and the general public about economics and principled tax policy. Our research efforts focus on the scope of taxing authority, the definition of tax, economic incidence, and taxpayer protections.

[1] See, e.g., Gibbons v. Ogden, 22 U.S. (9 Wheat.) 1, 224 (1824) (Johnson, J., concurring).

[2] See U.S. Const. art. I, § 8, cl. 3 (Interstate Commerce Clause); U.S. Const. art. I, § 10, cl. 2 (Import-Export Clause); U.S. Const. art. I, § 10, cl. 3 (Tonnage Clause); U.S. Const. art. IV, § 2, cl. 1 (Privileges and Immunities Clause); U.S. Const., amend. XIV, § 1 (Privileges or Immunities Clause).

[3] James Madison, The Federalist No. 42 (1788).

[4] 1 Story Const § 497.

[5] See, e.g., Freeman v. Hewit, 329 U.S. 249, 252-53 (1946) ("A State is ... precluded from taking any action which may fairly be deemed to have the effect of impeding the free flow of trade between States"); Leloup v. Port of Mobile, 127 U.S. 640, 648 (1888) ("No State has the right to lay a tax on interstate commerce in any form.").

[6] 430 U.S. 274 (1977).

[7] The power of the federal courts to act when Congress is silent is inferred as an implication of the Commerce Clause, a doctrine often referred to as the "dormant" or "negative" Commerce Clause. See, e.g., Willson v. The Black Bird Creek Marsh Co., 27 U.S. 245 (1829). The Commerce Clause prohibits states from imposing a tax on activity out-of-state while leaving identical activity in-state untaxed. See Boston Stock Exchange v. State Tax Comm'n, 429 U.S. 318 (1977) (invalidating a New York tax imposed solely on activity out-of-state while leaving identical activity in-state untaxed); Westinghouse Elec. Co. v. Tully, 466 U.S. 388 (1984) (invalidating a New York scheme exempting activity in-state while simultaneously imposed a tax on identical activity out-of-state); Bacchus Imports, Ltd. v. Dias, 468 U.S. 263 (1984) (invalidating a Hawaii tax imposed on a category of products but exempting activity in-state); Am. Trucking Ass'n v. Scheiner, 483 U.S. 266 (1987) (invalidating a Pennsylvania scheme imposing fees on all trucks while reducing other taxes for trucks in-state only); New Energy Co. v. Limbach, 486 U.S. 269 (1988) (invalidating an Ohio tax credit to all ethanol producers but disallowed for non-Ohio producers); West Lynn Creamery, Inc. v. Healy, 512 U.S. 186 (1994) (invalidating a Massachusetts general tax on dairy producers where the revenue was then distributed to domestic dairy producers); Camps/Newfound/Owatanna, Inc. v. Town of Harrison, 520 U.S. 564 (1997) (invalidating Maine's denial of the general charitable deduction to organizations that primarily serve non-Maine residents). But see Dep't. of Revenue of Ky. v. Davis, 553 U.S. 328 (2008) (upholding Kentucky's exclusion from tax of interest earned from its state bonds, but not other states bonds, on the grounds that Kentucky is acting as a market participant no different from any other bond issuer). But see

The Import-Export Clause prohibits states from penalizing activity that crosses state lines, particularly imports. See, e.g., Michelin Corp. v. Wages, 423 U.S. 276, 295 (1976) (stating that the Import-Export Clause prohibits import taxes that "create special protective tariffs or particular preferences for certain domestic goods...."). Justice Clarence Thomas, a critic of dormant commerce clause jurisprudence, nonetheless argues that taxes that discriminate against nonresidents should be invalidated by the courts under the Import-Export Clause. See Camps/Newfound/Owatanna, 520 U.S. at 610 (Thomas, J., dissenting) ("That the expansion effected by today's decision ﬁnds some support in the morass of our negative Commerce Clause case law only serves to highlight the need to abandon that failed jurisprudence and to consider restoring the original Import-Export Clause check on discriminatory state taxation to what appears to be its proper role.").

The Tonnage Clause prohibits charges on shipping freight.

The Privileges and Immunities Clause of Article IV and the Privileges or Immunities Clause of the Fourteenth Amendment protects the right of citizens to cross state lines in pursuit of an honest living. See, e.g., United Bldg. & Constr. Trades v. Mayor, 465 U.S. 208, 219 (1984) (identifying "pursuit of a common calling" as a privilege of citizenship protected by the Constitution); Saenz v. Roe, 526 U.S. 489 (1999) (invalidating a law that did not restrict state travel per se but discouraged the crossing of state lines with a punitive and discriminatory law); id. at 511 (Rehnquist, J., dissenting) ("The right to travel clearly embraces the right to go from one place to another, and prohibits States from impeding the free passage of citizens); Erwin Chemerinsky, Constitutional Law 450 (2d ed. 2002) ("The vast majority of cases under the [Article IV] privileges and immunities clause involve states discriminating against out-of-staters with regard to their ability to earn a livelihood.").

[8] Public L. 86-272, 73 Stat. 555 (codified at 15 U.S.C. § 381 et seq.) (preempting state and local income taxes on a business if the business's in-state activity is limited to soliciting sales of tangible personal property, with orders accepted outside the state and goods shipped into the state); 4 U.S.C. § 111 (preempting discriminatory state taxation of federal employees); 4 U.S.C. § 113 (preempting state taxation of nonresident members of Congress); 4 U.S.C. § 114 (preempting discriminatory state taxation of nonresident pensions); 7 U.S.C. § 2013 (preempting state taxation of food stamps); 12 U.S.C. § 531 (preempting state taxation of Federal Reserve banks, other than real estate taxes); 15 U.S.C. § 391 (preempting discriminatory state taxes on electricity generation or transmission); 31 U.S.C. § 3124 (preempting state taxation of federal debt obligations); 43 U.S.C. § 1333 (2)(A) (preempting state taxation of the outer continental shelf); 45 U.S.C. § 101 (preempting state income taxation of nonresident water carrier employees); 45 U.S.C. § 501 (preempting state income taxation of nonresident employees of interstate railroads and motor carriers and Amtrak ticket sales); 45 U.S.C. § 801 et seq. (preempting discriminatory state taxation of interstate railroads); 47 U.S.C. § 151 (preempting state taxation of Internet access, aside from grandfathered taxes); 47 U.S.C. § 152 (preempting local but not state taxation of satellite telecommunications services); 49 U.S.C. § 101 (preempting state taxation of interstate bus and motor carrier transportation tickets); 49 U.S.C. § 1513 et seq. (preempting state taxation of interstate air carriers and air transportation tickets); 49 U.S.C. § 40116(b) (preempting state taxation of air passengers); 49 U.S.C. § 40116(c) (preempting state taxation of flights unless they take off or land in the state); 49 U.S.C. § 40101 (preempting state income taxation of nonresident airline employees); 50 U.S.C. § 574 (preempting state taxation of nonresident members of the military stationed temporarily in the state).

[9] See id.

[10] See id.

[11] See New State Ice Co. v. Liebmann, 285 U.S. 262, 311 (1932) (Brandeis, J., dissenting) ("It is one of the happy incidents of the federal system that a single courageous State may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country.").

[12] Daniel Shaviro, "An Economic and Political Look at Federalism in Taxation," 90 Mich. L. Rev. 895, 957 (1992).

[13] Wash. Rev. Code § 82.04.066 (2010) (emphasis added).

[14] Wash. Rev. Code § 82.04.462(3)(b)(i) (2010).

[15] Wash. Rev. Code § 82.04.462(3)(b)(ii) (2010).

[16] Wash. Admin. Code § 458-20-19402(5)(a)(i)(C)(II) (emergency rule effective Jan. 28, 2011 through Sep. 24, 2011), http://dor.wa.gov/Docs/Rules/draft/20-19402-19403cr3efrmdraft2011-4.pdf.

[17] Washington State Department of Revenue, "Economic Nexus Summary" (Jan. 19, 2010) at 2-3 (emphasis original).

[18] Id.

[19] See Council on State Taxation, "Nonresident Personal Income Tax Withholding."

[20] Id.

[21] See David Hoffman & Scott A. Hodge, "Nonresident State and Local Income Taxes in the United States," Tax Foundation Special Report No. 130 (Jul. 1, 2004), http://www.taxfoundation.org/research/show/94.html.

[22] See National Bellas Hess, Inc. v. Dept. of Revenue of Ill., 386 U.S. 753, 759-60 (1967).

[23] See Nat'l Geographic Society v. Ca. Bd. Of Equalization, 430 U.S. 551, 559 (1977).

[24] See Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

[25] See Mark Robyn, "Colorado Amazon Regulations Ruled Unconstitutional," (Apr. 4, 2012), http://www.taxfoundation.org/blog/show/28111.html

State Tax Collections Rising in Post-Recession Recovery

Tue, 24 Apr 2012 00:00:00 EDT

After two years of falling revenue, total state government tax collections increased by nearly 9 percent during 2011, according to data released by the United States Census Bureau.[1] Total collections were $757 billion last year, [2] still slightly less than 2007 levels prior to the recession. Figure 1 below shows state government tax collections since fiscal year 2000. Total collections have increased by approximately 40 percent in nominal terms over this time period.

All major types of state taxes saw increased collections in 2011, as seen in Figure 2. Individual income and corporate income tax collections had the largest increases, increasing by 9.8 and 9.4 percent, respectively. Although 7 states (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) do not levy an individual income tax, [3] these collections accounted for the largest proportion of total state collections nationwide: 34.2 percent in 2011. Sales taxes were the next largest, making up 31 percent of the total. Excise taxes alone brought in over $131 million for state governments, amounting to 17.4 percent of their total tax collections. Corporate income accounted for a mere 5.3 percent, with smaller taxes composing the remaining total.

While the recession caused a drop in state tax revenues across the board, some tax sources were more volatile than others. Examining percent changes in tax collections since 2000, it is clear that revenue from state corporate income taxes has by far been the most volatile over the last decade. This is largely due to the fact that taxable corporate incomes are highly dependent on the health of the economy. Individual income tax exhibited significant volatility over the last decade as well. Sales and excise taxes were more stable, though they were still subject to year over year declines during the recession. It ultimately remains to be seen where tax collection growth rates will stabilize as the economy continues to recover.

1. Rudy Telles, Sheila O’Sullivan, & Jesse Willhide, State Government Tax Collections Summary Report: 2011, United States Census Bureau, Governments Division Brief G11-STC, http://www2.census.gov/govs/statetax/2011stcreport.pdf.

2. This data was updated on April 17, 2012 and is available at http://www.census.gov/newsroom/releases/archives/governments/cb12-62.html.

3. In addition, Tennessee and New Hampshire do not tax wage income but do tax capital gains and dividends.

Taxmageddon Looms, Potentially Pushing Tax Freedom Day Later than Ever

Mon, 16 Apr 2012 00:00:00 EDT

While Tax Freedom Day[1] is just around the corner, on April 17 this year, try to enjoy it. If Congress fails to act, “Taxmageddon”—the roughly $500 billion tax increase scheduled to occur January 1, 2013—could push Tax Freedom Day to the end of April or beyond.

Taxmageddon, as Curtis Dubay[2] and others[3] have described it, is the result of a litany of expiring tax provisions, all occurring at the end of this year. The biggest expiring provisions are the Bush tax cuts, the payroll tax holiday, and the Alternative Minimum Tax (AMT) patch.

The table below shows the effect of all expiring provisions in terms of days added to America’s total tax burden. While this year it will take Americans 107 days to pay the total tax burden, these federal tax increases will add another 11 days, pushing Tax Freedom Day to the end of April. Add to this the fact that state and local tax collections are surging and it means that Tax Freedom Day next year could easily be a record breaker.[4] The all-time latest Tax Freedom Day occurred on May 1, 2000, after huge stock market gains produced huge capital gains tax collections.

The table breaks Taxmageddon down according to the major tax types. The biggest effect is on the federal individual income tax, the burden of which would increase more than 5 days unless these tax increases are halted. This is mainly the result of expiration of the Bush tax cuts and the AMT patch, which would each add more than 2 days to the burden. Another partial day would be added by the expiration of various “tax-extenders,” most of which affect businesses, and are included here to the extent that they are used by pass-through businesses, such as S-corporations, partnerships, and sole proprietorships, that file under the individual code.[5] The largest tax extender by far is bonus depreciation, which this year allows companies to write off 50 percent of the cost of investment.[6]

The corporate income tax burden would increase more than 3 days, partly as a result of these expiring tax-extenders. Besides bonus depreciation, some of the other large tax-extenders that primarily affect C-corporations include the R&D tax credit, Subpart F for active financing income, and the alcohol fuel tax credit. Additionally, corporate profits are projected to continue their recent accent as the economy recovers, adding to the tax burden.

More than 2 days would be added by expiration of the payroll tax holiday. Finally, expiration of the Bush tax cuts would increase the estate tax burden considerably, but because the estate tax is such a small part of the total burden, it would add only a partial day.

Tax Burden Due to Increase More than 11 Days if Congress Fails to Act
Individual Income Tax	5.3
Bush Tax Cuts	2.6
Alternative Minimum Tax	2.2
Tax-Extenders	0.4
Corporate Income Tax	3.4
Payroll Tax	2.5
Estate Tax	0.2
Total	11.3
Note: The methodology[7] is the same as that for Tax Freedom Day,[8] but it should be noted that these projections are less accurate since they are one more year out, into 2013, based on CBO[9] estimates of GDP and tax collections. Totals may not sum due to rounding.

1. See William McBride, Tax Freedom Day 2012, Special Report No. 298, http://taxfoundation.org/news/show/28074.html.

2. See Curtis Dubay, “Taxmageddon: Massive Tax Increase Coming in 2013,” Heritage Foundation Issue Brief (Apr. 4, 2012), http://www.heritage.org/research/reports/2012/04/taxmageddon-massive-tax-increase-coming-in-2013.

3. Ezra Klein, “‘Taxmageddon’ in one table,” Washington Post (Mar. 30, 2012), http://www.washingtonpost.com/blogs/ezra-klein/post/taxmageddon-in-one-table/2012/03/30/gIQA1GkElS_blog.html.

4. State tax collections are up 9 percent in 2011 over the year before. See Joseph Henchman, State Tax Collections Rise 9 Percent, Tax Foundation Tax Policy Blog, http://taxfoundation.org/blog/show/28125.html.

5. More than half of business income is taxed under the individual code. For a break-down of how various tax-extenders and other tax expenditures effect standard C-corporations versus pass-through entities. See Robert Carroll & Gerald Prante, The Flow-Through Business Sector and Tax Reform, Ernst & Young LLP, Apr. 2011,
http://www.s-corp.org/wp-content/uploads/2011/04/Flow-Through-Report-Final-2011-04-08.pdf.

6. Congressional Budget Office, The Budget and Economic Outlook, Jan. 31, 2012, http://cbo.gov/publication/42905. See the section on expiring tax provisions.

7. Tax Freedom Day: A Description of Its Calculation and Answers to Some Methodological Questions, Working Paper No. 3, http://www.taxfoundation.org/news/show/23039.html.

8. William McBride, Tax Freedom Day 2012, Special Report No. 198, http://taxfoundation.org/news/show/28074.html.

9. Congressional Budget Office, CBO Releases Updated Budget Projections for Fiscal Years 2012 to 2022, http://cbo.gov/publication/43079.

Sales Tax Rates in Major U.S. Cities

Wed, 11 Apr 2012 00:00:00 EDT

Sales taxes in the United States are levied not only by state governments but also by city, county, Native American, and special district governments. In many cases these local sales taxes can have a profound impact on the total rate that consumers see at the check-out register.

Several private firms maintain databases of the sales tax rates in the 9,600 local jurisdictions in the United States that levy them. Here, we list the combined state and local sales tax rates in major U.S. cities, defined as all U.S. Census-designated incorporated places with a population over 200,000. This report complements our annual calculation of the average of all local sales taxes in each state.[1]

Highest and Lowest Sales Taxes Among Major Cities

Birmingham and Montgomery, both in Alabama, have the highest combined state and local sales tax rate among major U.S. cities, at 10 percent. They are followed by Chicago, Illinois; Glendale, Arizona; and Seattle, Washington, each with rates of 9.5 percent.

Portland, Oregon and Anchorage, Alaska have neither a state nor local sales tax. Honolulu, Hawaii has the third lowest sales tax among major cities with a rate of 4.5 percent; however, Hawaii's overly broad sales tax makes this not strictly comparable with other states. Five local jurisdictions in Virginia (Arlington, Chesapeake, Norfolk, Richmond, and Virginia Beach) are also relatively low on the list, levying just a 5 percent statewide sales tax.

The Role of Competition in Sales Tax

Evasion of sales tax is most likely to occur in areas where there is a significant difference between two jurisdictions' sales tax rates. Research indicates that consumers can and do leave high-tax areas to make major purchases in low-tax areas, such as from cities to suburbs.[2] For example, strong evidence exists that Chicago-area consumers make major purchases in surrounding suburbs or online to avoid Chicago's high sales tax rates.[3] At the statewide level, businesses sometimes locate just outside the borders of high sales tax areas to avoid being subjected to their rates. The state of Delaware actually uses its state border welcome sign to remind motorists that Delaware is the "Home of Tax-Free Shopping."[4] State and local governments should be cautious about raising rates too high relative to their neighbors because doing so may lead to revenue losses despite the higher tax rate.

Sales Tax Bases: The Other Half of the Equation

This report ranks states and cities based on tax rates and does not account for differences in tax bases (the structure of sales taxes, defining what is taxable and non-taxable). States can vary greatly in this regard. For instance, most states exempt groceries from the sales tax, others tax groceries at a limited rate, and still others tax groceries at the same rate as all other products.[5] Some states exempt clothing or tax it at a reduced rate.[6] The taxation of services and business-to-business transactions also vary widely by state.[7] Experts generally agree that Hawaii has the broadest sales tax in the United States, taxing many products multiple times and, by one estimate, ultimately taxing 99.21 percent of the state's personal income. This base is far wider than the national median, where the sales tax base applies to 34.46 percent of personal income. [8]

Conclusion

Of course, sales taxes are just one part of an overall tax structure and should be considered in context. For example, Washington State has high sales taxes but no income tax; Oregon has no sales tax but high income taxes. While many factors influence business location and investment decisions, sales taxes are something within policymakers' control that can have immediate impacts. One gauge of competitiveness is how a city's sales tax rate compares to its neighbors.

City	State	State Rate	Local Rate	Total Rate	Rank
Birmingham (a)	Alabama	4.0%	6.0%	10.0%	1
Montgomery	Alabama	4.0%	6.0%	10.0%	1
Chicago	Illinois	6.25%	3.25%	9.5%	3
Glendale	Arizona	6.6%	2.9%	9.5%	3
Seattle	Washington	6.5%	3.0%	9.5%	3
Phoenix	Arizona	6.6%	2.7%	9.3%	6
Memphis	Tennessee	7.0%	2.25%	9.25%	7
Nashville	Tennessee	7.0%	2.25%	9.25%	7
Tucson	Arizona	6.6%	2.5%	9.1%	9
Mesa	Arizona	6.6%	2.45%	9.05%	10
Baton Rouge	Louisiana	4.0%	5.0%	9.0%	11
New Orleans (b)	Louisiana	4.0%	5.0%	9.0%	11
Scottsdale	Arizona	6.6%	2.35%	8.95%	13
New York	New York	4.0%	4.875%	8.875%	14
Chandler	Arizona	6.6%	2.2%	8.8%	15
Gilbert	Arizona	6.6%	2.2%	8.8%	15
Buffalo	New York	4.0%	4.75%	8.75%	17
Fremont (c)	California	7.25%	1.5%	8.75%	17
Long Beach (c)	California	7.25%	1.5%	8.75%	17
Los Angeles (c)	California	7.25%	1.5%	8.75%	17
Oakland (c)	California	7.25%	1.5%	8.75%	17
Spokane	Washington	6.5%	2.2%	8.7%	22
Tulsa	Oklahoma	4.5%	4.017%	8.517%	23
San Francisco (c)	California	7.25%	1.25%	8.5%	24
Saint Louis	Missouri	4.225%	4.266%	8.491%	25
Oklahoma City	Oklahoma	4.5%	3.875%	8.375%	26
Austin (d)	Texas	6.25%	2.0%	8.25%	27
Corpus Christi	Texas	6.25%	2.0%	8.25%	27
Dallas	Texas	6.25%	2.0%	8.25%	27
El Paso	Texas	6.25%	2.0%	8.25%	27
Fort Worth	Texas	6.25%	2.0%	8.25%	27
Garland	Texas	6.25%	2.0%	8.25%	27
Houston	Texas	6.25%	2.0%	8.25%	27
Irving	Texas	6.25%	2.0%	8.25%	27
Laredo	Texas	6.25%	2.0%	8.25%	27
Lubbock	Texas	6.25%	2.0%	8.25%	27
Plano	Texas	6.25%	2.0%	8.25%	27
San Jose (c)	California	7.25%	1.0%	8.25%	27
San Antonio	Texas	6.25%	1.875%	8.125%	39
Henderson	Nevada	6.85%	1.25%	8.1%	40
Las Vegas	Nevada	6.85%	1.25%	8.1%	40
North Las Vegas	Nevada	6.85%	1.25%	8.1%	40
Arlington	Texas	6.25%	1.75%	8.0%	43
Atlanta	Georgia	4.0%	4.0%	8.0%	43
Aurora (e)	Colorado	2.9%	5.1%	8.0%	43
Philadelphia	Pennsylvania	6.0%	2.0%	8.0%	43
Rochester	New York	4.0%	4.0%	8.0%	43
San Bernardino (c)	California	7.25%	0.75%	8.0%	43
Stockton (c)	California	7.25%	0.75%	8.0%	43
Fresno (c)	California	7.25%	0.725%	7.975%	50
Kansas City (f)	Missouri	4.225%	3.625%	7.85%	51
Minneapolis	Minnesota	6.875%	0.9%	7.775%	52
Anaheim (c)	California	7.25%	0.5%	7.75%	53
Chula Vista (c)	California	7.25%	0.5%	7.75%	53
Cleveland	Ohio	5.5%	2.25%	7.75%	53
Irvine (c)	California	7.25%	0.5%	7.75%	53
Riverside (c)	California	7.25%	0.5%	7.75%	53
Sacramento (c)	California	7.25%	0.5%	7.75%	53
San Diego (c)	California	7.25%	0.5%	7.75%	53
Santa Ana (c)	California	7.25%	0.5%	7.75%	53
Reno	Nevada	6.85%	0.875%	7.725%	61
Saint Paul	Minnesota	6.875%	0.75%	7.625%	62
Denver	Colorado	2.9%	4.72%	7.62%	63
Colorado Springs	Colorado	2.9%	4.5%	7.4%	64
Modesto (c)	California	7.25%	0.125%	7.375%	65
Wichita	Kansas	6.3%	1.0%	7.3%	66
Charlotte	North Carolina	4.75%	2.5%	7.25%	67
Bakersfield (c)	California	7.25%	0.0%	7.25%	67
Durham	North Carolina	4.75%	2.25%	7.0%	69
Fayetteville	North Carolina	4.75%	2.25%	7.0%	69
Fort Wayne	Indiana	7.0%	0.0%	7.0%	69
Indianapolis	Indiana	7.0%	0.0%	7.0%	69
Jersey City	New Jersey	7.0%	0.0%	7.0%	69
Lincoln	Nebraska	5.5%	1.5%	7.0%	69
Newark	New Jersey	7.0%	0.0%	7.0%	69
Omaha (g)	Nebraska	5.5%	1.5%	7.0%	69
Hialeah	Florida	6.0%	1.0%	7.0%	69
Jacksonville	Florida	6.0%	1.0%	7.0%	69
Miami	Florida	6.0%	1.0%	7.0%	69
Pittsburgh	Pennsylvania	6.0%	1.0%	7.0%	69
Saint Petersburg	Florida	6.0%	1.0%	7.0%	69
Tampa	Florida	6.0%	1.0%	7.0%	69
Albuquerque (h)	New Mexico	5.125%	1.8745%	6.9995%	83
Columbus (i)	Ohio	5.5%	1.25%	6.75%	84
Greensboro	North Carolina	4.75%	2.0%	6.75%	84
Raleigh	North Carolina	4.75%	2.0%	6.75%	84
Toledo	Ohio	5.5%	1.25%	6.75%	84
Winston-Salem	North Carolina	4.75%	2.0%	6.75%	84
Cincinnati	Ohio	5.5%	1.0%	6.5%	89
Orlando	Florida	6.0%	0.5%	6.5%	89
Boston	Massachusetts	6.25%	0.0%	6.25%	91
Baltimore	Maryland	6.0%	0.0%	6.0%	92
Boise	Idaho	6.0%	0.0%	6.0%	92
Des Moines	Iowa	6.0%	0.0%	6.0%	92
Detroit	Michigan	6.0%	0.0%	6.0%	92
Lexington	Kentucky	6.0%	0.0%	6.0%	92
Louisville	Kentucky	6.0%	0.0%	6.0%	92
Washington	District of Columbia	6.0%	0.0%	6.0%	92
Milwaukee	Wisconsin	5.0%	0.6%	5.6%	99
Madison	Wisconsin	5.0%	0.5%	5.5%	100
Arlington (c), (j)	Virginia	5.0%	0.0%	5.0%	101
Chesapeake (c)	Virginia	5.0%	0.0%	5.0%	101
Norfolk	Virginia	5.0%	0.0%	5.0%	101
Richmond (c)	Virginia	5.0%	0.0%	5.0%	101
Virginia Beach (c)	Virginia	5.0%	0.0%	5.0%	101
Honolulu (h), (k)	Hawaii	4.0%	0.5%	4.5%	106
Anchorage	Alaska	0.0%	0.0%	0.0%	107
Portland	Oregon	0.0%	0.0%	0.0%	107

(a) Most of Birmingham is located within Jefferson County and is subject to a 10 percent sales tax. However, part of the city lies in Shelby County and is subject to a total rate of 9 percent.

(b) Most of New Orleans is located within Orleans Parish and is subject to a 9 percent sales tax. However, part of the city lies in Jefferson Parish and is subject to a total rate of 8.75 percent.

(c) California (1%) and Virginia (1%) levy mandatory, statewide add-on sales taxes at the local level; these are included in their state sales tax rates.

(d) Most of Austin is located within Travis and Williamson counties and is subject to an 8.25 percent sales tax. However, part of the city lies in Hays County and is subject to a total rate of 7.25 percent.

(e) Most of Aurora is located within Arapahoe County and is subject to an 8 percent sales tax. However, part of the city lies in Adams County and is subject to a total rate of 8.5 percent.

(f) Most of Kansas City is located within Jackson County and is subject to a 7.85 percent sales tax. However, part of the city lies in Clay County and is subject to a total rate of 7.6 percent.

(g) Most of Omaha is located within Douglas County and is subject to a 7 percent sale tax. However, part of the city lies in Sarpy County and is subject to a total rate of 5.5 percent.

(h) The sales taxes in Hawaii and New Mexico have broad bases that include many services.

(i) Most of Columbus is located within Franklin County and is subject to a 6.75 percent sales tax. However, part of the city lies in Delaware County and is subject to a total rate of 7.25 percent.

(j) Arlington is a county without any incorporated municipalities. However, we treat it as a city here because it is included in the Census Bureau’s annual list of incorporated places.

(k) In the table, "Honolulu" refers to the incorporated portion of the larger City and County of Honolulu.

Sources: Sales Tax Clearinghouse, U.S. Census Bureau, Google Maps

[1] See Scott Drenkard, State & Local Sales Taxes in 2012, Tax Foundation Fiscal Fact No. 291, Feb. 14, 2012, at http://www.taxfoundation.org/news/show/27967.html.

[2] Mehmet Serkan Tosun & Mark Skidmore, Cross-Border Shopping and the Sales Tax: A Reexamination of Food Purchases in West Virginia (Working Paper, 2005), available at http://www.rri.wvu.edu/pdffiles/Tosunwp2005-7.pdf. See also Randolph T. Beard, Paula A. Gant, Richard P. Saba, Border-Crossing Sales, Tax Avoidance, and State Tax Policies: An Application to Alcohol, Southern Economic Journal, 64( 1), 293-306 (1997).

[3] Susan Chandler, The Sales Tax Sidestep, The Chicago Tribune, July 20, 2008, at http://articles.chicagotribune.com/2008-07-20/business/0807190001_1_sales-tax-tax-avoidance-tax-landscape

[4] Raise taxes, and they'll move, constituents tell one delegate, Marylandreporter.com, Aug. 3, 2011, http://marylandreporter.com/2011/08/03/raise-taxes-and-theyll-move-constituents-tell-one-delegate/

[5] For a list, see Tax Foundation Background Paper no. 62, 2012 State Business Tax Climate Index, http://www.taxfoundation.org/taxdata/show/22661.html.

[6] State Sales Taxes on Clothing, Tax Foundation Tax Policy Blog (Jan. 24, 2012), http://taxfoundation.org/blog/show/27915.html

[7] For a representative list, see Tax Foundation Background Paper no. 62, 2012 State Business Tax Climate Index, http://www.taxfoundation.org/taxdata/show/22661.html.

[8] John Mikesell, The Disappearing Retail Sales Tax, State Tax Notes, Mar. 5, 2012, 777-791.

Special Report No. 198: Tax Freedom Day 2012

Mon, 02 Apr 2012 00:00:00 EDT

Tax Freedom Day Arrives on April 17th, 2012

Tax Freedom Day® 2012 arrives on April 17 this year, four days later than last year due to higher federal income and corporate tax collections. That means Americans will work 107 days into the year, from January 1 to April 17, to earn enough money to pay this year’s combined 29.2% federal, state, and local tax bill.

If the federal government raised taxes enough to close the budget deficit—an additional $1.014 trillion—Tax Freedom Day would come on May 14 instead of April 17. That’s an additional 27 days of government spending paid for by borrowing. This year’s federal budget deficit remains high, though it has declined slightly over the past two years.

As the economic recovery continues, the growth in individual incomes and corporate profits will increase tax revenues and push Tax Freedom Day ever later in the year. The latest ever Tax Freedom Day was May 1, 2000—meaning Americans paid 33.0% of their total income in taxes. A century earlier, in 1900, Americans paid only 5.9% of their income in taxes, meaning Tax Freedom Day came on January 22.

Tax Freedom Day is a vivid, calendar-based illustration of government’s cost, and it gives Americans an easy way to gauge the overall tax take. Conceived by Florida businessman Dallas Hostetler in 1948, he deeded the concept to the Tax Foundation upon his retirement in 1971. In 1990 sufficient data became available to calculate a separate Tax Freedom Day for each state.

We assume that the nation starts working on January 1, earning the same amount each day and spending nothing. When the nation has finally earned enough to pay all the taxes that will be due for that year, Tax Freedom Day has arrived. This year, Americans will pay $2.62 trillion in federal taxes and $1.42 trillion in state-local taxes, for a total tax bill of 29.2 percent.

Historical Tax Freedom Day

Tax Freedom Day has not always been this late in the year. World War I tax increases led to a jump in Tax Freedom Day from 1917’s January 24 to 1918’s February 8 to 1921’s February 22. In the 1920s, when Justice Oliver Wendell Holmes described taxes as the price of civilized society, Tax Freedom Day was arriving in February.

The Great Depression and the Hoover/Roosevelt tax increases led not only to a later Tax Freedom Day but a shift in who was collecting. In 1932, Americans spent 10 days paying federal taxes and 46 days paying state and local taxes. By 1940, Americans worked 33 days to pay each. World War II brought increased federal spending and borrowing, with Tax Freedom Day arriving in April for the first time in 1943.

The federal tax burden never returned to pre-war levels. The fifties and sixties also saw a rise in state-local tax burdens and a boost in economic growth following the 1964 Kennedy/Johnson tax cut. Vietnam War-era tax increases and the “stagflation” of the 1970s pushed personal incomes into higher tax brackets, and by 1981, Tax Freedom Day arrived on April 24.

The Reagan tax cut signed into law that year ushered in an economic boom; federal revenues grew but the economy grew even faster. Despite pressure on state and local taxes following taxpayer revolts like Proposition 13 in California, the strong economic growth led to increased tax collections, and in 1989, Tax Freedom Day arrived on April 22. That year, federal income tax revenues as a share of the economy were higher than they had been in nearly all years prior, when the top rate exceeded 90 percent.

A string of record-setting federal tax burdens followed, and the latest ever Tax Freedom Day occurred on May 1, 2000. With federal revenue routinely exceeding even its own forecasts, there was strong popular pressure for a major tax cut.

The new president delivered on his tax cut promises, which, combined with a recession in 2001, caused the tax burden to fall considerably. In 2003, Tax Freedom Day arrived on April 14, more than two weeks earlier than it had in 2000. Since 2007, stimulus tax cuts and a weakening economy have pushed Tax Freedom Day earlier still. In 2009, Tax Freedom Day was on April 10, earlier than any time since Lyndon Johnson was in the White House. Meanwhile, government spending rose, leading to a large gap between revenue and spending. This year marks the fourth year in a row of the federal budget deficit exceeding $1 trillion.

Tax Freedom Day By State

The total tax burden borne by residents of different states varies considerably, not only due to differing state tax policies, but also because of the steep progressivity of the federal tax system. This means higher-income states celebrate Tax Freedom Day later: Connecticut (May 5), New Jersey (May 1), and New York (May 1) residents face a significantly higher total federal tax burden than lower-income states.

Residents of Tennessee will bear the lowest average tax burden in 2012, with Tax Freedom Day arriving for them on March 31. Also early are Louisiana (April 1), Mississippi (April 1), South Carolina (April 3), and South Dakota (April 4).

The Countdown is Over. We're #1

Sun, 01 Apr 2012 00:00:00 EDT

It's official. After eight years of having the second-highest corporate tax rate among industrialized countries, the United States has now assumed the top spot following Japan's scheduled corporate rate cut on April 1, 2012. Since 2001, Japan had levied the highest combined corporate tax rate among OECD nations at 39.5 percent[1], slightly higher than the 39.2 percent combined federal-state rate in the U.S. Japan's new rate is 38.01 percent, which includes a temporary 10 percent surtax that will expire after 2014.[2]

The attention given to the Japanese rate cut has overshadowed the fact that Great Britain also cut their corporate tax rate on April 1^st from 26 percent to 24 percent, and will cut the rate again to 23 percent in 2013.[3] Moreover, on January 1^st of this year, Canada cut its federal corporate tax rate from 16.5 percent to 15 percent.[4] Canada's combined rate is about 26 percent when the average rate of the Canadian provinces is added to their federal rate.

But the race toward lower corporate tax rates extends well beyond the larger economies. According to Paying Taxes 2012, published by the World Bank and PricewaterhouseCoopers, there have been 133 major corporate tax cuts globally since 2006. [5] Indeed, between 2006 and 2010 alone, more than 75 countries cut their corporate tax rates - some more than once.

The nearby chart illustrates how the U.S. has fallen behind in the global tax race simply by standing still. Indeed, 2012 marks the 21^st year in which the U.S. corporate tax rate has been above the simple average of OECD nations. Even if we account for country sizes, the weighted average of OECD nations fell below the U.S. rate in 1998 and been getting lower ever since.

Currently, the U.S. corporate rate is more than 50 percent higher than the simple average of the 33 other member nations in the OECD. And, our rate is roughly ten percentage points higher than the weighted average of OECD nations.

Skeptics will point out that the OECD averages are being dragged down by the low rates of smaller nations such as Ireland, Poland, and Slovakia. However, the chart also shows clearly that the average of the larger Group of Seven[6] (or G-7) nations has also been falling - especially driven by the dramatic rate cuts instituted by Canada and Great Britain.

Taking the recent Canadian, British, and Japanese rate cuts into account, the weighted average of the G-7 nations is now below 32 percent - three percentage points lower than the federal U.S. rate alone and seven points below the combined U.S. rate.

The table below lists the current corporate tax rates of the 34 OECD nations and their ranking as of April 1^st. Ireland has the lowest rate of 12.5 percent, while four nations (the Czech Republic, Hungary, Poland, and the Slovak Republic) share the next lowest rate of 19 percent. Five nations (Chile, Greece, Iceland, Slovenia, and Turkey) all levy a corporate tax rate of 20 percent.

The table also takes a ten-year snapshot comparing the current rates with the rates imposed by each country in 2002. The tiny 0.1 percentage point reduction in the U.S. rate is entirely the result of reduction in various state rates over the past ten years. Of the 33 non-U.S. OECD nations, 28 cut their corporate rate during the past ten years while two had no change. Meanwhile, three countries (Chile, Hungary, and Iceland) increased their rates over the same period. However, all of these nations have rates that are 20 percent or below.

The country that cut its rate the most over the ten year period was Greece, by 15 percentage points, from 35 percent to 20 percent. Turkey had the next largest rate cut of 13 percentage points (from 33 percent to 20 percent) followed by Canada, the Czech Republic, and Israel which each cut their rates by 12 percentage points.

Many will discount the importance of the U.S.'s high statutory corporate tax rate by saying that because of "loopholes" in the tax code, our effective tax rate is much lower. However, Tax Foundation economists have shown that even after accounting for tax deductions, the U.S. effective tax rate is still remains one of the highest among industrialized nations.[7]

OECD Statutory Corporate Tax Rates

Country	2012 Tax Rate	2012 Ranking	2002 Tax Rate	2002 Ranking	Change in Tax Rate 2002-2012	Change in Ranking 2002-2012
Australia	30	6	30	19	0	13
Austria	25	17	34	13	-9	-4
Belgium	34	4	40.17	2	-6.2	-2
Canada	26.1	15	38.05	5	-12	-10
Chile	20	25	15	34	5	9
Czech Republic	19	30	31	17	-12	-13
Denmark	25	17	30	19	-5	2
Estonia	21	24	26	27	-5	3
Finland	26	16	29	23	-3	7
France	34.4	3	35.43	8	-1	5
Germany	30.2	5	38.9	4	-8.7	-1
Greece	20	25	35	9	-15	-16
Hungary	19	30	18	31	1	1
Iceland	20	25	18	31	2	6
Ireland	12.5	34	16	33	-3.5	-1
Israel	24	22	36	6	-12	-16
Italy	27.5	12	36	6	-8.5	-6
Japan	38.01	2	40.87	1	-2.9	-1
Korea	24.2	21	29.7	22	-5.5	1
Luxembourg	28.8	9	30.38	18	-1.6	9
Mexico	30	6	35	9	-5	3
Netherlands	25	17	34.5	12	-9.5	-5
New Zealand	28	10	33	14	-5	4
Norway	28	10	28	24	0	14
Poland	19	30	28	24	-9	-6
Portugal	26.5	13	33	14	-6.5	1
Slovak Republic	19	30	25	28	-6	-2
Slovenia	20	25	25	28	-5	3
Spain	30	6	35	9	-5	3
Sweden	26.3	14	28	24	-1.7	10
Switzerland	21.2	23	24.42	30	-3.2	7
Turkey	20	25	33	14	-13	-11
United Kingdom	25	17	30	19	-5	2
United States	39.2	1	39.3	3	-0.1	2
Simple Avg/Non-US OECD	24.9		30.3		-5.4
Weighted Avg/Non-US OECD	29.3		35.4		-6.1
Weighted Avg/Non-US G-7	31.8		37.5

[1] The OECD calculates the combined rate at 39.5 percent while Japanese documents frequently cite a combined rate of 40.69 percent. http://www.meti.go.jp/english/aboutmeti/policy/fy2012/fy2012tax_02.pdf

[2] The scheduled rate cut on April 1, 2012 lowered the federal rate from 30 percent to 25.5 percent. Including the sub-national rates, Japan's overall "normal" rate is 35.6 percent. However, the temporary surtax adds another 2.37 percentage points to the overall rate for 2012, 2013, and 2014 tax years. In 2015 and beyond, the combined rate in Japan will return to 35.64 percent.

[3] http://www.hmrc.gov.uk/rates/corp.htm

[4] http://www.cra-arc.gc.ca/tx/bsnss/tpcs/crprtns/rts-eng.html

[5] http://www.doingbusiness.org/~/media/FPDKM/Doing%20Business/Documents/Special-Reports/Paying-Taxes-2012.pdf

[6] The G-7 nations include: Canada, France, Germany, Great Britain, Italy, Japan, and the U.S.

[7] See: Philip Dittmer, "U.S. Corporations Suffer High Effective Tax Rates by International Standards," Tax Foundation Special Report No. 195, September 2011, and William McBride, "Beyond the Headlines: What Do Corporations Pay in Income Tax?," Tax Foundation Special Report No. 194, September 2011.

Beyond Congress�s Power to Tax: Constitutional Questions Surrounding the Health Care Law�s Individual Mandate

Thu, 29 Mar 2012 00:00:00 EDT

Hearing Before the Committee on Ways & Means, Health Subcommittee,
U.S. House of Representatives

March 29, 2012

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Oral Statement

Mr. Chairman, Mr. Ranking Member, and members of the Committee:

Thank you for the opportunity to speak with you today about the Tax Foundation's perspective on whether the health care law's individual mandate is within Congress's power to lay and collect Taxes, granted by Article I, Section 8 of the Constitution. Since our founding in 1937, the Tax Foundation has advanced the ideas of simpler, more sensible tax policy with reliable research and principled analysis of tax issues at all levels of government.

The government's primary argument to sustain the individual mandate is under the Commerce Clause, and that is the subject of much of the discussion in the briefs and in the case generally. But the government secondarily argues that the mandate is an exercise of Congress's power to levy taxes, because it is projected to raise revenue.

We authored our brief in this case because we are very concerned by this argument and this reasoning. One of the primary goals of the legal program at the Tax Foundation is to keep vibrant an understanding of the differences between taxes, fees, and penalties. Taxes are exactions imposed for the primary purpose of raising revenue for general spending. Penalties are exactions imposed for the primary purpose of punishing for an unlawful or undesirable act.

We argue in our brief that the evidence shows that this is a penalty. Everyone says its purpose was not to raise revenue but to discourage behavior. The statute calls it a penalty 12 times and a tax zero times. JCT calls it a penalty 24 times and includes it in their policy and regulatory sections, not the revenue provisions. The IRS cannot use liens and levies to enforce the mandate, the way they can with taxes. The President told all of us, when the bill was being considered, that he "absolutely reject[ed]" the idea that it is a tax. The justices this week seem very critical of the government's efforts to convince them otherwise.

Now you may ask why it matters. I assure you that it is not just some obsession with no impact on the real world. There are three reasons why it's very important.

First, there are countless laws at the federal level and in every state that treat taxes with some level of heightened scrutiny that is not given to other laws, including fines and penalties. These include the federal law that says you can't challenge a tax until it is collected (so that governments can operate), tax uniformity requirements in every state, tax supermajority requirements in 16 states, voter approval thresholds, multiple reading requirements, and so on. If these provisions are to do what they are meant to do, you have to be able to tell the difference between taxes and non-taxes.

Second, the definition I outlined is not something we conjured up at the Tax Foundation. It is widely used and relied upon by courts across the country. Our brief contains five pages of listed cases that would be jeopardized by a contrary ruling, and we have identified only four states that depart from it. If the government in this case is successful at persuading the Supreme Court to adopt a completely different definition based just on whether revenue is incidentally raised, the taxpayer protections I mentioned would be jeopardized. Also jeopardized would be the ability of state and local governments to collect fees and fines that they rely upon.

Third, it goes to the very conception of how we pay for government. Taxes are things that we pay so that there will be services for everyone. As Professor Randy Barnett said this week, they're your duty, in return for what government does to protect you and everyone else, and to equate that with a requirement to do business with private companies, to say that those are the same thing, is very disturbing.

Now, I am a lawyer, so this is the point where I say that if you don't believe me on everything I've said so far, try this: if it is a tax, it's one that's not permitted. Article I, § 9, cl. 4 of the Constitution permits a direct tax only if it is apportioned among the states in proportion to population. Although the Founders disagreed on whether a tax on carriages violated this provision, they agreed that a tax directly levied on an individual would. Alexander Hamilton, not usually suspicious of big government, called this provision one that would enable the government to collect taxes while not doing so in an abusive way.

A meaningful distinction between "tax" and "penalty" is vital to give operation to numerous federal and state provisions relating to tax policy, and we hope the Supreme Court will agree with us.

Thank you.

Written Statement

Mr. Chairman, Mr. Ranking Member, and members of the Committee:

Thank you for the opportunity to speak with you today about the Tax Foundation’s perspective on whether the health care law’s individual mandate is within Congress’s power to lay and collect Taxes, granted by Article I, Section 8 of the Constitution. Since our founding in 1937, the Tax Foundation has advanced the ideas of simpler, more sensible tax policy with reliable research and principled analysis of tax issues at all levels of government.

As you know, the federal government is a government of limited and defined powers, so for the health care law’s individual mandate to be valid, some grant of power in the Constitution must be found to sustain it. While the government and most of the other briefs in the case focus on Congress’s power to regulate interstate commerce as the most relevant provision, the government has secondarily relied on Congress’s power to tax. We authored our brief in the case to refute the government’s mischaracterization of the individual mandate as a tax, to explain why the definition they propose is unworkable, and to warn that an adverse ruling on this point jeopardizes important taxpayer protections and well-defined case law in nearly every state.

A Tax is an Exaction Imposed for the Primary Purpose of Raising Revenue for Government Spending

I want to take a brief moment to explain why this is so important. While some may equate a tax as any government action that results in costs, monetary or non-monetary, the general public and the courts have been careful to distinguish between different forms of government-collected exactions. Long-standing American suspicion of taxes, which dates from colonial times, has led to numerous federal and state restrictions specific only to taxes, such as the federal Anti-Injunction Act, tax supermajority requirements in 16 states, tax uniformity requirements in nearly every state, and voter approval thresholds. For these taxpayer protections to mean anything, a workable definition of “tax” is required.

Federal and state courts have risen to meet that need, articulating a definition that is widely accepted today. First, what matters is how the tax operates and not necessarily what it was labeled by policymakers who passed it. Otherwise, creative labeling (for which there is great political incentive) would nullify any restrictions. Second, look at what entity imposes the assessment, upon whom it is imposed, and how the revenue is used. Taking all that together, the definition that has emerged is that a tax is an exaction imposed for the primary purpose of raising revenue for general spending. This is in contrast to a fee, which is an exaction imposed for the primary purpose of recovering from the payor the cost of providing a particular service to the payor, and in contrast to a penalty, which is an exaction imposed for the primary purpose of punishment for an unlawful act.

We at the Tax Foundation work extensively on this issue, and our brief spends 5 pages listing case after case from federal and state courts that use this definition. (See Appendix.) Taxes are enacted primarily to raise revenue for general spending, penalties are enacted primarily to punish.

The Individual Mandate’s Charge is a Penalty and Not a Tax Because Its Primary Purpose is Not to Raise Revenue but to Penalize

Applying that definition here, the individual mandate is not a tax because its primary purpose is to punish, not to raise revenue. The most common reason cited for its purpose is to regulate so-called “free riders” who use health care services but do not bear the cost. President Obama said to ABC News in 2009 that he “absolutely reject[s] the notion” that the individual mandate is a tax. The bill itself refers to the mandate as a “requirement to maintain minimum essential coverage,” a “shared responsibility payment,” and a “penalty.” 26 U.S.C. § 5000A et seq. In fact, the law refers to it as a “penalty” twelve times and as a “tax” zero times. See id. The mandate also does not share the same enforcement provisions as taxes, with the IRS denied the use of liens or levies to enforce the provision. See 26 U.S.C. § 5000A(g)(2).

The Joint Committee on Taxation, which produced the technical explanation of the bill, refers to it as a tax in its subheading, but all of its other references evidence JCT’s judgment that the mandate is not a tax. See Joint Committee on Taxation, Technical Explanation of the Revenue Provisions of the “Reconciliation Act of 2010,” As Amended, in Combination with the “Patient Protection and Affordable Care Act” at 31 (Mar. 21, 2010), http://www.jct.gov/publications.html?func=startdown&id=3673. Aside from the reference in the subheading, the JCT never again refers to the mandate as a “tax” and instead invariably refers to it as a “penalty,” doing so 24 times in its technical explanation of how the provision operates. See id. at 31-34. The explanation also falls under the policy and regulatory provisions of the Act, not under the “Revenue Provisions” heading. See id. at i-ii. JCT also left the mandate out of its revenue projections, where it estimated the financial impact of all provisions of the bill related to raising revenue. See Joint Committee on Taxation, Estimated Revenue Effects of the Amendment in the Nature of a Substitute to H.R. 4872, The “Reconciliation Act of 2010,” As Amended, In Combination With the Revenue Effects of H.R. 3590, The “Patient Protection And Affordable Care Act (‘PPACA’),” As Passed by the Senate, And Scheduled For Consideration By The House Committee On Rules On March 20, 2010, at 1-3 (Mar. 20, 2010), http://www.jct.gov/publications.html?func=startdown&id=3672.

Our brief also lists Supreme Court cases that emphasize a firm distinction between taxes and penalties. See, e.g., United States v. Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213, 224 (1996), quoting La Franca, 282 U.S. at 572 (“[A] ‘penalty,’ as the word is here used, is an exaction imposed by statute as punishment for an unlawful act.”); Dep’t of Rev. of Montana v. Kurth Ranch, 511 U.S. 767, 779-80 (1994) (“[W]hereas fines, penalties, and forfeitures are readily characterized as sanctions, taxes are typically different because they are usually motivated by revenue-raising, rather than punitive, purposes.”); Bailey v. Drexel Furniture Co., 259 U.S. 20, 38 (1922) (“Taxes are occasionally imposed in the discretion of the Legislature on proper subjects with the primary motive of obtaining revenue from them and with the incidental motive of discouraging them by making their continuance onerous. They do not lose their character as taxes because of the incidental motive. But there comes a time in the extension of the penalizing features of the so-called tax when it loses its character as such and becomes a mere penalty, with the characteristics of regulation and punishment.”).

While incidental revenue may be generated, the undeniable purpose of the individual mandate is to punish, discourage, and reduce illegal behavior, as a penalty and not a tax.

If the Mandate is a Tax, It Would Be an Unconstitutional Capitation Tax Unapportioned by State Population

In asserting that the individual mandate is permissible under the Taxing Power, the Government does not address the fact that if this were true, this tax would be a capitation tax unapportioned by state population, in direct violation of the constitutional requirement that “No capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.” U.S. CONST. art. I, § 9, cl. 4. A direct tax is only permissible if it is apportioned among the states in proportion to population, or levied on incomes. See U.S. CONST. amend. XVI; Eisner v. Macomber, 252 U.S. 189, 206 (1920) (“A proper regard for its genesis, as well as its very clear language, requires also that this amendment shall not be extended by loose construction, so as to repeal or modify, except as applied to income, those provisions of the Constitution that require an apportionment according to population for direct taxes upon property, real and personal. This limitation still has an appropriate and important function, and is not to be overridden by Congress or disregarded by the courts.”).

The prohibition of unapportioned direct taxes exists for a strong purpose. Alexander Hamilton, conceding that a federal government with unlimited taxing power invited tyranny, explained that “[t]he proportion of these taxes is not to be left to the discretion of the national Legislature but is to be determined by the numbers of each State as described in the second section of the first article.” THE FEDERALIST NO. 36, 226, 229-30 (1788). Hamilton characterized the provision as a compromise that ensured that the federal government could have recourse to direct taxation if needed, but not in a way that could invite abuse or partiality. See id. George Mason, who felt that the provision was not sufficiently restrictive on government direct taxation, nevertheless described it correctly as meaning “that the quantity to be raised of each state, should be in proportion to their numbers in the manner therein directed.” GEORGE MASON, VIRGINIA RATIFYING CONVENTION PAPERS 3:1087 (June 17, 1788).

Assuming arguendo that the Government’s characterization of the mandate as a tax is correct, it would operate as a levy on individuals and not their incomes. The mandate penalty in 2016, for example, is imposed either in the amount of $695 per uninsured adult, or at the rate of 2.5 percent of the uninsured taxpayer’s income in excess of the filing threshold (in 2010, $9,350), whichever is greater. See 26 U.S.C. § 5000A(c). Although the latter calculation could conceivably be considered a tax on income, the former direct amount cannot be. If it is a tax, it is a capitation tax, levied directly on the individual. Because its collection is not apportioned according to state population, its operation would violate U.S. CONST. art. I, § 9, cl. 4.

Conclusion

A meaningful distinction between “tax” and “penalty” is vital to give operation to numerous federal and state provisions relating to tax policy. If the U.S. Supreme Court held that a tax is any government collection of revenue, then government revenue collection efforts across the country would be imperiled, as many revenue sources are not subjected to the heightened restrictions that “taxes” are. To collect fees or impose criminal fines, states for the first time would see these charges subjected to supermajority, multiple reading, and other requirements. While some states may choose to extend such procedural requirements to non-tax revenue sources, this should be done explicitly through the legislative process, not by announcing a new definition of “tax” not comprehended at the time these provisions were adopted.

It is for these reasons that we requested that the Court find that the individual mandate exceeds Congress’s Taxing Power under the U.S. Constitution.

Appendix: Federal and State Case Law Imperiled by a Ruling That the Individual Mandate is a Tax

•    United States v. State of New York, 315 U.S. 510, 515-16 (1942) (“But a tax for purposes of [the Bankruptcy Code] includes any pecuniary burden laid upon individuals or property for the purpose of supporting the government, by whatever name it may be called.”) (internal citations omitted);
•    United States v. La Franca, 282 U.S. 568, 572 (1931) (“A ‘tax’ is an enforced contribution to provide for the support of government; a ‘penalty,’ as the word is here used, is an exaction imposed by statute as punishment for an unlawful act.”).
•    San Juan Cellular Tel. Co. v. Pub. Serv. Comm’n of Puerto Rico, 967 F.2d 683, 685 (1st Cir. 1992) (finding that a tax is thus an exaction imposed by the government, on the public, for the purpose of raising revenue which is then spent on general (not particular) public purposes; a charge not imposed by government, or a charge collected from those receiving particularized benefits, or a charge collected for primary purpose other than raising revenue, is not a tax.)
•    Valero Terrestrial Corp. v. Caffrey, 205 F.3d 130, 134 (4th Cir. 2000) (applying San Juan Cellular to determine if a charge “qualifies” as a tax);
•    Neinast v. Texas, 217 F.3d 275, 278 (5th Cir. 2000) (applying San Juan Cellular);
•    Hedgepeth v. Tennessee, 215 F.3d 608, 612 (6th Cir. 2000) (describing San Juan Cellular as the “leading decision” used for “the definition of the term ‘tax’”);
•    RTC Commercial Assets Trust 1995-NP3-1 v. Phoenix Bond & Indem. Co., 169 F.3d 448, 457 (7th Cir. 1999) (“Penalties stand on a different footing. States do not assess penalties for the purpose of raising revenue. . . .”);
•    Chicago & Nw. Transp. Co. v. Webster County Bd. of Supervisors, 71 F.3d 265, 267 (8th Cir. 1995) (“A government levy is a tax if it raises revenue to spend for the general public welfare.”);
•    Bidart Bros. v. California Apple Comm’n, 73 F.3d 925, 931 (9th Cir. 1996) (applying San Juan Cellular test to “determin[e] whether an assessment is a tax”);
•    Hill v. Kemp, 478 F.3d 1236, 1244 (10th Cir. 2007) (finding that a tax’s “primary purpose . . . is revenue rather than regulation”);
•    Seven-Sky v. Holder, 661 F.3d 1, 8 (D.C. Cir. 2011) (“It is well established that Congress used the term ‘tax’ in the Tax Injunction Act to mean assessments made for the purpose of raising revenues, not regulatory ‘penalties’ intended to encourage compliance with a law.”);
•    Rural Tel. Coal. v. F.C.C., 838 F.2d 1307, 1314 (D.C. Cir. 1988) (“[A] regulation is a tax only when its primary purpose judged in legal context is raising revenue.”);
•    Lightwave Tech., LLC v. Escambia County, 804 So.2d 176, 178 (Ala. 2001) (finding that a charge “designed to generate revenue” for general spending is a tax);
•    May v. McNally, 55 P.3d 768, 773-74 (Ariz. 2002) (adopting San Juan Cellular);
•    City of North Little Rock v. Graham, 647 S.W.2d 452, 453 (Ark. 1983) (finding that a tax “is a means of raising revenue to pay additional money for services already in effect”);
•    Sinclair Paint Co. v. State Bd. of Equalization, 937 P.2d 1350, 1354 (Cal. 1997) (“In general, taxes are imposed for revenue purposes, rather than in return for a special benefit conferred or privilege granted.”);
•    Zelinger v. City & County of Denver, 724 P.2d 1356, 1358 (Colo. 1986) (“A hallmark of such taxes is that they are intended to raise revenue to defray the general expenses of the taxing entity.”);
•    Stuart v. Am. Sec. Bank, 494 A.2d 1333, 1337 (D.C. 1985) (describing taxes as “for the purpose of raising revenue”);
•    Gunby v. Yates, 102 S.E.2d 548, 550 (Ga. 1958) (“A tax is an enforced contribution exacted pursuant to legislative authority for the purpose of raising revenue to be used for public or governmental purposes . . . .”);
•    State v. Medeiros, 973 P.2d 736, 742 (Haw. 1999) (holding that a tax does not apply to direct beneficiaries of a service, does not directly defray the costs of a particular service, or is not necessarily proportionate to the benefit received);
•    BHA Inv., Inc. v. State, 63 P.3d 474, 479 (Idaho 2003) (“[T]axes are solely for the purpose of raising revenue.”);
•    Crocker v. Finley, 459 N.E.2d 1346, 1350 (Ill. 1984) (“[A] charge having no relation to the services rendered, assessed to provide general revenue rather than compensation, is a tax.”);
•    Ennis v. State Highway Comm’n, 108 N.E.2d 687, 693 (Ind. 1952) (“Taxes are levied for the support of government . . . .”);
•    City of Hawarden v. US W. Commc’ns, Inc., 590 N.W.2d 504, 507 (Iowa 1999) (holding that an exaction intended to raise revenue is a tax);
•    Citizens’ Util. Ratepayer Bd. v. State Corp. Comm’n, 956 P.2d 685, 708 (Kan. 1998) (“The primary purpose of a tax is to raise money, not regulation.”);
•    Krumpelman v. Louisville & Jefferson County Metro. Sewer Dist., 314 S.W.2d 557, 561 (Ky. 1958) (“[T]axes are generally held to be a rate or duty levied each year for purposes of general revenue . . . .”);
•    Audubon Ins. Co. v. Bernard, 434 So.2d 1072, 1074 (La. 1983) (holding that “revenue is the primary purpose” of a tax);
•    Bd. of Overseers of the Bar v. Lee, 422 A.2d 998, 1004 (Me. 1990) (“[T]axes are primarily intended to raise revenue . . . .”);
•    Workmen’s Comp. Comm’n v. Prop. & Cas. Ins. Guar. Corp., 570 A.2d 323, 325 (Md. 1990) (finding that taxes “are intended to raise revenue for public purposes”);
•    Emerson Coll. v. City of Boston, 462 N.E.2d 1098, 1105 (Mass. 1984) (finding that a charge “collected not to raise revenues” but for another purpose is not a tax);
•    Bolt v. City of Lansing, 587 N.W.2d 264, 269 (Mich. 1998) (holding that a charge with “a revenue-raising purpose” is a tax);
•    County Joe, Inc. v. City of Eagan, 560 N.W.2d 681, 686 (Minn. 1997) (holding that a charge “expressly intended to raise revenue” is a tax);
•    Leggett v. Missouri State Life Ins. Co., 342 S.W.2d 833, 875 (Mo. 1961) (finding that a charge is not a tax unless “the object of [it] is to raise revenue to be paid into the general fund of the government to defray customary governmental expenditures”);
•    Monarch Mining Co. v. State Highway Comm’n, 270 P.2d 738, 740 (Mont. 1954) (“Taxes are levied for the support of government, and their amount is regulated by its necessities.”);
•    Douglas County Contractors Ass’n v. Douglas County, 929 P.2d 253, 257 (Nev. 1996) (holding that a charge with the “true purpose . . . to raise revenue” is a tax);
•    Horner v. Governor, 951 A.2d 180, 183 (N.H. 2008) (finding that a tax must be “intended to raise additional revenue” not “solely to support a governmental regulatory activity made necessary by the actions of those who are required to pay the charge”);
•    Resolution Trust Corp. v. Lanzaro, 658 A.2d 282, 290 (N.J. 1995) (finding that a tax “is intended primarily to raise revenue”); Scott v. Donnelly, 133 N.W.2d 418, 423 (N.D. 1965) (“If the primary purpose is revenue, it is a tax; on the other hand, if the primary purpose is regulation, it is not a tax.”);
•    Olustee Co-op Ass’n v. Oklahoma Wheat Utilization Research and Market Dev. Comm’n, 391 P.2d 216, 218 (Okl. 1964) (citing definition of tax in part including purpose “to provide public revenue”);
•    Woodward v. City of Philadelphia, 3 A.2d 167, 170 (Pa. 1938) (“[T]axes are defined to be burdens or charges imposed by the legislative power upon persons or property to raise money for public purposes, and to defray the necessary expenses of government.”);
•    State v. Foster, 46 A. 833, 835-36 (R.I. 1900) (“If the imposition of such a condition has for its primary object the regulation of the business, trade, or calling to which it applies, its exercise is properly referable to the police power; but if the main object is the obtaining of revenue, it is properly referable to the taxing power.”);
•    Brown v. County of Horry, 417 S.E.2d 565, 568 (S.C. 1992) (citing with approval the standard that “a tax is an enforced contribution to provide for the support of
government . . . .”);
•    Valandra v. Viedt, 259 N.W.2d 510, 512 (S.D. 1977) (“[T]axes are imposed for the purpose of general revenue . . . .”);
•    Memphis Retail Liquor Dealers’ Ass’n v. City of Memphis, 547 S.W.2d 244, 245-46 (Tenn. 1977) (“If the imposition is primarily for the purpose of raising revenue, it is a tax . . . .”);
•    Hurt v. Cooper, 110 S.W.2d 896, 899 (Tex. 1937) (finding that a tax is a charge with the “primary purpose” of “raising of revenue”);
•    V-1 Oil Co. v. Utah State Tax Comm’n, 942 P.2d 906, 911 (Utah 1996), vacated on other grounds, 942 P.2d 915 (Utah 1997) (“Generally speaking, a tax raises revenue for general governmental purposes . . . .”);
•    Marshall v. Northern Virginia Transp. Authority, 657 S.E.2d 71, 77-78 (Va. 2008) (“We consistently have held that when the primary purpose of an enactment is to raise revenue, the enactment will be considered a tax, regardless of the name attached to the act.”);
•    City of Spokane v. Spokane Police Guild, 553 P.2d 1316, 1319 (Wash. 1976) (“[I]f the primary purpose of legislation is regulation rather than raising revenue, the legislation cannot be classified as a tax even if a burden or charge is imposed.”);
•    City of Huntington v. Bacon, 473 S.E.2d 743, 752 (W.Va. 1996) (“The primary purpose of a tax is to obtain revenue for the government . . . .”);
•    State v. Jackman, 211 N.W.2d 480, 485 (Wis. 1973) (“A tax is one whose primary purpose is to obtain revenue . . . .”)

Other Support:
•    4 Cooley, The Law of Taxation, ch. 29 § 1784 (4th ed. 1924) (“If revenue is the primary purpose and regulation is merely incidental the imposition is a tax; while if regulation is the primary purpose the mere fact that incidentally a revenue is also obtained does not make the imposition a tax . . . .”);
•    BLACK’S LAW DICTIONARY 1214 (9th ed. 2009) (defining tax as “[a] charge, usu. monetary, imposed by the government on persons, entities, transactions, or property to yield public revenue.”).

Contrary Case Law:
•    Apocada v. Wilson, 525 P.2d 876, 884-85 (N.M. 1974) (holding that a charge that raises revenue beyond costs is not a tax);
•    Heatherly v. State, 678 S.E.2d 656, 657 (N.C. 2009) (dividing equally on the question of definition of tax);
•    State ex. rel. Petroleum Underground Storage Tank Release Comp. Bd. v. Withrow, 579 N.E.2d 705, 710 (Ohio 1991) (“It is not possible to come up with a single test that will correctly distinguish a tax from a fee in all situations where the words ‘tax’ and ‘fee’ arise.”);
•    Auto. Club of Oregon v. State, 840 P.2d 674, 678 (Or. 1992) (describing “tax” as any revenue collected by government, separate from “assessment”).

Supplementary Statement

Mr. Chairman, Mr. Ranking Member, and members of the Committee:

Congressman Kind directed a statement at me but due to time limitations I was unable to respond during the hearing. I appreciate the opportunity to submit this supplementary statement in response.

Congressman Kind stated that his primary purpose for supporting the law was that it would raise revenue, and therefore, it is a tax. First, let me thank the congressman for recognizing the importance of a clear line between taxes and penalties, based on the purpose of the assessment. Generally, the purpose should be determined by looking at all available evidence. Here, Congressman Kind's assertion is at odds with the text of the statute itself, the CBO report, the JCT report, the President's statements, statements of his colleagues on both sides of the aisle, the whole nationwide debate we had at the time, and justices across-the-board this week. The primary purpose of the law, objectively, is to punish so-called free riders and change their behavior, not to raise revenue.

As to Congressman Kind's critique of this hearing itself, let me give one reason for why he should not consider a discussion focused on constitutional issues to be a "waste of time," as he put it. One does not have to be a member of the Judiciary Committee or on the Supreme Court to have views on what is constitutional. Professor Siegel has his views. I have mine. Many of us here do. The Judiciary Committee and the Supreme Court are not the only arbiters of this. This is especially the case for you, members of the committee, who took an oath to defend the Constitution. I would not think it a waste of your time to hear input on what is and is not constitutional.

Thank you.
________________________

ABOUT THE TAX FOUNDATION
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Lottery Tax Rates Vary Greatly By State

Thu, 29 Mar 2012 00:00:00 EDT

Fiscal Fact No. 295

With the Mega Millions jackpot reaching a record $540 million, Americans in 43 states and the District of Columbia are lining up to buy tickets for Friday's drawing. Everyone knows that winners must choose between a lump sum payment and installment payments, but where you purchase your winning ticket also matters, due to state income and withholding taxes.

As with wage income, some amount of lottery winnings is withheld for the government before you calculate your total tax bill when filing your income tax the following year. While lottery winnings of $600 or less are not reported to the IRS, winnings in excess of $5,000 are subject to a 25 percent federal withholding tax. In other words, if one person wins the jackpot and chooses the $389 million lump sum payment, $97 million will go straight to the IRS. Next April, the jackpot winner or winners can see if any of that amount gets refunded, or if they owe even more.

The same is true at the state level. While lottery winnings are subject to state income tax in most states, withholding tax varies from zero (California, Delaware, Pennsylvania, and the states with no state income tax) to over 12 percent in New York City (see Table 1). Arizona and Maryland have withholding rates for non-residents, so an out-of-state winner who bought a ticket in those two states could face double withholding.

Table 1: Lottery Withholding Tax Rates by State

State	Withholding Tax Rate (%)
Alabama	No lottery
Alaska	No lottery
Arizona	5.0% (residents); 6.0% (non-residents)
Arkansas	7.00%
California	None
Colorado	4.00%
Connecticut	6.70%
Delaware	None
Florida	No income tax
Georgia	6.00%
Hawaii	No lottery
Idaho	7.80%
Illinois	5.00%
Indiana	3.40%
Iowa	5.00%
Kansas	5.00%
Kentucky	6.00%
Louisiana	5.00%
Maine	5.00%
Maryland	9.25% residents; 7.5% non-residents
Massachusetts	5.00%
Michigan	4.35%
Minnesota	7.25%
Mississippi	No lottery
Missouri	4.00%
Montana	6.90%
Nebraska	5.00%
Nevada	No lottery
New Hampshire	No income tax
New Jersey	10.80%
New Mexico	6.00%
New York	8.97% (plus 3.648% for New York City or 0.897% for Yonkers)
North Carolina	7.00%
North Dakota	5.54%
Ohio	6.00%
Oklahoma	4.00%
Oregon	8.00%
Pennsylvania	None
Rhode Island	7.00%
South Carolina	7.00%
South Dakota	No income tax
Tennessee	No income tax
Texas	No income tax
Utah	No lottery
Vermont	6.00%
Virginia	4.00%
Washington	No income tax
West Virginia	6.50%
Wisconsin	7.75%
Wyoming	No lottery
District of Columbia	8.50%

Source: USA Mega.

States rely heavily on lottery revenue, collecting an average of $58 per person in "profit" aside from any income tax collections. (See Table 2.) While no government labels its lottery as a tax—North Carolina fought to a tie in their state supreme court recently to avoid such a label—lottery "profits" are an implicit tax. After prizes have been awarded and operating costs have been covered, the remaining money is transferred to state coffers. To the extent this revenue is used for general government purposes, it is a tax. Further, because state lotteries pay out an average of only 60 percent of gross revenues in prizes (compared to about 90 percent for casino slot machines or table games), state-run lotteries are only viable as a monopoly, in conjunction with a ban on private lotteries.

Some argue that while it is a tax, it is a "voluntary" one since the revenue is handed over to the government enthusiastically. But this argument confuses the purchase of a product with the payment of the tax on the product. True, the purchase of the product is voluntary, but the tax portion of the ticket price is not, just as a sales tax is compulsory on the purchase of clothing or books. The voluntary nature of the purchase does not make the tax any less of a tax.

Table 2: State Implicit Lottery Tax Revenue Per Capita, Fiscal Year 2010

State	Implicit Tax Revenue Per Capita	Rank
U.S. Average	$58	-
Alabama	No lottery	-
Alaska	No lottery	-
Arizona	$81	13
Arkansas	$124	8
California	$28	32
Colorado	$22	37
Connecticut	$83	12
Delaware	$370	1
Florida	$$67	15
Georgia	$92	10
Hawaii	No lottery	-
Idaho	$25	34
Illinois	$50	21
Indiana	$28	31
Iowa	$23	36
Kansas	$24	35
Kentucky	$50	23
Louisiana	$29	30
Maine	$40	27
Maryland	$87	11
Massachusetts	$137	7
Michigan	$68	14
Minnesota	$17	41
Mississippi	No lottery	-
Missouri	$42	26
Montana	$11	42
Nevada	No lottery	-
New Hampshire	$50	22
New Jersey	$105	9
New Mexico	$21	38
New York	$138	6
North Carolina	$45	24
North Dakota	$9	43
Ohio	$64	17
Oklahoma	$25	33
Oregon	$142	5
Pennsylvania	$64	16
Rhode Island	$324	2
South Carolina	$54	18
South Dakota	$145	4
Tennessee	$51	20
Texas	$42	25
Utah	No lottery	-
Vermont	$33	28
Virginia	$54	19
Washington	$19	39
West Virginia	$314	3
Wisconsin	$31	29
Wyoming	No lottery	-

Note: The implicit tax revenue is the portion of lottery revenue kept by the state, or the "profit." It does not include federal or state income tax on winnings.

Source: U.S. Census Bureau, Tax Foundation calculations.

Important Questions to Ask in Evaluating a Film Tax Incentive Program

Thu, 22 Mar 2012 00:00:00 EDT

Hearing of the Finance Committee of the Alaska House of Representatives

Members of the Committee:

I thank you for the opportunity to speak with you and submit written testimony with regards to Senate Bill 23, which would extend the present state film tax credit ten years past its 2013 expiration date and caps total credits to be awarded at $200 million through 2023. We take no position on the bill but offer analysis based on our examination of film tax incentive programs generally in the United States.

For those unfamiliar with the Tax Foundation, we are a non-partisan, non-profit organization that has monitored fiscal policy at all levels of government since 1937. We have produced the Facts & Figures handbook since 1941, calculate Tax Freedom Day each year, and have a wealth of facts, rankings, and other information at our website, www.TaxFoundation.org. We have been widely cited for three major reports on film tax incentives:

"Film Tax Incentives & Credits: Blockbuster Support for Lackluster Policy" (2010), http://www.taxfoundation.org/publications/show/25706.html
"More States Abandon Film Tax Incentives as Programs' Ineffectiveness Become Apparent" (2011)
"Motion Picture Association Attacks Tax Foundation Critique of Film Tax Subsidies" (2011), http://www.taxfoundation.org/news/show/27410.html

As these reports note, film tax incentive programs have exploded in recent years, growing from 4 states offering $2 million in 1999, to a peak of 40 states offering $1.4 billion in 2010. In the past few years, however, a record number of states are reconsidering, re-evaluating, or even outright de-funding, reducing, or eliminating their film incentive program. Michigan, most notably as it was one of the most generous incentive states, has sharply reduced their program. On the other hand, California, the state from which much of this television and film production was lured, adopted a new $100 million-a-year program in 2009 that most states are finding it hard to outbid. New York has also increased its program to $420 million per year, and Louisiana, one of the first states to adopt a program, allocates over $100 million a year to it.

We find the economic evidence to compelling that these programs are a poor use of limited taxpayer dollars, because they are costly in the short-term and, in the long-term, are incapable of achieving the economic development goals their promoters often emphasize. However, for states that consider a film incentive to be a priority for their state's resources, we offer three questions to be sure to ask.

Question to Ask #1: What is the Purpose of the Film Tax Credit?

Generally, states have adopted film tax incentives out of a desire to build a film industry in the state. Because California (and to some extent, New York) have already done this, and because most states are far behind early tax program adopters like Hawaii, Louisiaana, and the Canadian provinces, this can be very difficult. Productions flock to whichever state offers the most generous incentive and leave as soon as another state offers a more generous one.

The underlying framework for film tax credits to build a permanent industry is therefore flawed. The idea is to subsidize each production as it flows through the state, in the hopes that enough productions will be cycling through, creating a critical mass that builds lasting infrastructure that in turn, at some future date, can survive successfully without ongoing state financial support of the industry. No state has achieved this economic development model with film tax incentives; the closest is Louisiana, which has seen substantial infrastructure investment but with no end in sight to annual state film incentive support. If Alaska wants sound stages, film studios, editing facilities, and other permanent infrastructure, it would be more direct and probably more effective to subsidize those projects directly rather than indirectly through individual productions.

The other primary justification for film incentive programs is pride: anger at seeing the state depicted in a movie or TV show that was filmed somewhere else, or at seeing the state depicted unfavorably. This concern is legitimate, to say the least, but if addressing it adequately requires millions of dollars that could otherwise go to more pressing public needs or left with taxpayers, it should be evaluated carefully.

Question to Ask #2: What is the Revenue Impact?

We sometimes hear that film tax incentives are a free lunch with no negative revenue impact, because the credit is only paid if new activity is generated that would not have occurred otherwise. This is misleading, because most film incentive programs (including Alaska's) are either transferable or refundable, meaning that the credits do in fact reduce tax payments that would have been made in absence of the program. While film incentive beneficiaries were successful for many years at claiming a zero cost to these programs, much of the reason for recent state reconsideration has been the recognition that a billion and a quarter dollars might have better uses in times of tight state budgets than subsidizing one of the most profitable industries in America. At minimum, legislators should view the credits paid against other possible uses for that tax money.

Question to Ask #3: Is the Program Cost-Effective?

Film tax incentives have been involved in serious scandals in a handful of states (including jail time for some), primarily due to limited auditing, evaluation, and legislative oversight of these programs. While categorized as a tax credit, these programs involve government officials awarding millions of dollars to selected and limited applicants with taxpayer resources for a public policy goal. All of these things should be measured and reviewed to police against waste, fraud, and abuse.

A crucial measure to program effectiveness is incentive dollars spent per full-time equivalent (FTE) job created. Beneficiaries often speak of the large numbers of jobs created by film incentive programs, but with many industry jobs lasting mere weeks, one must look at the FTE figures to evaluate effectiveness properly. Michigan's discovery that they were distributing over $100,000 for every FTE job that was created was instrumental in their decision to restructure the program, as they concluded that there were more cost-effective avenues for economic development and job creation.

Subsidizing anything gets you more of that thing. The question is whether the benefits of a given amount of net new job creation and the net new investment exceed the cost. (I would note, however, that states must continuously increase the generosity of their programs or risk losing productions. It's a never-ending escalation that no state can truly win, making it unlikely that any permanent industry will result from it.)

One measure of that is whether the tax credit pays for itself in induced tax revenue collections, or more than $1 generated for every $1 spent. Aside from Ernst & Young's studies paid for by economic development authorities or the MPAA, every independent study has found film tax credits generate less than 30 cents for every $1 of spending (accounting even for movie-induced tourism, increased business to non-film businesses, and other indirect effects):

Arizona's Department of Commerce calculated 28 cents on the dollar.
Connecticut's Department of Economic Development found a 7 cent return on every $1 spent.
Two studies in Louisiana found between 13 and 18 cents on the dollar.
Massachusetts' Department of Revenue found it got 16 cents on the dollar.
Michigan's Senate Fiscal Agency found 11 cents on the dollar.
New Mexico's Legislative Finance Office found 14 cents. (E&Y did a New Mexico study too, calculating $1.50 on the dollar, but having the same problems as their Michigan and New York studies.)
Pennsylvania's Legislative Budget & Finance Committee found 24 cents on the dollar.

Of the above studies, only Massachusetts's study did not assume that all film and television production occurred because of the credit. All the other numbers should thus be considered on the high end.

Conclusion

Film tax credits do not pay for themselves. While some benefits accrue to in-state filmmakers and suppliers, on the whole they are a net transfer from taxpayers to out-of-state production company beneficiaries. The sheer magnitude of the amounts that various states are spending to lure productions makes it very difficult for any state to gain a lasting competitive edge over the others. Programs have steadily got more generous as states outbid each other, and it is telling that two of the most generous states (Michigan and New Mexico) recently greatly scaled back their programs. Other states continue to debate film tax credits' merits.

At a minimum, film incentive programs should be required disclose credit amounts awarded by recipient, how much was spent per full-time equivalent (FTE) job was created, and reviewed periodically for their effectiveness by legislative oversight or independent third parties.

Again, thank you for the opportunity to testify. We are always available for questions or further testimony on this and other state tax policy matters.

Meals Taxes in Major U.S. Cities

Thu, 01 Mar 2012 00:00:00 EST

Highest in Minneapolis, Chicago, Virginia Beach, Seattle, and Washington, D.C.

Fiscal Fact No. 293

Tourists and business travelers quickly learn that taxes on meals are sometimes higher than taxes on other goods. Meals taxes generally apply to purchases of prepared food that are consumed in a restaurant or similar establishment, or taken "to go" for later consumption. In contrast, sales of groceries (or "non-prepared food") are completely exempt from state sales tax in 30 states and the District of Columbia and partly exempt in a further eight states. Meals taxes are usually locally imposed but are sometimes imposed at the state level.

These high "prepared food" taxes are sometimes justified as a "luxury tax" intended to target higher-income individuals, although the wide diversity of takeout dining options suggests that such a tax is poorly targeted to achieve that goal. One could say that it is a tax on individuals with less flexible schedules or who do not like to cook--rich or poor.

Others justify these taxes as tourism taxes, designed to shift tax burdens to business and vacation travelers, similar to high taxes on hotel rooms and car rentals. Because the benefit derived from added economic activity from visitors and travelers probably exceeds the government services they use during their stay, "tourism" taxes are generally bad policy because they shift tax burdens away from those residents who actually demand and benefit from government services.

Regardless of the justification, meals taxes can add significant costs and lead to administrative complexity. For example, the Massachusetts Department of Revenue provides the following examples in attempting to explain which food transactions are subject to sales tax, which are subject to additional meals tax, and which are tax-exempt:

Example: If a restaurant serves a patron a lasagna dinner, then the dinner is taxable.

However, if the restaurant also sells frozen lasagna dinners that patrons heat in their own homes, these dinners are not considered meals and therefore are not taxable because they require additional preparation.

Example: If a patron purchases a pizza and two cans of soda from a restaurant, then both the pizza and sodas are taxable.

However, if the patron purchases a pizza and a two-liter bottle of soda to go, then the pizza is taxable, but the bottle of soda is tax-exempt since it was sold in an unopened original container of at least 26 fluid ounces.

Example: If a restaurant offers a patron, upon presentation of a coupon, two meals for the usual price of one, the price of the free meal is excluded from the meals tax. The tax is due only on the actual amount the restaurant charges the patron.[1]

Those who run restaurants and other eating establishments bear the burden of complying with these often complex rules.

The table below lists the sales tax and meals tax in the 50 U.S. cities with the highest population. Some key findings:

Thirty-five of the 50 cities do not charge a higher tax on meals than on other goods.

Visitors to Minneapolis, Minnesota pay the highest meals tax: a combined 10.775 percent rate. Combined rates are also high in Chicago, Illinois (10.75 percent), Virginia Beach, Virginia (10.5 percent), Seattle, Washington (10 percent), and Washington, D.C. (10 percent).

Visitors to Virginia Beach, Virginia see the highest jump from the regular sales tax to the meals tax: a 110% increase from 5 percent to 10.5 percent.

Table 1: Meals Taxes in the 50 U.S. Cities with Largest Population

Population Rank	City	State	Sales Tax	Additional Meals Tax	Combined Tax on Meals	Combined Tax Rank
1	New York City	NY	8.875%	-	8.875%	18
2	Los Angeles	LA	8.75%	-	8.75%	19
3	Chicago	IL	9.50%	1.25%	10.75%	2
4	Houston	TX	8.25%	-	8.25%	25
5	Philadelphia	PA	8%	-	8%	33
6	Phoenix	AZ	9.30%	-	9.30%	7
7	San Antonio	TX	8.25%	-	8.13%	30
8	San Diego	CA	7.75%	-	7.75%	37
9	Dallas	TX	8.25%	-	8.25%	25
10	San Jose	CA	8.25%	-	8.50%	22
11	Jacksonville	FL	7%	2%	9%	14
12	Indianapolis	IN	7%	2%	9%	14
13	San Francisco	CA	8.50%	-	8.50%	22
14	Austin	TX	8.25%	-	8.25%	25
15	Columbus	OH	6.75%	-	6.75%	45
16	Fort Worth	TX	8.25%	-	8.25%	25
17	Louisville	KY	6%	-	6%	46
18	Charlotte	NC	8%	1%	9%	14
19	Detroit	MI	6%	-	6%	46
20	El Paso	TX	8.25%	-	8.25%	25
21	Memphis	TN	9.25%	-	9.25%	9
22	Baltimore	MD	6%	-	6%	46
23	Boston	MA	6.25%	0.75%	7%	43
24	Seattle	WA	9.50%	0.50%	10%	4
25	Washington	DC	6%	4%	10%	4
26	Nashville	TN	9.25%	-	9.25%	9
27	Denver	CO	4.10%	4%	8.10%	31
28	Milwaukee	WI	5.60%	0.05%	5.65%	49
29	Portland	OR	-	-	-	50
30	Las Vegas	NV	8.10%	-	8.10%	31
31	Oklahoma City	OK	8.375%	-	8.375%	24
32	Albuquerque	NM	6.9995%	-	6.9995%	44
33	Tucson	AZ	9.10%	-	9.10%	11
34	Fresno	CA	7.975%	-	7.975%	36
35	Sacramento	CA	7.75%	-	7.75%	37
36	Long Beach	CA	8.75%	-	8.75%	19
37	Kansas City	MO	7.85%	1.23%	9.08%	12
38	Mesa	AZ	9.05%	-	9.05%	13
39	Virginia Beach	VA	5%	5.50%	10.50%	3
40	Atlanta	GA	8%	-	8%	33
41	Colorado Springs	CO	7.40%	-	7.40%	42
42	Omaha	NE	7%	2.50%	9.50%	6
43	Raleigh	NC	6.75%	1%	7.75%	37
44	Miami	FL	7%	2%	9%	14
45	Cleveland	OH	7.75%	-	7.75%	37
46	Tulsa	OK	7.50%	-	7.50%	41
47	Oakland	CA	8.75%	-	8.75%	19
48	Minneapolis	MN	7.775%	3%	10.775%	1
49	Wichita	KS	9.30%	-	9.30%	7
50	Arlington	TX	8%	-	8%	33

Source: Tax Foundation review of city and state websites.

[1] Massachusetts Department of Revenue, A Guide to Sales Tax on Meals, http://www.mass.gov/dor/individuals/taxpayer-help-and-resources/tax-guides/meals-tax-guide.html.

Location Matters

Wed, 29 Feb 2012 00:00:00 EST

You can read the full study below in ScribD or download the PDF here. The book's introduction is below.

The following tables are included in the book but may also be viewed separately:

Find your state's pages here.
View one of the seven firm type here.
Summary tables for new and mature firms are here.

Download a PowerPoint presentation here.

Location Matters

Introduction
State and local taxes represent a significant business cost for corporations operating in the United States; in fact, they often have a material impact on net operating margins. Consequently, business location decisions for new manufacturing facilities, corporate headquarter relocations, and the like often are influenced by assessments of relative tax burdens across multiple states.

Widespread interest in corporate tax burdens has led to a number of studies from a variety of think tanks, media organizations, and research groups. None of these studies, however, provide comparisons of actual state business tax burdens.

Some studies compare total tax collections or business tax collections per capita or as a percent of total tax revenue. The shortcoming of this approach is that collections are not burdens: many business taxes are collected in one state but paid by companies in other states. Comparing state collections thus does not accurately portray the relative tax burden that real-world businesses would incur in each state.

Some studies assess the relative value of tax incentives available for different types of businesses, such as new job tax credits, new investment tax credits, sales tax exemptions, and property tax abatements. However, these studies can give the incorrect impression that all businesses in a state enjoy such incentives. They also do not typically account for increased tax rates for mature businesses that may be required to support such incentives.

Some studies, including the Tax Foundation's widely cited annual State Business Tax Climate Index, define model tax structure principles and measure the state's tax code relative to that model. The State Business Tax Climate Index is a useful tool for lawmakers to understand how neutral and efficient their state's tax system is compared to other states and to identify areas where their system can be improved. However, this does not address the bottom line question asked by many business executives: "How much will our company pay in taxes?"

Individual firms considering expansion frequently calculate their tax bill in various states, but these calculations are not often released publicly and are usually confined to a small number of states.

To fill the void left by these studies, the Tax Foundation, in collaboration with KPMG LLP, the U.S. audit, tax and advisory firm, set out to develop and publish a landmark, apples-to-apples comparison of corporate tax costs in the 50 states. Tax Foundation economists designed seven model firms, and KPMG modeling experts calculated each firm's tax bill in each state. The study accounts for all business taxes: corporate income taxes, property taxes, sales taxes, unemployment insurance taxes, capital stock taxes, inventory taxes, and gross receipts taxes. Additionally, each firm was modeled twice in each state: once as a new firm eligible for tax incentives, and once as a mature firm not eligible for such incentives.

Tax Foundation economists then used the raw model results to perform the ensuing industry and state comparisons. The result is a comprehensive calculation of real-world tax burdens that we designed as a valuable resource for a variety of stakeholders:

• Governors, legislators, and state officials can better understand and address their competitive position with other states.

• CEOs, CFOs, and corporate America can better evaluate the relative competitiveness of states in which they operate or states they are considering for investment.

• Businesses and trade organizations can better identify policy improvements for each state.

• Site-selection experts can screen states more accurately and quickly for consideration by their clients.

• National, state, and local media organizations can more effectively report on the tax competitiveness of the 50 states.

The Location Matters study, together with our annual State Business Tax Climate Index, will provide the tools to fully understand each state's business tax system, the burdens it imposes, and a roadmap for improving it.

Study Overview and Key Findings

The study is comprised of four chapters and an appendix. Chapter 1 outlines the objectives and scope of the study. The chapter describes the seven model firms that were analyzed, the specific taxes that were included in the study, the locations that were chosen in each state, and the other factors that could influence the results.

Chapter 2 presents two measures of a state's overall business tax competitiveness, first for mature firms and then for newly established firms. Each state is ranked based upon a composite score that is an average of the state's scores across the seven different firm types. As Table 1 indicates, for mature firms, Wyoming ranks first overall with the lowest average tax burden across the seven firm types, while Pennsylvania ranks 50th overall with the highest average tax burden across the seven firm types. For newly established firms, Nebraska ranks first overall with the lowest average tax burden across the seven model firms while Hawaii ranks 50th with the highest average tax burden across the seven firms.

Chapter 3 focuses on each of the seven firm types and compares the tax burden in each state for both mature and new firms. These results are summarized in Tables 2 through 5. The first- and 50th-ranked states for each firm type are as follows:

• Corporate Headquarters:

Mature: Wyoming ranked first, Pennsylvania ranked 50th.

New: Nebraska ranked first, Pennsylvania ranked 50th.

• R&D Facility:

Mature: Louisiana ranked first, Pennsylvania ranked 50th.

New: Louisiana ranked first, Pennsylvania ranked 50th.

• Retail Store:

Mature: Wyoming ranked first, Pennsylvania ranked 50th.

New: South Dakota ranked first, Iowa ranked 50th.

• Call Center:

Mature: South Dakota ranked first, New Jersey ranked 50th.

New: Nebraska ranked first, West Virginia ranked 50th.

• Distribution Center:

Mature: Wyoming ranked first, Iowa ranked 50th.

New: Ohio ranked first, Kansas ranked 50th.

• Capital-Intensive Manufacturing:

Mature: Wyoming ranked first, Hawaii ranked 50th.

New: Louisiana ranked first, Maryland ranked 50th.

• Labor-Intensive Manufacturing:

Mature: Wyoming ranked first, Hawaii ranked 50th.

New: Louisiana ranked first, Hawaii ranked 50th.

Chapter 4 summarizes the results for each state. The chapter is aimed at legislators and reporters who need the basic facts on the state's business tax system and brief talking points on why the state scored as it did for the key firm types.

The Appendix provides more detail on the study's methodology and assumptions. It is intended for the serious researcher who wants to understand how the modeling was done and where to find the source data for the tax information.

The Tax Foundation is indebted to Hartley Powell, Ulrich Schmidt and Ann Holley at KPMG for all of their expertise, research, and guidance on this project. Also, this project would not have been possible without the tremendous support of Glenn Mair of MMK Consulting.

Tax Foundation contributors include: Scott Drenkard, Alicia Hansen, Joseph Henchman, Scott Hodge, Nick Kasprak, Laura Lieberman, David Logan, Will McBride, and Kail Padgitt. The Tax Foundation is responsible for all of the analysis and data presented in this report and, of course, any errors.

About the Tax Foundation
Founded in 1937, the Tax Foundation is a nonpartisan, 501 (c )(3) not-for-profit organization dedicated to providing taxpayers and lawmakers reliable data and sound analysis on public finances at the federal, state, and local levels of government.

About KPMG LLP
KPMG LLP, the audit, tax and advisory firm (www.kpmg.com/us), is the U.S. member firm of KPMG International Cooperative ("KPMG International"). KPMG International's member firms have 138,000 professionals, including more than 7,900 partners, in 150 countries.

Recommendations for North Dakota�s Tax System

Thu, 16 Feb 2012 00:00:00 EST

Tax Foundation Fiscal Fact No. 292

Introduction

At the request of the North Dakota Taxpayers Association, we offer a list of recommendations to improve North Dakota's business tax climate. The recommendations are derived from our State Business Tax Climate Index, which we produce annually to enable business leaders, government policymakers, and taxpayers to gauge how their states' tax systems compare according to the economic principles of simplicity, neutrality, and broad tax bases with low tax rates.

The states that score best in the Index are those that embrace the established tax reform approach of broadening the tax bases and lowering the tax rates. Reforms along those lines can of course affect revenue totals. While we recommended specific base-broadening changes, we have not included any specific corresponding rate reductions in the analysis, for two reasons. First, state revenue officials are better positioned than we are to estimate revenue effects. Second, North Dakotans must decide for themselves whether they want tax reform to raise the same amount of revenue or reduce revenue.

All Index rank changes listed in this analysis represent what the effect would have been had North Dakota had the relevant change in effect on July 1, 2011, the first day of the standard state fiscal year and the snapshot date for the 2012 Index. If all of the changes listed below had been in effect on July 1, 2011, North Dakota would have ranked fifth overall in the FY2012 edition of the Index, instead of 29th.

The following changes would broaden the state's tax bases and thus allow for lower tax rates without reducing tax revenue. These reduced tax rates (which are unspecified and therefore not reflected in the new rankings) could improve the state's score further and provide more flexibility to choose among our other recommendations without necessarily changing the state's final Index rank.

Corporate Income Tax

• Provide for unlimited business net operating loss (NOL) carry-backs of up to three years. About a quarter of states allow NOL carry-backs, with the maximum generally three years. Of those that allow it, most do not limit the amount that can be carried back.

• Broaden the corporate tax base by eliminating tax preferences such as investment credits, job credits, and research and development (R&D) credits.

• Eliminate the throwback rule. About half of states have no throwback rule.

• Adjust tax brackets for inflation to avoid automatic real corporate tax increases due to inflation.

• Currently, North Dakota requires taxpayers to make an addition to income if foreign taxes were deducted from income at the federal level. North Dakota should eliminate this provision, effectively allowing the deduction for foreign taxes paid. Twenty-one states allow the federal deduction to flow through to the state tax calculation.

Without any rate changes, the above corporate base changes would have been enough to improve North Dakota's rank to fourth, up from 21st place, in the corporate tax component of the Index had they been in effect on July 1, 2011. Reductions in corporate tax rates, potentially made revenue-neutral by the base-broadening mentioned, would further improve North Dakota's score, as would moving to a flat rate structure.

Individual Income Tax

• Utah and Indiana ranked 10th and 11th respectively. Each has a flat, one-rate individual income tax. If North Dakota emulated this model-for example, moving to a single 3.99 percent rate with an increased standard deduction and personal exemption (to a combined level of $15,000 per spouse)--this would represent significant improvement. Had such a system been in effect on July 1, 2011, the state would have ranked 11th in the individual income tax Index component, up from 35th.

• Investment income is double taxed by the federal tax system, and states should avoid aggravating that distortion with further state taxes. If North Dakota eliminated income taxes on capital gains, interest, and dividend income, they would be the first state with an individual income tax to do so. This change, in addition to the rate change above, would have improved North Dakota's rank to eighth for the individual income tax component (again, up from 35th).

North Dakota should also consider broadening the income tax base by eliminating special credits and deductions. While North Dakota currently adopts federal itemized deductions by starting their calculation with federal taxable income, calculating state tax solely on the calculation of federal adjusted gross income (AGI) would greatly simplify the system, eliminate economic distortions, and allow the state to lower the statutory tax rate even further. Such a change would not directly impact the state's Index score (the Index focuses on business taxes), but the broader base would allow for further rate reductions that would improve the state's score.

Sales Tax

Retail sales taxes are meant to tax consumption. Business-to-business transactions are not consumption; purchases by end-users are consumption. We recommend eliminating the sales tax on all business-to-business transactions and taxing all final retail sales to end-users, including services.

The above sales tax recommendations, if they had been in effect on July 1, 2011, would have improved the state's rank to sixth best on the sales tax Index component, up from 15th, which would be the best of the states with a statewide sales tax. Expanding the sales tax base to consumer services would allow for a lower rate, which would improve the state's score further.

Unemployment Insurance (UI) Tax:

• Reduce the time period for new businesses to qualify for an experience rating from three years to one year.

• Do not charge employers for UI claims for separations that were beyond the employer's control (e.g. employee left voluntarily) or for employees who continue to work part-time.

• All state laws use a system of experience rating by which individual employers' contribution rates vary by some measure of the historical risk of unemployment. North Dakota should consider changing to an experience rating formula for businesses that is based on statewide experience rather than the experience of each individual business. Unlike other formulas, a state experience formula (called a "benefit-wage-ratio formula" by U.S. Dept. of Labor) adjusts tax rates based on statewide conditions, rather than adjusting them based on each businesses' employment history. This is desirable because it avoids the "shut-down effect" where struggling businesses face increasing UI tax rates, making it harder for the business to survive and potentially hastening its failure.

These UI changes, if they had been in effect on July 1, 2011, would have improved North Dakota's rank on the unemployment insurance Index component to eighth place, up from 31st place.

Facts & Figures Handbook: How Does Your State Compare?

Wed, 15 Feb 2012 00:00:00 EST

How do taxes in your state compare nationally? This convenient pocket-size booklet compares the 50 states on 37 different measures of taxing and spending, including individual and corporate income tax rates, business tax climates, excise taxes, tax burdens and state spending.

Download the PDF or Excel workbook below. Purchase copies on Amazon.com here. If you'd like a large number of copies to share with your colleagues and friends, contact us about bulk discounts.

Errata: The Tax Foundation regrets the following typographical errors in the print edition of Facts and Figures. The online version shown here reflects these changes:

In Table 10, “Selected Federal Rates,” the brackets associated with Single and Head of Household filers are incorrect. Please see the online version for correct brackets.

In Table 11, “State Individual Income Tax Rates,” the top individual income tax bracket for Oklahoma is mistakenly listed as 5.3 percent in the print edition, while it is in fact 5.25 percent.

The title of Table 22, “State Cigarette Excise Tax Rates,” should read “As of January 1, 2012.” Print editions mistakenly read “As of January 1, 2011”

The values in Table 35 “State and Local Debt Per Capita,” are incorrect. The print edition mistakenly lists figures from the previous table. The online edition shows correct values.

State and Local Sales Taxes in 2012

Tue, 14 Feb 2012 00:00:00 EST

Tax Foundation Fiscal Fact No. 291

Introduction

Retail sales taxes are a transparent way to collect tax revenue. While graduated income tax rates and brackets are complex and confusing to many taxpayers, the sales tax is easier to understand: people can reach into their pocket and see the rate printed on a receipt.

Less known, however, are the local sales taxes collected in 36 states. These rates can be substantial, so a state with a moderate state sales tax rate could actually have a very high combined state-local rate compared to other states. This report provides a population-weighted average of local sales taxes in each state in an attempt to give a sense of the statutory local rate for each state.

Combined Rates

Five states do not have a statewide sales tax: Alaska, Delaware, Montana, New Hampshire and Oregon. Of these, Alaska and Montana^{^[1]} allow localities to charge local sales taxes.

In Alaska, high local rates in populous places like Juneau and Kodiak (5 and 6 percent, respectively) certainly increase the average local rate, but not enough to give Alaskans a higher combined rate than any state that charges a statewide rate.

The five highest combined rates are Tennessee (9.45 percent), Arizona (9.12 percent), Louisiana (8.85 percent), Washington (8.80 percent), and Oklahoma (8.66 percent).

Among the states with a statewide sales tax, the five with the lowest average combined rates are Hawaii (4.35 percent), Maine (5 percent), Virginia (5 percent), Wyoming (5.34 percent), and South Dakota (5.39 percent).

The highest total sales tax rate in the United States is in Tuba City, Arizona, which has a combined rate of 13.725 percent. This rate is composed of a 6.6 percent state tax, a 1.125 percent Coconino county tax, and an additional 6 percent tribal tax levied by the To'Nanees'Dizi local government.^{^[2],} ^{^[3]}

State Rates

California, despite a 1 percent reduction in its sales tax rate that took effect July 1, 2011, still has the highest state-level rate at 7.25 percent.^{^[4]} Five states tie for the second-highest statewide rate with 7 percent each: Indiana, Mississippi, New Jersey, Rhode Island, and Tennessee.

The lowest non-zero statewide sales tax is in Colorado, with a rate of 2.9 percent. Seven states follow with 4 percent: Alabama, Georgia, Hawaii, Louisiana, New York, South Dakota and Wyoming^{^[5]}.

Local Rates

The five states with the highest average local sales tax rates are Louisiana (4.85 percent), Colorado (4.54 percent), New York (4.48 percent), Alabama (4.33 percent), and Oklahoma (4.16 percent).

Mississippi has the lowest non-zero average local rate of 0.004 percent, attributable to the state's only local sales tax: a 0.25 percent sales tax in Tupelo, the birthplace of Elvis Presley, with a current population of 34,546.^{^[6]}

The highest city rate is 7 percent in Wrangell, Alaska, which--thanks to its small population (Census estimates 2,369 people)--does not have a substantive effect on the average local rate.

New Jersey has a unique system where certain shoreline and border jurisdictions are exempt from collecting the 7 percent state tax and instead collect a 3.5 percent local tax. We represent this anomaly as a negative 0.03 percent statewide average local rate, and the combined rate reflects this subtraction.

Table 1: State and Local Sales Tax Rates, As of January 1, 2012

State	State Tax Rate	Rank	Avg. Local Tax Rate (a)	Combined Rate	Rank
Ala.	4.00%	38	4.33%	8.33%	8
Alaska	None	46	1.77%	1.77%	46
Ariz.	6.60%	9	2.52%	9.12%	2
Ark.	6.00%	16	2.58%	8.58%	6
Calif. (b)	7.25%	1	0.86%	8.11%	12
Colo.	2.90%	45	4.54%	7.44%	15
Conn.	6.35%	11	None	6.35%	31
Del.	None	46	None	0.00%	47
Fla.	6.00%	16	0.62%	6.62%	29
Ga.	4.00%	38	2.84%	6.84%	24
Hawaii (c)	4.00%	38	0.35%	4.35%	45
Idaho	6.00%	16	0.02%	6.02%	35
Ill.	6.25%	13	1.95%	8.20%	10
Ind.	7.00%	2	None	7.00%	20
Iowa	6.00%	16	0.81%	6.81%	25
Kans.	6.30%	12	1.96%	8.26%	9
Ky.	6.00%	16	None	6.00%	36
La.	4.00%	38	4.85%	8.85%	3
Maine	5.00%	31	None	5.00%	43
Md.	6.00%	16	None	6.00%	36
Mass.	6.25%	13	None	6.25%	33
Mich.	6.00%	16	None	6.00%	36
Minn.	6.88%	7	0.30%	7.18%	17
Miss.	7.00%	2	0.00%	7.00%	19
Mo.	4.23%	37	3.26%	7.49%	14
Mont. (d)	None	46	None	0.00%	47
Nebr.	5.50%	28	1.27%	6.77%	26
Nev.	6.85%	8	1.08%	7.93%	13
N.H.	None	46	None	0.00%	47
N.J. (e)	7.00%	2	-0.03%	6.97%	22
N.M. (c)	5.13%	30	2.12%	7.24%	16
N.Y.	4.00%	38	4.48%	8.48%	7
N.C.	4.75%	35	2.10%	6.85%	23
N.D.	5.00%	31	1.39%	6.39%	30
Ohio	5.50%	28	1.25%	6.75%	27
Okla.	4.50%	36	4.16%	8.66%	5
Ore.	None	46	None	0.00%	47
Pa.	6.00%	16	0.34%	6.34%	32
R.I.	7.00%	2	None	7.00%	20
S.C.	6.00%	16	1.13%	7.13%	18
S.D.	4.00%	38	1.39%	5.39%	41
Tenn.	7.00%	2	2.45%	9.45%	1
Tex.	6.25%	13	1.89%	8.14%	11
Utah (b)	5.95%	27	0.73%	6.68%	28
Vt.	6.00%	16	0.14%	6.14%	34
Va. (b)	5.00%	31	None	5.00%	43
Wash.	6.50%	10	2.30%	8.80%	4
W.Va.	6.00%	16	None	6.00%	36
Wis.	5.00%	31	0.43%	5.43%	40
Wyo.	4.00%	38	1.34%	5.34%	42
D.C.	6.00%	-	-	6.00%	-

Note: Some states levy gross receipts taxes in addition to sales taxes.

(a) City, county and municipal rates vary. These rates are weighted by population to compute an average local tax rate.

(b) Three states levy mandatory, statewide, local add-on sales taxes at the state level: California (1%), Utah (1.25%), Virginia (1%), that we include in their state sales tax.

(d) Due to data limitations, table does not include sales taxes in local resort areas in Montana.

(e) Some counties in New Jersey are not subject to statewide sales tax rates and collect a local rate of 3.5%. Their average local score is represented as a negative.

Source: Tax Foundation; US Census Bureau; Sales Tax Clearinghouse

Methodology

Sales Tax Clearinghouse publishes quarterly sales tax data at the state, county and city level by zip code. These numbers are weighted according to Census 2010 population figures in an attempt to give a sense of prevalence of sales tax rates in a particular state.

It is worth noting that population numbers are only published at the zip code level every 10 years by the Census Bureau, so the methodology in this version is slightly different than past versions of this calculation.

It should also be noted that while the Census Bureau reports population data using a five-digit identifier that looks much like a zip code, this is actually what is called a "Zip Code Tabulation Area" (ZCTA), which attempts to create a geographical area associated with a given zip code. This is done because a surprisingly large number of zip codes do not actually have any residents. For example, the National Press Building in Washington, D.C., where the Tax Foundation is located, has its own zip code solely for postal reasons.

For our purposes, zip codes that do not have a corresponding ZCTA population figure are omitted from calculations. These omissions result in some amount of inexactitude, but on the whole should not have a palpable effect on resultant averages, because proximate zip code areas which do have a ZCTA population number assigned to them capture the tax rate of whatever jurisdiction the area is located in.

[1] Due to data limitations, this study does not include local sales taxes in resort areas in Montana.

[2] To'Nanees'Dizi Local Government Sales Tax Return. TC-FORM 600. http://www.tndtaxcode.com/forms/amended_FORM_600_07-12-11.pdf

[3] Vertex Inc. 2011 Sales Tax Rate Report. http://www.vertexinc.com/PressRoom/PDF/2012/vertex-end-of-year-sales-tax-rate-report-11.pdf. 30 January 2012.

[4] This number includes a mandatory 1 percent add-on tax which is collected by the state but distributed to local governments. Because of this, some sources will describe California's sales tax as 6.25 percent. A similar situation exists in Utah and Virginia.

[5] The sales taxes in Hawaii and South Dakota have bases that include many services, and as such are not strictly comparable to other sales taxes.

[6] U.S. Census Bureau; Census 2010, http://factfinder.census.gov.

The Health Care Individual Mandate is Beyond Congress�s Taxing Power

Mon, 13 Feb 2012 00:00:00 EST

The Health Care Individual Mandate is Beyond Congress's Taxing Power

Brief of the Tax Foundation as Amicus Curiae in Support of Respondents (Minimum Coverage Provision) in Department of Health & Human Services, et al. v. State of Florida, et al., No. 11-398

SUMMARY OF ARGUMENT

Long-standing American suspicion of taxes, which dates from colonial times, has led to numerous federal and state restrictions specific only to taxes, such as the federal Anti-Injunction Act, state-level supermajority or multiple reading requirements, and voter approval thresholds. These requirements in turn have necessitated a meaningful definition of "tax," particularly to contrast against other government actions that result in revenue, such as fees and penalties.

Federal and state courts have risen to meet that need, articulating a definition that is widely accepted today: (a) a tax is an exaction imposed for the primary purpose of raising revenue for general spending, (b) a fee is an exaction imposed for the primary purpose of recovering from the payor the cost of providing a particular service to the payor, and (c) a penalty is an exaction imposed for the primary purpose of punishing the payor for an unlawful act. This definitional construct has strong historical and economic underpinnings, is supported by this Court's precedents and the academic literature, and is widely used by numerous federal and state courts.

The individual mandate is thus properly considered a penalty and not a tax for purposes of the U.S. Constitution's Taxing Power and for purposes of the Anti-Injunction Act. Holding otherwise jeopardizes a widely-used, long-standing, working definitional construct, which would have severe implications for taxpayer protections and revenue statutes across the country.

ARGUMENT

I. THE INDIVIDUAL MANDATE OPERATES AS A PENALTY AND IS NOT A TAX.

A. A Tax is Widely Defined as an Exaction Imposed for the Primary Purpose of Raising Revenue for General Spending.

American antipathy to taxes is rooted deeply in our nation's history, from early colonial taxes to the Boston Tea Party to the Whiskey Rebellion to California's Proposition 13 to today. See, e.g., Alvin Rabushka, Taxation in Colonial America (2008) (describing "how the colonists strove to minimize, avoid, and evade British and local taxation . . . ."); Joseph D. Reid, Jr., Tax Revolts in Historical Perspective, 32 Nat'l Tax J. 67, 69 (1979) ("Tax revolts are as American as 1776."); Kirk J. Stark, The Right to Vote on Taxes, 96 Nw. U.L. Rev. 191, 191 (2001) ("Time and time again Americans have turned mutinous against taxes."). Policymakers therefore have a strong incentive to avoid raising taxes, or at least seek to raise revenue in ways that can avoid the "tax hiker" label.

Tax proposals consequently are usually subject to greater scrutiny than other policy proposals and, indeed, other revenue proposals. As one example, sixteen states require legislative supermajorities for tax increases.[1] Nearly every state requires uniformity in taxation. See, e.g., Joseph Henchman & Arushi Sharma, Virginia Constitution Requires Uniform Distribution of the Metrorail Tax Burden in Fairfax County, Tax Foundation Fiscal Fact No. 233 (June 2010) (reviewing state uniformity case law). Others include requirements that tax bills be passed multiple times, that tax bills be passed by a minimum quorum, or that tax bills not encompass any non-tax provisions. Many of these requirements are long-standing, with some reaffirmed by referendum in recent years. At the federal level, the Anti-Injunction Act insulates state tax collections from certain legal challenges to which they could otherwise be subject. See 28 U.S.C. § 2283.

A workable definition of "tax" is necessary to give meaning to these tax-specific procedural protections. Relying simply on the words used in the statute invites subterfuge and nullifies taxpayer protections. Too broad a definition threatens to take tax-related procedural protections beyond their intended scope. While some may equate a tax as any government action that results in costs, monetary or non-monetary, the general public and the courts have been careful to distinguish between different forms of government-collected exactions.

The distinction between taxes and other types of charges depends on the (1) entity that imposes the assessment, (2) the parties upon whom the assessment is imposed, and (3) the use of the revenue. See, e.g., San Juan Cellular Tel. Co. v. Pub. Serv. Comm'n of Puerto Rico, 967 F.2d 683, 685 (1st Cir. 1992). A tax is thus an exaction imposed by the government, on the public, for the purpose of raising revenue which is then spent on general (not particular) public purposes. A charge not imposed by government, or a charge collected from those receiving particularized benefits, or a charge collected for primary purpose other than raising revenue, is not a tax. See also United States v. State of New York, 315 U.S. 510, 515-16 (1942) ("But a tax for purposes of [the Bankruptcy Code] includes any pecuniary burden laid upon individuals or property for the purpose of supporting the government, by whatever name it may be called.") (internal citations omitted); United States v. La Franca, 282 U.S. 568, 572 (1931) ("A 'tax' is an enforced contribution to provide for the support of government; a 'penalty,' as the word is here used, is an exaction imposed by statute as punishment for an unlawful act."). The government is correct when it asserts that "the validity of an assessment under the Taxing Power does not depend on whether it is denominated a tax." Pet. Br. 56-59. It depends on the charge's purpose and effect.

This San Juan Cellular three-part test, while relatively recent, nicely encapsulates what is a long-running and enduring standard for defining taxes. See, e.g., Millard v. Roberts, 202 U.S. 429, 436 (1906), quoting 1 Story Const. § 880 ("Revenue bills . . . are those that levy taxes in the strict sense of the word and are not bills for other purposes which may incidentally create revenue."); 4 Cooley, The Law of Taxation, ch. 29 § 1784 (4th ed. 1924) ("If revenue is the primary purpose and regulation is merely incidental the imposition is a tax; while if regulation is the primary purpose the mere fact that incidentally a revenue is also obtained does not make the imposition a tax . . . ."); Black's Law Dictionary 1214 (9th ed. 2009) (defining tax as "[a] charge, usu. monetary, imposed by the government on persons, entities, transactions, or property to yield public revenue.").

Variations of this formulation, including the San Juan Cellular test, have been adopted by the vast majority of federal appellate courts and state supreme courts. See, e.g., Valero Terrestrial Corp. v. Caffrey, 205 F.3d 130, 134 (4th Cir. 2000) (applying San Juan Cellular to determine if a charge "qualifies" as a tax); Neinast v. Texas, 217 F.3d 275, 278 (5th Cir. 2000) (applying San Juan Cellular); Hedgepeth v. Tennessee, 215 F.3d 608, 612 (6th Cir. 2000) (describing San Juan Cellular as the "leading decision" used for "the definition of the term 'tax'"); RTC Commercial Assets Trust 1995-NP3-1 v. Phoenix Bond & Indem. Co., 169 F.3d 448, 457 (7th Cir. 1999) ("Penalties stand on a different footing. States do not assess penalties for the purpose of raising
revenue. . . ."); Chicago & Nw. Transp. Co. v. Webster County Bd. of Supervisors, 71 F.3d 265, 267 (8th Cir. 1995) ("A government levy is a tax if it raises revenue to spend for the general public welfare."); Bidart Bros. v. California Apple Comm'n, 73 F.3d 925, 931 (9th Cir. 1996) (applying San Juan Cellular test to "determin[e] whether an assessment is a tax"); Hill v. Kemp, 478 F.3d 1236, 1244 (10th Cir. 2007) (finding that a tax's "primary purpose . . . is revenue rather than regulation"); Seven-Sky v. Holder, 661 F.3d 1, 8 (D.C. Cir. 2011) ("It is well established that Congress used the term 'tax' in the Tax Injunction Act to mean assessments made for the purpose of raising revenues, not regulatory 'penalties' intended to encourage compliance with a law."); Rural Tel. Coal. v. F.C.C., 838 F.2d 1307, 1314 (D.C. Cir. 1988) ("[A] regulation is a tax only when its primary purpose judged in legal context is raising revenue."); Lightwave Tech., LLC v. Escambia County, 804 So.2d 176, 178 (Ala. 2001) (finding that a charge "designed to generate revenue" for general spending is a tax); May v. McNally, 55 P.3d 768, 773-74 (Ariz. 2002) (adopting San Juan Cellular); City of North Little Rock v. Graham, 647 S.W.2d 452, 453 (Ark. 1983) (finding that a tax "is a means of raising revenue to pay additional money for services already in effect"); Sinclair Paint Co. v. State Bd. of Equalization, 937 P.2d 1350, 1354 (Cal. 1997) ("In general, taxes are imposed for revenue purposes, rather than in return for a special benefit conferred or privilege granted."); Zelinger v. City & County of Denver, 724 P.2d 1356, 1358 (Colo. 1986) ("A hallmark of such taxes is that they are intended to raise revenue to defray the general expenses of the taxing entity."); Stuart v. Am. Sec. Bank, 494 A.2d 1333, 1337 (D.C. 1985) (describing taxes as "for the purpose of raising revenue"); Gunby v. Yates, 102 S.E.2d 548, 550 (Ga. 1958) ("A tax is an enforced contribution exacted pursuant to legislative authority for the purpose of raising revenue to be used for public or governmental purposes . . . ."); State v. Medeiros, 973 P.2d 736, 742 (Haw. 1999) (holding that a tax does not apply to direct beneficiaries of a service, does not directly defray the costs of a particular service, or is not necessarily proportionate to the benefit received); BHA Inv., Inc. v. State, 63 P.3d 474, 479 (Idaho 2003) ("[T]axes are solely for the purpose of raising revenue."); Crocker v. Finley, 459 N.E.2d 1346, 1350 (Ill. 1984) ("[A] charge having no relation to the services rendered, assessed to provide general revenue rather than compensation, is a tax."); Ennis v. State Highway Comm'n, 108 N.E.2d 687, 693 (Ind. 1952) ("Taxes are levied for the support of government . . . ."); City of Hawarden v. US W. Commc'ns, Inc., 590 N.W.2d 504, 507 (Iowa 1999) (holding that an exaction intended to raise revenue is a tax); Citizens' Util. Ratepayer Bd. v. State Corp. Comm'n, 956 P.2d 685, 708 (Kan. 1998) ("The primary purpose of a tax is to raise money, not regulation."); Krumpelman v. Louisville & Jefferson County Metro. Sewer Dist., 314 S.W.2d 557, 561 (Ky. 1958) ("[T]axes are generally held to be a rate or duty levied each year for purposes of general revenue . . . ."); Audubon Ins. Co. v. Bernard, 434 So.2d 1072, 1074 (La. 1983) (holding that "revenue is the primary purpose" of a tax); Bd. of Overseers of the Bar v. Lee, 422 A.2d 998, 1004 (Me. 1990) ("[T]axes are primarily intended to raise revenue . . . ."); Workmen's Comp. Comm'n v. Prop. & Cas. Ins. Guar. Corp., 570 A.2d 323, 325 (Md. 1990) (finding that taxes "are intended to raise revenue for public purposes"); Emerson Coll. v. City of Boston, 462 N.E.2d 1098, 1105 (Mass. 1984) (finding that a charge "collected not to raise revenues" but for another purpose is not a tax); Bolt v. City of Lansing, 587 N.W.2d 264, 269 (Mich. 1998) (holding that a charge with "a revenue-raising purpose" is a tax); County Joe, Inc. v. City of Eagan, 560 N.W.2d 681, 686 (Minn. 1997) (holding that a charge "expressly intended to raise revenue" is a tax); Leggett v. Missouri State Life Ins. Co., 342 S.W.2d 833, 875 (Mo. 1961) (finding that a charge is not a tax unless "the object of [it] is to raise revenue to be paid into the general fund of the government to defray customary governmental expenditures"); Monarch Mining Co. v. State Highway Comm'n, 270 P.2d 738, 740 (Mont. 1954) ("Taxes are levied for the support of government, and their amount is regulated by its necessities."); Douglas County Contractors Ass'n v. Douglas County, 929 P.2d 253, 257 (Nev. 1996) (holding that a charge with the "true purpose . . . to raise revenue" is a tax); Horner v. Governor, 951 A.2d 180, 183 (N.H. 2008) (finding that a tax must be "intended to raise additional revenue" not "solely to support a governmental regulatory activity made necessary by the actions of those who are required to pay the charge"); Resolution Trust Corp. v. Lanzaro, 658 A.2d 282, 290 (N.J. 1995) (finding that a tax "is intended primarily to raise revenue"); Scott v. Donnelly, 133 N.W.2d 418, 423 (N.D. 1965) ("If the primary purpose is revenue, it is a tax; on the other hand, if the primary purpose is regulation, it is not a tax."); Olustee Co-op Ass'n v. Oklahoma Wheat Utilization Research and Market Dev. Comm'n, 391 P.2d 216, 218 (Okl. 1964) (citing definition of tax in part including purpose "to provide public revenue"); Woodward v. City of Philadelphia, 3 A.2d 167, 170 (Pa. 1938) ("[T]axes are defined to be burdens or charges imposed by the legislative power upon persons or property to raise money for public purposes, and to defray the necessary expenses of government."); State v. Foster, 46 A. 833, 835-36 (R.I. 1900) ("If the imposition of such a condition has for its primary object the regulation of the business, trade, or calling to which it applies, its exercise is properly referable to the police power; but if the main object is the obtaining of revenue, it is properly referable to the taxing power."); Brown v. County of Horry, 417 S.E.2d 565, 568 (S.C. 1992) (citing with approval the standard that "a tax is an enforced contribution to provide for the support of government . . . ."); Valandra v. Viedt, 259 N.W.2d 510, 512 (S.D. 1977) ("[T]axes are imposed for the purpose of general revenue . . . ."); Memphis Retail Liquor Dealers' Ass'n v. City of Memphis, 547 S.W.2d 244, 245-46 (Tenn. 1977) ("If the imposition is primarily for the purpose of raising revenue, it is a tax . . . ."); Hurt v. Cooper, 110 S.W.2d 896, 899 (Tex. 1937) (finding that a tax is a charge with the "primary purpose" of "raising of revenue"); V-1 Oil Co. v. Utah State Tax Comm'n, 942 P.2d 906, 911 (Utah 1996), vacated on other grounds, 942 P.2d 915 (Utah 1997) ("Generally speaking, a tax raises revenue for general governmental purposes . . . ."); Marshall v. Northern Virginia Transp. Authority, 657 S.E.2d 71, 77-78 (Va. 2008) ("We consistently have held that when the primary purpose of an enactment is to raise revenue, the enactment will be considered a tax, regardless of the name attached to the act."); City of Spokane v. Spokane Police Guild, 553 P.2d 1316, 1319 (Wash. 1976) ("[I]f the primary purpose of legislation is regulation rather than raising revenue, the legislation cannot be classified as a tax even if a burden or charge is imposed."); City of Huntington v. Bacon, 473 S.E.2d 743, 752 (W.Va. 1996) ("The primary purpose of a tax is to obtain revenue for the government . . . ."); State v. Jackman, 211 N.W.2d 480, 485 (Wis. 1973) ("A tax is one whose primary purpose is to obtain revenue . . . ."). But see Apocada v. Wilson, 525 P.2d 876, 884-85 (N.M. 1974) (holding that a charge that raises revenue beyond costs is not a tax); Heatherly v. State, 678 S.E.2d 656, 657 (N.C. 2009) (dividing equally on the question of definition of tax); State ex. rel. Petroleum Underground Storage Tank Release Comp. Bd. v. Withrow, 579 N.E.2d 705, 710 (Ohio 1991) ("It is not possible to come up with a single test that will correctly distinguish a tax from a fee in all situations where the words 'tax' and 'fee' arise."); Auto. Club of Oregon v. State, 840 P.2d 674, 678 (Or. 1992) (describing "tax" as any revenue collected by government, separate from "assessment").

B. The Individual Mandate's Charge is a Penalty and Not a Tax Because Its Primary Purpose is Not to Raise Revenue but to Penalize.

No evidence exists that the primary purpose of the individual mandate is to raise revenue, and for this reason, the individual mandate cannot be considered a tax for purposes of the U.S. Constitution or the Anti-Injunction Act. Of the various individuals and organizations opining on the purpose of the individual mandate, none have cited its ability to raise revenue.

The most common reason cited for the individual mandate's purpose is to regulate so-called "free riders," those who use health care services but do not bear the full cost themselves. President Obama, asked in a September 2009 ABC News interview whether the individual mandate is a tax, stated that he "absolutely reject[s] that notion," analogizing it to state mandates to purchase auto insurance which "[n]obody considers . . . a tax increase." Jacqueline Klingebiel, Obama: Mandate is Not a Tax, ABC News (Sep. 20, 2009), http://abcnews.go.com/blogs/ politics/2009/09/obama-mandate-is-not-a-tax. "[F]or us to say that you've got to take a responsibility to get health insurance is absolutely not a tax increase." Id. See also Bradley Herring, An Economic Perspective on the Individual Mandate's Severability from the PPACA, 364 New Eng. J. Med. 16e (Mar. 10, 2011) ("The primary purpose of the individual mandate is to mitigate this adverse selection . . . ."); BlueCross BlueShield of North Carolina, In the Spotlight: ACA Insurance Reforms (July 13, 2011), http://www.bcbsnc.com/assets/hcr/pdfs/spotlight_insurance_reforms.pdf ("From a policy perspective, the primary purpose for the individual mandate is to enable Guarantee Issue and Community Rating to work by creating a risk pool with a relative mix of healthy and unhealthy individuals."); Guatham Nagesh, "IRS chief: Buy health insurance or lose your tax refund," Daily Caller (Apr. 6, 2010) (describing IRS Commissioner Doug Shulman's speech outlining options to "penalize" taxpayers who do not comply with the mandate); Igor Volsky, "On Whether the Individal [sic] Mandate Is A Tax," ThinkProgress.org (July 20, 2010) ("The mandate is not a 'tax' in the sense that its primary purpose is to raise revenue[,] even though it meets the legal definition . . . [which includes] nearly any provision that adds money to the federal treasury.").

The statute's references to the individual mandate also contradict any suggestion that it is considered a tax. The mandate appears under the heading "Requirement to Maintain Minimum Essential Coverage." 26 U.S.C. § 5000A. The charge for not meeting this requirement is referred to as a "Shared Responsibility Payment." 26 U.S.C. § 5000A(b). The statute further refers to the mandate charge as a "penalty" twelve times and as a tax zero times. See 26 U.S.C. § 5000A et seq. The mandate also does not share the same enforcement provisions as taxes, with the IRS denied the use of liens or levies to enforce the provision. See 26 U.S.C. § 5000A(g)(2).

It is true that the Joint Committee on Taxation (JCT) technical explanation of the bill does refer to the individual mandate as an excise tax in its subheading on the individual mandate, but all other JCT references evidence the JCT's judgment that the mandate is not a tax. See Joint Committee on Taxation, Technical Explanation of the Revenue Provisions of the "Reconciliation Act of 2010," As Amended, in Combination with the "Patient Protection and Affordable Care Act" at 31 (Mar. 21, 2010), http://www.jct.gov/publications.html?func= startdown&id=3673. Aside from the reference in the subheading, the JCT never again refers to the mandate as a "tax" and instead invariably refers to it as a "penalty," doing so 24 times in its technical explanation of how the provision operates. See id. at 31-34. The explanation also falls under the policy and regulatory provisions of the Act, not under the "Revenue Provisions" heading. See id. at i-ii. JCT also left the mandate out of its revenue projections, where it estimated the financial impact of all provisions of the bill related to raising revenue. See Joint Committee on Taxation, Estimated Revenue Effects of the Amendment in the Nature of a Substitute to H.R. 4872, The "Reconciliation Act of 2010," As Amended, In Combination With the Revenue Effects of H.R. 3590, The "Patient Protection And Affordable Care Act ('PPACA')," As Passed by the Senate, And Scheduled For Consideration By The House Committee On Rules On March 20, 2010, at 1-3 (Mar. 20, 2010), http://www.jct.gov/ publications.html?func=startdown&id=3672.

This Court has repeatedly recognized a firm distinction between taxes and penalties, the latter of which are regulatory in nature, designed with the purpose of deterring and punishing people who are engaging in illegal activities. See, e.g., United States v. Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213, 224 (1996), quoting La Franca, 282 U.S. at 572 ("[A] 'penalty,' as the word is here used, is an exaction imposed by statute as punishment for an unlawful act."); Dep't of Rev. of Montana v. Kurth Ranch, 511 U.S. 767, 779-80 (1994) ("[W]hereas fines, penalties, and forfeitures are readily characterized as sanctions, taxes are typically different because they are usually motivated by revenue-raising, rather than punitive, purposes."); Bailey v. Drexel Furniture Co., 259 U.S. 20, 38 (1922) ("Taxes are occasionally imposed in the discretion of the Legislature on proper subjects with the primary motive of obtaining revenue from them and with the incidental motive of discouraging them by making their continuance onerous. They do not lose their character as taxes because of the incidental motive. But there comes a time in the extension of the penalizing features of the so-called tax when it loses its character as such and becomes a mere penalty, with the characteristics of regulation and punishment.").

The individual mandate is properly described as a penalty, not a tax, because these definitions describe the individual mandate quite well. Those who must make a payment must do so precisely because they have not adhered to the regulatory provisions of the Act. While incidental revenue may be generated, the undeniable purpose of the individual mandate is to punish, discourage, and reduce illegal behavior, as a penalty and not a tax.

II. the government's contention that the individual mandate is a tax does not address thE FACT THat it would be AN UNCONSTITUTIONAL CAPITATION TAX UNAPPORTIONED BY STATE POPULATION.

In asserting that the individual mandate is permissible under the Taxing Power, the Government does not address the fact that if this were true, this tax would be a capitation tax unapportioned by state population, in direct violation of the constitutional requirement that "No capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken." U.S. Const. art. I, § 9, cl. 4. A direct tax is only permissible if it is apportioned among the states in proportion to population, or levied on incomes. See U.S. Const. amend. XVI; Eisner v. Macomber, 252 U.S. 189, 206 (1920) ("A proper regard for its genesis, as well as its very clear language, requires also that this amendment shall not be extended by loose construction, so as to repeal or modify, except as applied to income, those provisions of the Constitution that require an apportionment according to population for direct taxes upon property, real and personal. This limitation still has an appropriate and important function, and is not to be overridden by Congress or disregarded by the courts.").

The prohibition of unapportioned direct taxes exists for a strong purpose. Alexander Hamilton, conceding that a federal government with unlimited taxing power invited tyranny, explained that "[t]he proportion of these taxes is not to be left to the discretion of the national Legislature but is to be determined by the numbers of each State as described in the second section of the first article." The Federalist No. 36, 226, 229-30 (1788). Hamilton characterized the provision as a compromise that ensured that the federal government could have recourse to direct taxation if needed, but not in a way that could invite abuse or partiality. See id. George Mason, who felt that the provision was not sufficiently restrictive on government direct taxation, nevertheless described it correctly as meaning "that the quantity to be raised of each state, should be in proportion to their numbers in the manner therein directed." George Mason, Virginia Ratifying Convention Papers 3:1087 (June 17, 1788).

Assuming arguendo that the Government's characterization of the mandate as a tax is correct, it would operate as a levy on individuals and not their incomes. The mandate penalty in 2016, for example, is imposed either in the amount of $695 per uninsured adult, or at the rate of 2.5 percent of the uninsured taxpayer's income in excess of the filing threshold (in 2010, $9,350), whichever is greater. See 26 U.S.C. § 5000A(c). Although the latter calculation could conceivably be considered a tax on income, the former direct amount cannot be. If it is a tax, it is a capitation tax, levied directly on the individual. Because its collection is not apportioned according to state population, its operation would violate U.S. Const. art. I, § 9, cl. 4.

III. HOLDING THAT THE INDIVIDUAL MANDATE IS A TAX WOULD LEAD TO SERIOUS NEGATIVE CONSEQUENCES FOR LEGAL JURISPRUDENCE.

This Court should be reluctant to reject the widely-accepted definition of "tax" as an exaction imposed for the primary purpose of raising revenue for general spending, because to do so would jeopardize settled precedent and taxpayer protections at the federal level and in nearly every state. There has been no development in law that necessitates such a far-reaching change.

A meaningful distinction between "tax" and "penalty" is vital to give operation to numerous federal and state provisions relating to tax policy. If this Court held that a tax is any government collection of revenue, then government revenue collection efforts across the country would be imperiled, as many revenue sources are not subjected to the heightened restrictions that "taxes" are. To collect fees or impose criminal fines, states for the first time would see these charges subjected to supermajority, multiple reading, and other requirements. While some states may choose to extend such procedural requirements to non-tax revenue sources, this should be done explicitly through the legislative process, not by announcing a new definition of "tax" not comprehended at the time these provisions were adopted.

This Court should therefore be cautious not to encourage treating penalties as taxes, as that would render many state powers, and potentially the Taxing Power's limitations, meaningless.

CONCLUSION

For the foregoing reasons, Amicus Curiae Tax Foundation respectfully requests that the decision below be affirmed as to their conclusion that the Minimum Coverage Provision exceeds Congress's Taxing Power under the U.S. Constitution.

Respectfully Submitted,

Joseph D. Henchman
Counsel of Record
Vice President, Legal Projects
Tax Foundation
529 14th Street, N.W., Suite 420
Washington, DC 20045
202-464-6200
henchman@taxfoundation.org

February 13, 2012

INTEREST OF THE AMICUS CURIAE

Tax Foundation submits this brief as amicus curiae in support of Respondents in the above-captioned matter.

The Tax Foundation is a non-partisan, non-profit research organization founded in 1937 to make information about government finance more understandable and accessible to the general public. Based in Washington, D.C., our analysis is guided by the principles of sound tax policy: simplicity, neutrality, transparency, and stability. The Tax Foundation's Center for Legal Reform furthers these goals by educating the legal community about economics and principled tax policy.

By addressing the definition of "tax" under Article I of the U.S. Constitution and the Anti-Injunction Act, this Court will consider a question that has been considered and will continue to be considered by nearly every federal court and state. Therefore, this decision and the rationale behind it will have a large impact upon the legality of certain taxes throughout the country. The Tax Foundation is in a unique position to aid this Court because of our extensive research in tax, fee, and penalty issues considered by courts, the academic community, and economists. Accordingly, the Tax Foundation has an institutional interest in this Court's ruling.

[1] Arizona (two-thirds requirement since 1992), Arkansas (three-fourths requirement since 1934), California (two-thirds requirement since 1979), Colorado (two-thirds requirement since 1992), Delaware (three-fifths requirement since 1980), Florida (three-fifths requirement for corporate income taxes since 1971), Kentucky (three-fifths requirement since 2000), Louisiana (two-thirds requirement since 1966), Michigan (three-fourths requirement for property taxes since 1994), Mississippi (three-fifths requirement since 1970), Missouri (two-thirds requirement since 1996), Nevada (two-thirds requirement since 1996), Oklahoma (three-fourths requirement since 1992), Oregon (three-fifths requirement since 1996), South Dakota (two-thirds requirement since 1996), Washington (two-thirds requirement since 1993).

Global Evidence on Taxes and Economic Growth: Payroll Taxes Have No Effect

Wed, 08 Feb 2012 00:00:00 EST

Focus Should Be on Cutting Corporate and Individual Income Taxes

Tax Foundation Fiscal Fact No. 290

Introduction

Congress is currently debating whether to extend throughout the year the payroll tax holiday, which is currently set to expire at the end of February. The original holiday lasted all of 2011 and reduced the employee share of Social Security payroll taxes from 6.2 percent to 4.2 percent. The two-month extension that passed in December reflects the difficultly in agreeing how to pay for a full-year extension. This is because the budgetary cost of a full-year extension is considerable: about $120 billion according to the Joint Committee on Taxation.

Proponents of the holiday argue that the economic recovery is fragile, that continued short-term stimulus is in order as a result, and that the payroll tax holiday is particularly effective in this regard because it puts cash in the pockets of those most likely to spend it. While there is a certain appeal to this argument, many economists have a different view of the short-run dynamics of stimulus measures in general and this payroll tax holiday in particular.

The long-term growth effects of a payroll tax holiday extension are worth considering as well, as the U.S. appears mired in a long run of slow growth. Here the evidence is quite conclusive: Based on OECD data on 34 member countries between 2000 and 2010, there is no significant relationship between payroll taxes and long-term economic growth. In contrast, corporate income taxes have a highly significant and negative effect on long-term growth.

The estimates suggest that cutting the corporate rate by 10 percentage points is associated with an increase in total real GDP growth of 11.1 percentage points over the period. This would move the U.S. from below average to above average in terms of economic growth among OECD countries. Personal income taxes on high incomes also have a significant negative effect on growth, such that cutting the rate by 10 percentage points is associated with an increase in total real GDP growth of 7.5 percentage points over the period. This would bring the U.S. to roughly an average level of growth relative to OECD peers.

The U.S. will soon have the highest corporate income tax rate among OECD countries and it already has the most progressive income tax systems of any industrialized nation.[1] Thus, the evidence strongly suggests that the key to boosting long-term economic growth in the U.S. is to cut tax rates on corporate and individual income.

Background

Standard economic theory suggests that taxes are a major determinant of long-term growth. Particularly damaging to growth are taxes on saving, investing, entrepreneurship, and high-productivity labor.[2] Other factors affecting growth include education, average per capita income, demographics, size of the economy, rule of law, and regulation. Many economists have attempted to account for all these factors, often with mixed results due to data limitations.

However, the following simple correlations of the data in Table 1 show that certain taxes in particular explain a great deal of the variation in long-term economic growth.

Table 1 shows cumulative real economic growth in OECD countries over the years 2000 to 2010, where 2010 is the most recent data available from the OECD. This period may be considered the long term in that it exceeds the business cycle, which generally ran from the peak in 2000 to the next peak in 2007 with recessions in 2001 and 2008-2009. Over the entire 11-year period, the U.S. grew 16.7 percent, which was well below the OECD average of 24.9 percent. The fastest-growing country was the Slovak Republic, at 59.7 percent, followed by Korea, Poland, Turkey, and Chile. The slowest-growing country was Italy, at 2.5 percent, followed by Denmark, Portugal, Japan, and Germany.

Table 1 also shows various tax rates in OECD countries, averaged over the period 2000 to 2010. The corporate rate is the combined central and sub-central statutory rate. The personal income tax rate is the combined central and sub-central average effective tax rate at four income levels, as defined by the OECD.[3] The Social Security payroll tax rate is the employee plus employer share of Social Security contributions, expressed as a share of wages at four wage levels, again defined by the OECD.

Over this period, the U.S. corporate income tax rate was the second-highest in the OECD, at 39.3 percent, which was slightly below Japan's rate of 40 percent, and well above the OECD average of 28.5 percent. Averaged over the period, Ireland had the lowest corporate rate, at 14.5 percent (the current rate is 12.5 percent). Nearly every OECD country, 30 of 34, reduced their corporate rate during this period, with Greece and Ireland reducing theirs by half.

Personal income taxes are progressive in every OECD country, meaning the high-income earners pay a higher rate than low-income earners. Some countries are more progressive than others over the income range shown. For instance, Denmark had the highest average personal income tax rate on those making 167 percent of the average wage. Chile had the lowest rate, barely above zero, because of a generous personal exemption that exceeded the average wage. U.S. personal income tax rates were slightly above the OECD average for all four income levels.[4]

Social Security payroll taxes, in contrast, are typically regressive or proportional over the income range shown, because they only apply to income up to a certain threshold. In the U.S. in 2010, that threshold was $106,800. This gave the U.S. a slightly regressive rate structure over this income range. Across this income range, U.S. payroll tax rates were well below the OECD average. France and Hungary had the highest payroll tax rates, at around 50 percent, while New Zealand had the lowest at zero percent.

Table 1: GDP Growth and Tax Rates in OECD Countries, 2000-2010
	Real GDP Growth	Corp. Income Tax Rate	Personal Income Tax Rate				Social Security Payroll Tax Rate
	Real GDP Growth	Corp. Income Tax Rate	67% of Avg. Wage	100% of Avg. Wage	133% of Avg. Wage	167% of Avg. Wage	67% of Avg. Wage	100% of Avg. Wage	133% of Avg. Wage	167% of Avg. Wage
Australia	35.6%	30.4%	18.4%	23.2%	26.8%	30.4%	6.1%	6.1%	6.1%	6.1%
Austria	16.6%	29.1%	7.4%	12.0%	15.5%	16.5%	34.7%	34.7%	34.2%	30.6%
Belgium	14.7%	35.7%	22.0%	28.3%	32.5%	35.1%	42.3%	44.8%	45.5%	45.5%
Canada	20.4%	35.0%	13.2%	16.8%	20.4%	22.8%	18.2%	18.6%	15.6%	13.4%
Chile	44.1%	16.3%	0.0%	0.0%	0.0%	0.1%	7.0%	7.0%	7.0%	7.0%
Czech Rep.	39.6%	26.0%	7.9%	10.8%	12.8%	14.3%	47.0%	47.0%	47.0%	47.0%
Denmark	5.8%	28.0%	26.8%	30.5%	35.9%	39.6%	12.2%	10.9%	10.2%	9.8%
Estonia	41.2%	23.8%	17.3%	19.4%	20.5%	21.1%	34.4%	34.4%	34.4%	34.4%
Finland	20.3%	27.4%	18.4%	24.7%	29.0%	31.9%	30.5%	30.6%	30.6%	30.7%
France	11.9%	35.2%	12.2%	14.9%	17.8%	20.3%	49.3%	55.5%	54.7%	54.3%
Germany	9.7%	37.8%	15.2%	21.2%	25.9%	29.8%	41.2%	41.2%	38.2%	34.2%
Greece	23.5%	31.1%	0.0%	2.0%	6.2%	9.3%	44.0%	44.0%	44.0%	44.0%
Hungary	21.5%	18.2%	12.2%	21.2%	26.3%	28.4%	51.1%	50.1%	49.6%	49.3%
Iceland	24.1%	19.6%	18.5%	24.3%	27.5%	32.0%	6.1%	6.0%	6.0%	5.9%
Ireland	26.6%	14.5%	9.1%	16.6%	23.0%	26.7%	16.2%	16.6%	16.4%	16.0%
Israel	35.7%	31.9%	7.5%	13.3%	17.2%	21.4%	11.3%	13.0%	13.9%	14.4%
Italy	2.5%	32.5%	14.8%	19.4%	22.8%	25.6%	42.1%	42.1%	42.1%	42.1%
Japan	7.3%	40.0%	5.7%	7.2%	8.9%	11.6%	24.6%	24.6%	24.6%	23.3%
Korea	50.0%	28.1%	1.1%	3.2%	5.9%	8.0%	16.3%	16.3%	16.2%	15.3%
Luxembourg	30.8%	31.1%	7.6%	14.5%	19.8%	22.9%	24.8%	24.7%	24.7%	24.7%
Mexico	19.9%	31.4%	-3.1%	3.2%	8.2%	10.6%	14.7%	13.2%	12.8%	12.5%
Netherlands	14.6%	30.6%	4.5%	12.5%	19.9%	26.0%	37.7%	29.6%	24.0%	19.2%
New Zealand	29.4%	32.2%	17.9%	19.4%	22.5%	25.0%	0.0%	0.0%	0.0%	0.0%
Norway	16.5%	28.0%	18.3%	22.0%	26.3%	29.0%	20.7%	20.7%	20.7%	20.7%
Poland	46.6%	22.4%	5.2%	6.5%	7.2%	7.7%	36.8%	36.8%	36.8%	36.8%
Portugal	6.9%	29.5%	5.7%	11.4%	14.7%	18.2%	34.8%	34.8%	34.8%	34.8%
Slovak Rep.	59.7%	21.9%	5.0%	8.2%	10.4%	12.0%	44.5%	44.5%	44.4%	44.1%
Slovenia	30.5%	23.7%	8.8%	12.3%	15.5%	18.1%	40.7%	40.9%	41.0%	42.2%
Spain	22.7%	33.4%	9.5%	14.0%	17.0%	19.0%	36.7%	36.7%	36.7%	35.5%
Sweden	22.5%	27.7%	20.5%	22.6%	29.1%	34.0%	39.4%	39.4%	38.3%	37.1%
Switzerland	17.9%	22.7%	7.0%	10.0%	12.6%	14.7%	12.4%	12.4%	12.4%	12.2%
Turkey	46.0%	26.5%	12.7%	14.4%	15.6%	17.1%	35.4%	35.4%	34.8%	33.7%
U.K.	15.0%	29.5%	15.1%	17.2%	19.3%	23.5%	17.5%	19.5%	19.0%	17.8%
U.S.	16.7%	39.3%	13.9%	16.5%	20.3%	22.7%	16.3%	16.0%	15.8%	15.7%
OECD Avg.	24.9%	28.5%	11.1%	15.1%	18.6%	21.3%	27.9%	27.9%	27.4%	26.8%
Source: OECD; http://www.oecd.org/document/60/0,3746,en_2649_34533_1942460_1_1_1_1,00.html
Note: GDP growth is cumulative, 2000-2010. Tax rates are averages over the period 2000-2010. The corporate rate is the combined central and sub-central statutory rate. The personal income tax rate is the combined central and sub-central average effective tax rate on various income levels. The social security payroll tax rate is the employee plus employer share of social security contributions, as a share of various wage levels. For a full description of the methodology, see Taxing Wages, OECD, May 11, 2011.

Results

Payroll taxes and growth. Our first task is to look at the relationship between payroll taxes and economic growth. As Figure 1 shows, there is no relationship between payroll taxes and long-term economic growth. Some countries, such as Slovakia, have high payroll taxes and high growth while other countries, such as the United States, have relatively low payroll taxes and low growth.

The OECD provides data on both the employee and employer share of social Security payroll taxes, at four different income levels, and none has any relationship to long-term growth. This is not because payroll taxes are a small source of revenue; they are in fact typically a larger source of revenue than either corporate or personal income taxes.

Corporate income taxes and growth. In contrast, Figure 2 shows that corporate income taxes have a highly significant and negative effect on long-term growth. The R² statistic is 0.243, indicating that 24.3 percent of the variation in long-term growth across OECD countries is determined by corporate income taxes. This very likely makes it the single largest determinant of economic growth. The slope of the fitted line is -1.11, indicating that cutting the corporate rate by 10 percentage points is associated with an increase in cumulative real GDP growth of 11.1 percentage points. The correlation is significant at the 1 percent level.

The observations (countries) are more tightly clustered around the fitted line at the high end of corporate tax rates. This indicates that the relationship is more significant when corporate rates are high, as they are in the U.S. For example, the seven countries with the highest corporate tax rates all experience below-average economic growth. However, corporate rates matter at the low end as well, since the seven fastest-growing countries all have below-average corporate rates.

Personal income taxes and growth. Figure 3 shows that personal income taxes on high incomes (167 percent of the average wage) also have a highly significant and negative effect on long-term growth. The R² statistic is 0.235, indicating that 23.5 percent of the variation in long-term growth across OECD countries is determined by personal income taxes on high incomes. This very likely makes it the second-largest determinant of economic growth, after corporate taxes. The slope of the fitted line is -0.75, indicating that cutting the personal income tax rate by 10 percentage points is associated with an increase in cumulative real GDP growth of 7.5 percentage points - a large effect but somewhat less than that of the corporate tax. The correlation is significant at the 1 percent level.

As with the corporate tax, the seven fastest-growing countries all have below-average tax rates on high incomes. Supporting evidence is offered by the fact that the fastest-growing country, the Slovak Republic, put in a place a flat personal income tax of 19 percent in 2004.[5] Table 1 indicates there remains a degree of progressivity, probably owing to a large personal exemption, but it is much less progressive than the OECD average.

Tax rates on lower incomes have less effect on growth. All of the Bush-era tax laws will expire at the end of 2012 and there are some lawmakers who advocate extending only the tax laws benefiting low- and middle-income taxpayers. However, the evidence suggests that such a policy will have little effect on long-term economic growth.

We tested the relationship between the tax rates on three lower income levels - upper-middle-income workers (133 percent of the average wage), middle-income (100 percent of the average wage), and low-income workers (67 percent of the average wage) - and long-term economic growth. The results can be seen in Figures 4, 5, and 6. These charts clearly show that taxes on lower incomes are less significant, and the level of significance declines with each level of income. There is no significant relationship between long-term growth and taxes on the lowest level of income. The fact that the ordering lines up with the theoretical prediction makes these results highly robust and unlikely to be driven by spurious factors.

That is not to say that the estimated magnitudes may not be somewhat biased by the omitted variables mentioned earlier. For instance, it is likely that having a low per capita income, as all seven of the fastest-growing countries do, is also a major determinant of growth. Having a low per capita income may also be correlated with low corporate and personal income taxes, such that the estimates shown here capture both effects. This is an area for further investigation; however, existing research takes into account such factors and the results are broadly consistent with those presented here.[6]

Source: OECD.

Note: See Table 1 for a description of the data. The correlation is -0.06, with a t-statistic of -0.33, making this correlation insignificant.

Source: OECD.

Note: See Table 1 for a description of the data. The correlation is -0.49, with a t-statistic of -3.20, making this correlation significant at the 1% level.

Source: OECD.

Note: See Table 1 for a description of the data. The correlation is -0.48, with a t-statistic of -3.14, making this correlation significant at the 1% level.

Source: OECD.

Note: See Table 1 for a description of the data. The correlation is -0.45, with a t-statistic of -2.88, making this correlation significant at the 1% level.

Source: OECD.

Note: See Table 1 for a description of the data. The correlation is -0.40, with a t-statistic of -2.46, making this correlation significant at the 5% level.

Source: OECD.

Note: See Table 1 for a description of the data. The correlation is -0.32, with a t-statistic of -1.92, making this correlation insignificant.

Conclusion

The political debate over the payroll tax holiday has revolved around possible short-term growth effects, when in fact the bigger issue is a long-run growth slowdown. For instance, since 2000 the U.S. has grown at a rate that is well below the OECD average. Moreover, based on OECD data over this period, Social Security payroll taxes do not appear to have any significant effect on long-term economic growth. This is not because payroll taxes are inconsequential; in most countries they are a larger source of revenue than personal income taxes.

In contrast, corporate income taxes have a highly significant and negative effect on long-term growth.

The seven fastest-growing countries in the OECD all have below-average corporate taxes and below-average personal income taxes on high-income earners. The U.S., on the other hand, has the second-highest corporate tax rate in the OECD, and an above-average personal income tax rate. Of the three tax rates considered here, the only one where the U.S. is below average - more than 10 percentage points below average - is the one that does not matter for long-term growth: the payroll tax.

If lawmakers want to have the biggest impact on boosting long-term economic growth in the U.S., they should turn their attention to cutting tax rates on corporate and individual income.

[1] "Growing Unequal? Income Distribution and Poverty in OECD Countries," Organization for Economic Cooperation and Development, 2008. p. 112.

[2] For more on this, see William McBride, "How to Judge a Tax Plan," Tax Foundation Fiscal Fact No. 286.

[3] For a full description of the methodology, see Taxing Wages, OECD, May 11, 2011.

[4] This indicates the progressivity of the U.S. personal income tax system is about on par with the OECD average, however, this only over a limited income range. More comprehensive measures of progressivity by the OECD indicate the U.S. system is the most progressive in the OECD. See the following: "Growing Unequal? Income Distribution and Poverty in OECD Countries," Organization for Economic Cooperation and Development, 2008. p. 112.

[5] http://taxfoundation.org/blog/show/27720.html

[6] Young Lee and Roger Gordon, "Tax Structure and Economic Growth", Journal of Public Economics, 89, 2005.

The authors estimate that reducing the corporate rate by 10 percentage points adds 1 to 2 points to annual GDP growth, which is a slightly stronger effect on growth than is found here.

Asa Johansson, Christopher Heady, Jens Arnold, Bert Brys and Laura Vartia, "Tax and Economic Growth", OECD Economics Department Working Paper No. 620, July 11, 2008.

The authors find that corporate income taxes are most damaging to growth, followed by personal income taxes, consumption and property taxes.

Jens Arnold, "Do Tax Structures Affect Economic Growth? Empirical Evidence From a Panel of OECD Countries", OECD Economics Department Working Papers No. 642, October 14, 2008.

The author finds that progressivity of personal income taxes negatively affects growth.

Tangible Personal Property Tax Reform: Options to Foster Simplicity and Competitiveness in Florida�s Tax Code

Wed, 01 Feb 2012 00:00:00 EST

Testimony before the Finance and Tax Committee of the Florida House of Representatives

Mr. Chairman and Members of the Finance and Tax Committee of the Florida House of Representatives:

I write with regards to HJR 1003, the proposed constitutional amendment, and HB 1005, the implementing bill (to provide tax relief for businesses paying the tangible personal property tax). I appreciate the opportunity to submit this testimony in providing some of the broader perspective on tangible personal property taxation.

Personal property taxes are waning in popularity as a tax collection mechanism. In the past 12 years, eight states have made changes to remove or decrease the impact of tangible personal property (TPP) taxation, whether through raising the exemption or removing particularly distortionary TPP taxes on inventory. Notably, in 2008, Washington, D.C. raised its exemption to $225,000; and in 2009, Ohio began a phase-out of TPP taxation. Fourteen states already substantially exempt tangible personal property from taxes. However, these states are primarily clustered in the Northeast and Midwest. If Florida were to remove its tangible personal property tax, it would gain notice as the only state within 600 miles to not have one.

The economic impact of TPP taxes reaches far beyond those businesses that are required to file each year. TPP taxes are especially distortionary in their effect on people's and business's choices, which affects each member of the Florida economy.

The renewed discussion of the efficacy of tangible personal property taxes presents a golden opportunity for Florida to move toward a more simple tax code; one that encourages technological advancement and offers a more competitive business environment than neighboring states.

Compliance and Economic Impacts of Taxing Personal Property

In the movie My Summer Story (MGM 1994), set in 1940s Indiana, the main family learns that the TPP tax collector is en route. The whole neighborhood erupts into a flurry of activity, peddling dressers on wheelbarrows and strapping couches to the roofs of their cars, scrambling to hide anything of value from being assessed. Everyone wastes time complying with and attempting to evade the tax, and the tax certainly depresses investment in new purchases. While today's TPP usually only applies to business property, the negative effects are no different.

Tangible personal property taxes generally require that a detailed schedule of all items in a business location be inventoried, totaled, listed, and depreciated according to an approximation of fair market value over the lifetime of the product. While some standard depreciation methods exist for common products and machinery, there is a great deal of guesswork afforded to depreciation methods used for miscellaneous office supplies, specialty machinery and mundane objects.[1]

As opposed to taxes on real estate, where levies are based on official appraisals of property, the self-evaluation of personal property leaves much of the value of the product up to the discretion of the taxpayer. The present tax thus creates unfortunate incentives to evade or misrepresent tax liability.[2] They also represent a particular barrier to start-up businesses and expanding businesses, as their compliance burden rises with new investments.

Exemptions versus Preferential Tax Treatment
Florida currently does not tax tangible personal property until it crosses the threshold of $25,000. On one hand, this exemption prevents smaller firms from being subject to the complexities of this tax. However, institutionalizing a two-tier system where some businesses are subject to the tax and others are not may lead to distortions, as firms could structure themselves in a way to avoid the tax.

With that said, raising the exemption with the end goal of removing the tangible personal property tax is an appropriate method of phasing out the tax. Giving localities the freedom to reduce rates, increase exemptions, or fully eliminate the tangible personal property tax in their jurisdiction would foster competitive approaches and should be encouraged.

Conclusion
Though tangible personal property taxes are an important revenue source to many localities, their effect on economic decision-making is not worth the price tag. Other less distortionary methods for collecting local revenue exist, and can be implemented in those jurisdictions that rely heavily on TPP revenue. The bills as proposed provide an opportunity for Florida to improve its business tax climate and put the state on the path to eliminating this outmoded tax.

[1] How to Depreciate Property. Publication 946 (2010). Internal Revenue Service website.

http://www.irs.gov/businesses/small/article/0,,id=137026,00.html.

[2] Florida Tangible Personal Property Tax Return and Instructions. DR-405. http://dor.myflorida.com/dor/forms/2007/dr405a.pdf

Reversal of the Trend: Income Inequality Now Lower than It Was under Clinton

Mon, 30 Jan 2012 00:00:00 EST

Download a PDF of this study.

Tax Foundation Fiscal Fact No. 289

Introduction

Numerous academic studies have shown that income inequality in the U.S. over the 20th century exhibits a U-shape. After reaching a peak in the 1920s, it fell during the Great Depression and World War II and rebounded mainly in the 1980s and 1990s.¹ The rebound has been attributed to various economic factors, such as globalization, immigration, the growth of super-star salaries, and the computer revolution. However, these factors might better be described as the normal outcomes of a growing economy, according to Adam Smith’s idea that the division of labor is limited by the extent of the market. The resurgence of inequality has also been attributed to tax policy, particularly the reduction of top marginal rates on personal income from 94 percent in 1945 to 28 percent in 1988.²

The first decade of the 21st century does not exhibit the same trend. Based on the most recent IRS data, from 2009, income inequality has fluctuated considerably since 2000 but is now at about the level it was in 1997. Thus, the Bush-era tax cuts (which had provisions benefitting both high- and low-income taxpayers) did not lead to increased income inequality. By contrast, inequality rose 12 percent between 1993 and 2000, following two tax rate increases on high-income earners. Thus, changes in inequality over the last two decades appear to be driven more by the business cycle than by tax policy.

Why 2006 and 2007 Are Not Representative

The most recent published studies on income inequality use 2006 or 2007 as their end point, without fully correcting for the business cycle. For example, in an article published in March 2011,³ Atkinson, Piketty, and Saez look at income shares from the early 20th century up to 2007, finding:

After a precipitous (10 percentage point) decline during World War II and stability in the postwar decades, the top decile share [of income] has surged (a rise of more than 10 percentage points) since the 1970s and reached almost 50 percent by 2007, the highest level on record.

In a study published in October 2011, the Congressional Budget Office concludes that income inequality increased significantly between 1979 and 2007, and that part of the reason is that the federal tax code has become less progressive, i.e. redistributive.⁴ The most recent study,⁵ published in December 2011 by the Congressional Research Service (CRS), highlights just two years, 1996 and 2006, and concludes:

Changes in income from capital gains and dividends were the single largest contributor to rising income inequality between 1996 and 2006. Changes in tax policy also made a significant contribution to the increase in income inequality, but even in the absence of tax policy changes income inequality would likely have increased.

The CRS justifies their choice of years as follows:

The years 1996 and 2006 are examined for several reasons. First, both years were at approximately similar points of the business-cycle with moderate inflation (about 3%), a modest unemployment rate (about 5%), and moderate economic growth (3.7% in 1996 and 2.7% in 2006). Second, 2006 was the year before the August 2007 liquidity crunch and the onset of the severe 2007-2009 recession. Third, there were major tax policy changes between these two years. Fourth, both 1996 and 2006 were three years after the enactment of tax legislation that affected tax rates and are unlikely to be affected by short-run behavioral responses to these changes.

In fact, 1996 and 2006 are not even close to similar points in the business cycle: 1996 was at the beginning of an economic expansion that lasted another four years, while 2006 was at the end of an economic expansion that ended the following year.

It is deeply misleading to talk about income inequality without properly taking into account the business cycle. Since the peak of the business cycle in 2007, personal incomes have collapsed to a degree not seen since the Great Depression. The most dramatic collapse has been in high incomes, as the most recent IRS data shows.⁶ For example, since 2007 the number of millionaires has dropped 40 percent, while income reported by millionaires has dropped in half.⁷

Updated Measures of Income Inequality

Figure 1 illustrates how the Great Recession has dramatically reduced measures of income inequality. It shows the share of income attributable to the top 1 percent of income earners from 1980 to 2009. The top 1 percent income share peaked in 2007 at 22.8 percent and declined precipitously to 16.9 percent by 2009. This is about where it was in 1996-1997. This data is also shown in Table 1.

Figure 2 shows that another standard measure of income inequality, the Gini coefficient, is consistent with these results. The Gini coefficient is a ratio that ranges from zero to one, with zero indicating perfect equality and one indicating perfect inequality. As with the top 1 percent share, the Gini coefficient peaked in 2007, at 0.574. From there, it fell 7 percent to 0.535 in 2009, which is about where it was in 1997-1998.

Figure 1

Note: Income is Adjusted Gross Income. Source: IRS. http://www.irs.gov/taxstats/indtaxstats/article/0,,id=133521,00.html

Figure 2

Note: The income shares used to calculate the Gini coefficient are those provided by the IRS: Bottom 50, 75, 90, 95, and 99 percent. Additional percentiles, particularly at the low end, would make for a more accurate estimation, but nonetheless this method produces numbers that closely match other published estimates. Source: IRS. http://www.irs.gov/taxstats/indtaxstats/article/0,,id=133521,00.html

Both measures of income inequality exhibit a strong upward trend between the 1980s and 2000. The first episode occurred during the Reagan economic expansion of 1981-1988, and the second episode occurred during the Clinton expansion of 1993-2000. Each episode increased the top 1 percent share of the nation’s income by about 7 percentage points. Under Clinton, the top 1 percent’s share went from 13.8 percent in 1993 to 20.8 percent in 2000. Likewise, the Gini coefficient went from 0.498 in 1993 to 0.555 in 2000 – an increase of 12 percent.

In contrast, the period since 2000 exhibits no underlying trend in income inequality, but rather dramatic fluctuations resulting from the business cycle. Income inequality at the beginning and end of the Bush years was virtually unchanged, with the top 1 percent share going from 20.8 percent in 2000 to 20.0 percent in 2008. Likewise, the Gini coefficient went from 0.555 in 2000 to 0.557 in 2008. By 2009, as mentioned, both measures of income inequality had fallen to 1997 levels.

The Role of Tax Policy

The 20th century history of income inequality and income tax rates does indicate a strong relationship. As others have noted, it is very plausibly the case that income inequality only began to return to pre-Depression levels once tax rates returned to pre-Depression levels.⁸ The range of tax rates over this period is dramatic, going from a top marginal rate of 7 percent in 1913, to 94 percent in 1944-1945, to 28 percent in 1988.⁹

Since 1988, changes in tax rates have been relatively small, and do not appear to have had a consistent effect on income inequality. In 1991, George H.W. Bush raised the top marginal rate to 31 percent from 28 percent, and in 1993 Clinton raised it further to 39.6 percent. This was followed by a long period of increasing income inequality. By contrast, George W. Bush lowered rates in 2001 and 2003 and inequality fluctuated with the business cycle, ultimately falling below where it was in 2000.

Figure 3 shows the top marginal rate on ordinary personal income, from 1986 to 2009. 1986 was the last major tax reform, and it dramatically lowered the top marginal rate on ordinary income. This began a long trend of business income moving from the corporate code to the personal code in the form of pass-through entities such as partnerships and S-corporations, such that now the majority of business income is taxed under the personal code. Further, a large share of that business income accrues to high-income earners. For instance, about a third of the income of millionaires is from business sources.¹⁰ This alone might explain much of the measured increase in income inequality since 1986.

Top marginal rates on personal income are but one indication of how taxes might affect inequality. A more comprehensive measure of the overall progressivity of the income tax code is the share of income taxes paid by the top 1 percent, which is shown in Figure 4 as well as Table 1. The share of taxes paid by the top 1 percent has roughly doubled since the early 1980s, from 17.6 percent in 1981 to 36.7 percent in 2009. And unlike the top 1 percent’s share of income, the long-term upward trend remains intact. Since the peak in 2007, the share of taxes paid by the top 1 percent has fallen back to 1999-2000 levels, whereas the top 1 percent’s share of income has fallen further, to 1996-1997 levels.

This implies that the overall progressivity of the federal income tax code, taking into account income shares, has increased since 2000. Figure 5 and Table 1 show a measure of progressivity that takes into account income shares, where progressivity is defined as the ratio of the top 1 percent’s share of taxes paid over their share of income.¹¹ Progressivity by this measure is now higher than at any time since 1986, though it has mainly fluctuated with the business cycle without any long-run trend. The fact that progressivity has increased since Clinton was in office may be partly explained by the fact that the Bush tax cuts not only lowered top marginal rates, but also introduced the 10 percent bracket, expanded the 15 percent bracket, expanded the child credit, and made many tax credits refundable.¹²

Figure 3

Source: IRS, http://taxfoundation.org/taxdata/show/151.html

Figure 4

Source: IRS. http://www.irs.gov/taxstats/indtaxstats/article/0,,id=133521,00.html

Figure 5

Note: Progressivity is defined as the ratio of the top 1 percent’s tax share divided by their income share. The Tax Reform Act of 1986 changed the definition of adjusted gross income, so data before and after is not strictly comparable. Source: IRS, Tax Foundation summary: http://taxfoundation.org/research/show/250.html

Table 1 Progressivity of the Federal Income Tax Code, Taking into Account Income Shares

Year	Top 1% Income Share (A)	Top 1% Tax Share (B)	Progressivity (B/A)
1980	8.46%	19.05%	2.25
1981	8.30%	17.58%	2.12
1982	8.91%	19.03%	2.14
1983	9.29%	20.32%	2.19
1984	9.66%	21.12%	2.19
1985	10.03%	21.81%	2.17
1986	11.30%	25.75%	2.28
1987	12.32%	24.81%	2.01
1988	15.16%	27.58%	1.82
1989	14.19%	25.24%	1.78
1990	14.00%	25.13%	1.80
1991	12.99%	24.82%	1.91
1992	14.23%	27.54%	1.94
1993	13.79%	29.01%	2.10
1994	13.80%	28.86%	2.09
1995	14.60%	30.26%	2.07
1996	16.04%	32.31%	2.01
1997	17.38%	33.17%	1.91
1998	18.47%	34.75%	1.88
1999	19.51%	36.18%	1.85
2000	20.81%	37.42%	1.80
2001	17.53%	33.89%	1.93
2002	16.12%	33.71%	2.09
2003	16.77%	34.27%	2.04
2004	19.00%	36.89%	1.94
2005	21.20%	39.38%	1.86
2006	22.06%	39.89%	1.81
2007	22.83%	40.41%	1.77
2008	20.00%	38.02%	1.90
2009	16.93%	36.73%	2.17

Note: The Tax Reform Act of 1986 changed the definition of adjusted gross income, so data before and after is not strictly comparable. Source: IRS, Tax Foundation summary: http://taxfoundation.org/research/show/250.html

Capital Gains and Volatility

The overwhelming characteristic of income inequality in the last decade is its volatility. Much of this is due to the business cycle, and in turn fluctuations in the stock market and capital gains, since capital gains mainly accrue to high-income earners. For instance, in 2009 about 20 percent of the income of millionaires was from capital gains.¹³

Figure 6 shows capital gains as a share of income (for all tax filers, not just millionaires), from 1990 to 2009. Capital gains went from 10.2 percent of adjusted gross income in 2007 to 3.0 percent in 2009, while the tax rate on long-term capital gains remained 15 percent. Capital gains as a share of income are now lower than they were before the Bush tax cuts. Likewise, capital gains both increased and decreased between 1997 and 2002 while the capital gains rate stayed at 20 percent.

Figure 7 shows capital gains in dollar terms and compares it to the S&P 500. Clearly, capital gains track the stock market, and are not much affected in the short term by tax rates over this range. Capital gains realizations were $238 billion in 2002, peaked at $896 billion in 2007, and then collapsed to $231 billion by 2009 – a drop of 74 percent in two years. Thus, by this measure as well, capital gains are lower now than they were before the Bush tax cuts.

It’s possible that lowering the tax rate on capital gains created more volatility in the stock market and, thus, capital gains realizations and personal incomes. However, with only two major stock market cycles since 1990, the evidence is inconclusive. During this time, numerous other factors certainly contributed to stock market volatility, such as the internet revolution, war, monetary policy, demographics, and the housing bubble. In the longer series of data presented by Atkinson, Piketty, and Saez (2011), it is evident that the 1920s exhibited a similar degree of volatility in terms of inequality, capital gains, and the stock market. As well, the Revenue Act of 1921 brought the rate on capital gains well below the rate on ordinary income, to 12.5 percent. However, as with recent decades, numerous macroeconomic factors were present in the 1920s that likely had a larger impact on stock market volatility.

Figure 6

Source: IRS. http://www.irs.gov/taxstats/indtaxstats/article/0,,id=134951,00.html

Figure 7

Source: IRS. http://www.irs.gov/taxstats/indtaxstats/article/0,,id=134951,00.html

Conclusion

Income inequality has completely changed since the Great Recession began in late 2007. The long established upward trend has abruptly reversed itself, such that inequality is back where it was in about 1997. Moreover, inequality over the last decade is characterized by extreme volatility, owing to extreme volatility in capital gains, the stock market, and the economy. It is therefore no longer legitimate--if it ever was--to simply draw a line between two years and claim a trend in income inequality.

As a result, it is not evident that the Bush tax cuts in either the top marginal rate or capital gains rate had any long-term effect on inequality. If anything, they appear to have reduced inequality. Therefore, a return to Clinton-era tax rates would not necessarily reduce inequality. The Clinton- and Bush-era tax cuts in the capital gains rate may have resulted in more volatility in capital gains realizations, and thus affected volatility in the stock market, but this remains speculative.

Endnotes

1. See for example the following:

Daniel Feenberg and James Poterba, “The Income and Tax Share of Very High Income Households, 1960 – 1995,” American Economic Review, May 2000.
Thomas Piketty and Emmanuel Saez, “Income Inequality in the United States, 1913-1998,” The Quarterly Journal of Economics, February 2003. Data updated to 2008 here: http://elsa.berkeley.edu/~saez/
Anthony Atkinson, Thomas Piketty, and Emmanuel Saez, “Top Incomes in the Long Run of History,” Journal of Economic Literature, March 2011.

2. History of rates here: http://taxfoundation.org/taxdata/show/151.html

3. Anthony Atkinson, Thomas Piketty, and Emmanuel Saez, “Top Incomes in the Long Run of History,” Journal of Economic Literature, March 2011.

4. “Trends in the Distribution of Household Income between 1979 and 2007”, Congressional Budget Office, October 2011. See our critique here: http://www.taxfoundation.org/blog/show/27722.html

5. Thomas Hungerford, “Changes in the Distribution of Income among Tax Filers between 1996 and 2006: The Role of Labor Income, Capital Income, and Tax Policy,” Congressional Research Service, December 29, 2011. http://taxprof.typepad.com/files/crs-2.pdf

6. David Logan, “Summary of Latest Federal Individual Income Tax Data,” Tax Foundation, Fiscal Fact No. 285. http://www.taxfoundation.org/news/show/250.html

7. http://www.taxfoundation.org/blog/show/27679.html

8. Thomas Piketty and Emmanuel Saez, “Income Inequality in the United States, 1913-1998,” The Quarterly Journal of Economics, February 2003. Data updated to 2008 here: http://elsa.berkeley.edu/~saez/ Anthony Atkinson, Thomas Piketty, and Emmanuel Saez, “Top Incomes in the Long Run of History,” Journal of Economic Literature, March 2011.

9. History of rates here: http://taxfoundation.org/taxdata/show/151.html

10. http://www.taxfoundation.org/blog/show/27676.html

11. The OECD uses a similar measure of progressivity. For instance, see: Growing Unequal? Income Distribution and Poverty in OECD Countries, OECD, 2008.

12. http://taxfoundation.org/research/topic/172.html

13. http://www.taxfoundation.org/blog/show/27676.html

2012 State Business Tax Climate Index

Wed, 25 Jan 2012 00:00:00 EST

Tax Foundation Background Paper No. 62

Download a full PDF of the study here, or download Excel tables here. Purchase the study on Amazon.com here or contact us abotu bulk discounts.

The Tax Foundation presents the 2012 version of the State Business Tax Climate Index to enable business leaders, government policymakers, and taxpayers to gauge how their states’ tax systems compare.

The 10 best states in this year’s Index are:

1. Wyoming

2. South Dakota

3. Nevada

4. Alaska

5. Florida

6. New Hampshire

7. Washington

8. Montana

9. Texas

10. Utah

It is obvious that the absence of a major tax is a dominant factor in vaulting many of these 10 states to the top of the rankings. Property taxes and unemployment insurance taxes are levied in every state, but there are several states that 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 10 lowest ranked, or worst, states in this year’s Index are:

41. Iowa

42. Maryland

43. Wisconsin

44. North Carolina

45. Minnesota

46. Rhode Island

47. Vermont

48. California

49. New York

50. New Jersey

New Jersey scores at the bottom by having the third-worst individual income tax, the fifth-worst sales tax, the 13th-worst corporate tax, and the second-worst property tax. Rhode Island has improved from 47th to 46th by implementing a modest individual income tax reform, but still has the worst unemployment tax system and fifth-worst property tax system. Maryland improved from 44th to 42nd this year due mostly to the expiration of the state’s “millionaire’s tax” on high-income earners. The states in the bottom 10 suffer from the same afflictions: complex, non-neutral taxes with comparatively high rates.

Illinois moved most dramatically in its Index rank over the past year, falling twelve places (from 16th place in 2011 to 28th place in 2012).

The 2012 Index represents the tax climate of each state as of July 1, 2011, the first day of the standard 2012 state fiscal year.

Table 1.
2012 State Business Tax Climate Index Ranks and Component Tax Ranks

State	Overall Rank	Corporate Tax Rank	Individual Income Tax Rank	Sales Tax Rank	Unemployment Insurance Tax Rank	Property Tax Rank
Alabama	20	16	18	41	11	6
Alaska	4	27	1	5	28	13
Arizona	27	28	17	50	1	5
Arkansas	31	36	27	38	17	18
California	48	43	50	40	13	17
Colorado	16	20	16	44	23	9
Connecticut	40	25	31	30	32	50
Delaware	12	50	28	2	3	14
Florida	5	12	1	19	5	24
Georgia	34	9	40	12	22	39
Hawaii	35	4	41	31	30	15
Idaho	21	19	26	23	48	2
Illinois	28	45	13	33	43	44
Indiana	11	18	10	11	16	11
Iowa	41	48	32	25	35	36
Kansas	25	35	21	32	6	28
Kentucky	22	26	25	8	47	19
Louisiana	32	17	24	49	4	23
Maine	37	47	30	10	40	38
Maryland	42	14	46	9	45	40
Massachusetts	24	34	15	17	49	47
Michigan	18	49	11	7	44	30
Minnesota	45	42	44	36	34	26
Mississippi	17	11	19	28	8	29
Missouri	15	8	23	26	9	7
Montana	8	15	20	3	20	8
Nebraska	30	33	29	27	12	37
Nevada	3	1	1	42	42	16
New Hampshire	6	46	9	1	39	41
New Jersey	50	39	48	46	25	49
New Mexico	38	38	33	45	14	1
New York	49	23	49	37	46	45
North Carolina	44	29	43	47	7	35
North Dakota	29	21	35	15	31	4
Ohio	39	22	42	29	10	33
Oklahoma	33	7	38	39	2	12
Oregon	13	31	34	4	33	10
Pennsylvania	19	44	12	21	37	42
Rhode Island	46	40	36	24	50	46
South Carolina	36	10	39	20	38	21
South Dakota	2	1	1	34	41	20
Tennessee	14	13	8	43	27	48
Texas	9	37	7	35	15	31
Utah	10	5	14	22	24	3
Vermont	47	41	47	14	19	43
Virginia	26	6	37	6	36	27
Washington	7	30	1	48	18	22
West Virginia	23	24	22	18	26	25
Wisconsin	43	32	45	16	21	32
Wyoming	1	1	1	13	29	34
Note: Rankings do not average across to total. States without a given tax rank equally as number 1. Source: Tax Foundation

Table 2. State Business Tax Climate Index, 2011-2012
	FY 2012		FY 2011		Change From 2011 to 2012
State	Score	Rank	Score	Rank	Score	Rank
Alabama	5.31	20	5.35	20	-0.04	0
Alaska	7.36	4	7.44	3	-0.08	-1
Arizona	5.11	27	5.14	27	-0.03	0
Arkansas	4.94	31	4.94	32	0.00	1
California	3.71	48	3.61	48	0.10	0
Colorado	5.41	16	5.50	17	-0.10	1
Connecticut	4.56	40	4.53	40	0.03	0
Delaware	5.75	12	5.76	12	-0.01	0
Florida	6.90	5	6.84	5	0.06	0
Georgia	4.84	34	4.82	34	0.01	0
Hawaii	4.83	35	4.80	35	0.03	0
Idaho	5.23	21	5.21	22	0.02	1
Illinois	5.05	28	5.52	16	-0.47	-12
Indiana	5.99	11	5.99	11	0.00	0
Iowa	4.47	41	4.38	42	0.09	1
Kansas	5.13	25	5.14	26	-0.01	1
Kentucky	5.20	22	5.17	25	0.03	3
Louisiana	4.93	32	4.94	31	-0.01	-1
Maine	4.78	37	4.70	38	0.08	1
Maryland	4.43	42	4.21	44	0.22	2
Massachusetts	5.17	24	5.12	28	0.05	4
Michigan	5.37	18	5.37	19	-0.01	1
Minnesota	4.20	45	4.18	45	0.02	0
Mississippi	5.39	17	5.39	18	0.00	1
Missouri	5.47	15	5.63	14	-0.16	-1
Montana	6.25	8	6.30	7	-0.05	-1
Nebraska	4.95	30	4.99	30	-0.04	0
Nevada	7.45	3	7.42	4	0.03	1
New Hampshire	6.39	6	6.44	6	-0.05	0
New Jersey	3.33	50	3.34	50	-0.01	0
New Mexico	4.72	38	4.76	37	-0.04	-1
New York	3.59	49	3.60	49	-0.02	0
North Carolina	4.22	44	4.08	46	0.14	2
North Dakota	4.98	29	4.87	33	0.11	4
Ohio	4.56	39	4.54	39	0.03	0
Oklahoma	4.92	33	5.01	29	-0.09	-4
Oregon	5.62	13	5.61	15	0.01	2
Pennsylvania	5.32	19	5.33	21	-0.01	2
Rhode Island	4.18	46	3.88	47	0.30	1
South Carolina	4.82	36	4.77	36	0.05	0
South Dakota	7.54	2	7.57	2	-0.03	0
Tennessee	5.62	14	5.65	13	-0.03	-1
Texas	6.08	9	6.12	9	-0.03	0
Utah	6.04	10	6.09	10	-0.04	0
Vermont	4.17	47	4.23	43	-0.06	-4
Virginia	5.11	26	5.20	23	-0.08	-3
Washington	6.36	7	6.20	8	0.16	1
West Virginia	5.19	23	5.17	24	0.02	1
Wisconsin	4.38	43	4.40	41	-0.01	-2
Wyoming	7.67	1	7.63	1	0.04	0

DC	4.48		4.43		0.05

Note: The higher the score, the more favorable a state's tax system is for business. All scores are for fiscal years. Source: Tax Foundation

Introduction

While taxes are a fact of life, not all tax systems are created equal. One measure, total taxes paid, is relevant but other elements of a state tax system can also enhance or harm the competitiveness of a state’s business environment. The Index reduces many complex considerations to an easy-to-use ranking. (Our State-Local Tax Burdens report looks at tax burdens in states.)

The modern market is characterized by mobile capital and labor, with all types of business, small and large, tending to locate where they have the greatest competitive advantage. The evidence shows that states with the best tax systems will be the most competitive in attracting new businesses and most effective at generating economic and employment growth. It is true that taxes are but one factor in business decision-making. Other concerns, such as raw materials or infrastructure or a skilled labor pool, matter, but a simple, sensible tax system can positively or negatively impact business operations with regard to these very resources. Furthermore, unlike changes to a state’s health care, transportation, or education system—which can take decades to implement—changes to the tax code can quickly improve a state’s business climate.

It is important to remember that even in our global economy, states’ stiffest and most direct competition often comes from other states. The Department of Labor reports that most mass job relocations are from one U.S. state to another, rather than to an overseas location.¹ Certainly job creation is rapid overseas, as previously underdeveloped nations enter the world economy without facing the second-highest corporate tax rate in the world, as U.S. businesses do. So state lawmakers are right to be concerned about how their states rank in the global competition for jobs and capital, but they need to be more concerned with companies moving from Detroit, MI, to Dayton, OH, rather than from Detroit to New Delhi. This means that state lawmakers must be aware of how their states’ business climates match up to their immediate neighbors and to other states within their regions.

Anecdotes about the impact of state tax systems on business investment are plentiful. In Illinois early last decade, hundreds of millions of dollars of capital investments were delayed when then-Governor Rod Blagojevich proposed a hefty gross receipts tax. Only when the legislature resoundingly defeated the bill did the investment resume. In 2005, California-based Intel decided to build a multi-billion dollar chip-making facility in Arizona due to its favorable corporate income tax system. In 2010 Northrup Grumman chose to move its headquarters to Virginia over Maryland, citing the better business tax climate.² Anecdotes such as these reinforce what we know from economic theory: taxes matter to businesses, and those places with the most competitive tax systems will reap the benefits of business-friendly tax climates.

Tax competition is an unpleasant reality for state revenue and budget officials, but it is an effective restraint on state and local taxes. It also helps to more efficiently allocate resources because businesses can locate in the states where they receive the services they need at the lowest cost. When a state imposes higher taxes than a neighboring state, businesses will cross the border to some extent. Therefore states with more competitive tax systems score well in the Index because they are best suited to generate economic growth.

State lawmakers are always mindful of their states’ business tax climates but they are often tempted to lure business with lucrative tax incentives and subsidies instead of broad-based tax reform. This can be a dangerous proposition, as the example of Dell Computers and North Carolina illustrates. North Carolina agreed to $240 million worth of incentives to lure Dell to the state. Many of the incentives came in the form of tax credits from the state and local governments. Unfortunately Dell announced in 2009 that it would be closing the plant after only four years of operations.³ A 2007 USA Today article chronicled similar problems other states are having with companies that receive generous tax incentives.⁴

Lawmakers create these deals under the banner of job creation and economic development, but the truth is that if a state needs to offer such packages, it is most likely covering for a woeful business tax climate. A far more effective approach is to systematically improve the business tax climate for the long term so as to improve the state’s competitiveness. When assessing which changes to make, lawmakers need to remember these two rules:

1. Taxes matter to business. Business taxes affect business decisions, job creation and retention, plant location, competitiveness, the transparency of the tax system, and the long-term health of a state’s economy. Most importantly, taxes diminish profits. If taxes take a larger portion of profits, that cost is passed along to either consumers (through higher prices), employees (through lower wages or fewer jobs), or shareholders (through lower dividends or share value). Thus a state with lower tax costs will be more attractive to business investment, and more likely to experience economic growth.

2. States do not enact tax changes (increases or cuts) in a vacuum. Every tax law will in some way change a state’s competitive position relative to its immediate neighbors, its geographic region, and even globally. Ultimately it will affect the state’s national standing as a place to live and to do business. Entrepreneurial states can take advantage of the tax increases of their neighbors to lure businesses out of high-tax states.

In reality, tax-induced economic distortions are a fact of life, so a more realistic goal is to maximize the occasions when businesses and individuals are guided by business principles and minimize those cases where economic decisions are influenced, micromanaged, or even dictated by a tax system. The more riddled a tax system is with politically motivated preferences, the less likely it is that business decisions will be made in response to market forces. The Index rewards those states that apply these principles.

Ranking the competitiveness of 50 very different tax systems presents many challenges, especially when a state dispenses with a major tax entirely. Should Colorado’s tax system, which includes three relatively neutral taxes on general sales, individual income and corporate income, be considered more or less competitive than Alaska’s tax system, which includes a particularly burdensome corporate income tax but no tax on individual income or general statewide sales?

The Index deals with such questions by comparing the states on 118 different variables in the five important areas of taxation (major business taxes, individual income taxes, sales taxes, unemployment insurance taxes, and property taxes) and then adding the results up to a final, overall ranking. This approach has the advantage of rewarding states on particularly strong aspects of their tax systems (or penalizing them on particularly weak aspects) while also measuring the general competitiveness of their overall tax systems. The result is a score that can be compared to other states’ scores.Ultimately, both Alaska and Colorado score well.

A Review of the Economic Literature

Economists have not always agreed on how individuals and businesses react to taxes. As early as 1956, Charles Tiebout postulated that if citizens were faced with an array of communities that offered different types or levels of public goods and services at different costs or tax levels, then all citizens would choose the community that best satisfied their particular demands, revealing their preferences by “voting with their feet.” Tiebout’s article is the seminal work on the topic of how taxes affect the location decisions of taxpayers.

Tiebout suggested that citizens with high demands for public goods would concentrate themselves in communities with high levels of public services and high taxes while those with low demands would choose communities with low levels of public services and low taxes. Competition among jurisdictions results in a variety of communities, each with residents that all value public services similarly.

However, businesses sort out the costs and benefits of taxes differently from individuals. To businesses, which can be more mobile and must earn profits to justify their existence, taxes reduce profitability. Theoretically, then, businesses could be expected to be more responsive than individuals to the lure of low-tax jurisdictions.

No matter what level of government services individuals prefer, they want to know that public goods and services are provided efficiently. Because there is little competition for providing government goods and services, ferreting out inefficiency in government is notoriously difficult. There is a partial solution to this “information asymmetry” between taxpayers and government: “Yardstick Competition.” Shleifer (1985) first proposed comparing regulated franchises in order to determine efficiency. Salmon (1987) extended Shleifer’s work to look at sub-national governments. Besley and Case (1995) showed that “yardstick competition” affects voting behavior and Bosch and Sole-Olle (2006) further confirmed the results found by Besley and Case. Tax changes that are out of sync with neighboring jurisdictions will impact voting behavior.

The economic literature over the past 50 years has slowly cohered around this hypothesis. Ladd (1998) summarizes the post-World War II empirical tax research literature in an excellent survey article, breaking it down into three distinct periods of differing ideas about taxation: (1) taxes do not change behavior; (2) taxes may or may not change business behavior depending on the circumstances; and (3) taxes definitely change behavior.

Period one, with the exception of Tiebout, included the 1950s, 1960s and 1970s and is summarized succinctly in three survey articles: Due (1961), Oakland (1978) and Wasylenko (1981). Due’s was a polemic against tax giveaways to businesses, and his analytical techniques consisted of basic correlations, interview studies and the examination of taxes relative to other costs. He found no evidence to support the notion that taxes influence business location. Oakland was skeptical of the assertion that tax differentials at the local level had no influence at all. However, because econometric analysis was relatively unsophisticated at the time, he found no significant articles to support his intuition. Wasylenko’s survey of the literature found some of the first evidence indicating that taxes do influence business location decisions. However, the statistical significance was lower than that of other factors such as labor supply and agglomeration economies. Therefore, he dismissed taxes as a secondary factor at most.

Period two was a brief transition during the early- to mid-1980s. This was a time of great ferment in tax policy as Congress passed major tax bills, including the so-called Reagan tax cut in 1981 and a dramatic reform of the tax code in 1986. Articles revealing the economic significance of tax policy proliferated and became more sophisticated. For example, Wasylenko and McGuire (1985) extended the traditional business location literature to non-manufacturing sectors and found, “Higher wages, utility prices, personal income tax rates, and an increase in the overall level of taxation discourage employment growth in several industries.” However, Newman and Sullivan (1988) still found a mixed bag in “their observation that significant tax effects [only] emerged when models were carefully specified.” (Ladd, p. 89).

Ladd was writing in 1998, so her “period three” started in the late 1980s and continued up to 1998 when the quantity and quality of articles increased significantly. Articles that fit into period three begin to surface as early as 1985, as Helms (1985) and Bartik (1985) put forth forceful arguments based on empirical research that taxes guide business decisions. Helms concluded that a state’s ability to attract, retain, and encourage business activity is significantly affected by its pattern of taxation. Furthermore, tax increases significantly retard economic growth when the revenue is used to fund transfer payments. Bartik found that the conventional view that state and local taxes have little effect on business, as he describes it, is false.

Papke and Papke (1986) found that tax differentials between locations may be an important business location factor, concluding that consistently high business taxes can represent a hindrance to the location of industry. Interestingly, they use the same type of after-tax model used by Tannenwald (1996), who reaches a different conclusion.

Bartik (1989) provides strong evidence that taxes have a negative impact on business start-ups. He finds specifically that property taxes, because they are paid regardless of profit, have the strongest negative effect on business. Bartik’s econometric model also predicts that tax elasticities of –.1 to –.5 imply that a 10 percent cut in tax rates will increase business activity by 1 to 5 percent. Bartik’s findings, as well as those of Mark, McGuire, and Papke (2000) and ample anecdotal evidence of the importance of property taxes, buttress the argument for inclusion of a property index devoted to property-type taxes in the Index.

By the early 1990s, the literature expanded enough so that Bartik (1991) found 57 studies on which to base his literature survey. Ladd succinctly summarizes Bartik’s findings:

The large number of studies permitted Bartik to take a different approach from the other authors. Instead of dwelling on the results and limitations of each individual study, he looked at them in the aggregate and in groups. Although he acknowledged potential criticisms of individual studies, he convincingly argued that some systematic flaw would have to cut across all studies for the consensus results to be invalid. In striking contrast to previous reviewers, he concluded that taxes have quite large and significant effects on business activity.

Ladd’s “period three” surely continues to this day. Agostini and Tulayasathien (2001) examined the effects of corporate income taxes on the location of foreign direct investment in U.S. states. They determined that for “foreign investors, the corporate tax rate is the most relevant tax in their investment decision.” Therefore, they found that foreign direct investment was quite sensitive to states’ corporate tax rates.

Mark, McGuire, and Papke (2000) find that taxes are a statistically significant factor in private-sector job growth. Specifically, they find that personal property taxes and sales taxes have economically large negative effects on the annual growth of private employment (Mark, et al. 2000).

Harden and Hoyt (2003) point to Phillips and Gross (1995) as another study contending that taxes impact state economic growth, and they assert that the consensus among recent literature is that state and local taxes negatively affect employment levels. Harden and Hoyt conclude that the corporate income tax has the most significant negative impact on the rate of growth in employment.

Gupta and Hofmann (2003) regressed capital expenditures against a variety of factors, including weights of apportionment formulas, the number of tax incentives and burden figures. Their model covered 14 years of data and determined that firms tend to locate property in states where they are subject to lower income tax burdens. Furthermore, Gupta and Hofmann suggest that throwback requirements are most influential on the location of capital investment, followed by apportionment weights and tax rates, and that investment-related incentives have the least impact.

Other economists have found that taxes on specific products can produce behavioral results similar to those that were found in these general studies. For example, Fleenor (1998) looked at the effect of excise tax differentials between states on cross-border shopping and the smuggling of cigarettes. Moody and Warcholik (2004) examined the cross-border effects of beer excises. Their results, supported by the literature in both cases, showed significant cross-border shopping and smuggling between low-tax states and high-tax states.

Fleenor found that shopping areas sprouted in counties of low-tax states that shared a border with a high-tax state, and that approximately 13.3 percent of the cigarettes consumed in the United States during FY 1997 were procured via some type of cross-border activity. Similarly, Moody and Warcholik found that in 2000, 19.9 million cases of beer, on net, moved from low- to high-tax states. This amounted to some $40 million in sales and excise tax revenue lost in high-tax states.

Even though the general consensus of the literature has progressed to the view that taxes are a substantial factor in the decision-making process for businesses, there remain some authors who are not convinced.

Based on a substantial review of the literature on business climates and taxes, Wasylenko (1997) concludes that taxes do not appear to have a substantial effect on economic activity among states. He does, however, cite a State Policy Report article that asserts the opposite: that as long as the tax elasticity is negative and significantly different from zero, high-tax states will lose more economic activity than average or low-tax states. Indeed, State Policy Report continues, the highest-tax states, such as Minnesota, Wisconsin and New York, have acknowledged that high taxes may be responsible for the low rates of job creation in those states.⁵

Wasylenko’s rejoinder is that policymakers routinely overestimate the degree to which tax policy affects business location decisions, and that as a result of this misperception, they respond readily to public pressure for jobs and economic growth by proposing lower taxes. According to Wasylenko, other legislative actions are likely to accomplish more positive economic results because in reality, taxes do not drive economic growth. He asserts that lawmakers need better advice than just “Lower your taxes,” but there is no coherent message advocating a different course of action.

However, there is ample evidence that states certainly still compete for businesses using their tax systems. A recent example comes from Illinois, where in early 2011 lawmakers passed two major tax increases. The individual rate increased from 3 percent to 5 percent, and the corporate rate rose from 7.3 percent to 9.5 percent.⁶ The result was that many businesses threatened to leave the state, including some very high-profile Illinois companies such as Sears and the Chicago Mercantile Exchange. By the end of the year lawmakers had cut sweetheart deals with both of these firms, totaling $235 million over the next decade, to keep them from leaving the state.⁷

Measuring the Impact of Tax Differentials

Some recent contributions to the literature on state taxation criticize business and tax climate studies in general.⁸ Authors of such studies contend that comparative reports like the State Business Tax Climate Index do not take into account those factors which directly impact a state’s business climate. However, a careful examination of these criticisms reveals that the authors believe taxes are unimportant to businesses and therefore dismiss the studies as merely being designed to advocate low taxes.

Peter Fisher’s Grading Places: What Do the Business Climate Rankings Really Tell Us?, published by the Economic Policy Institute, criticizes five indexes: The Small Business Survival Index published by the Small Business and Entrepreneurship Council, Beacon Hill’s Competitiveness Reports, the Cato Institute’s Fiscal Policy Report Card, the Economic Freedom Index by the Pacific Research Institute, and this study. Fisher concludes: “The underlying problem with the five indexes, of course, is twofold: none of them actually do a very good job of measuring what it is they claim to measure, and they do not, for the most part, set out to measure the right things to begin with.” (Fisher 2005). Fisher’s major argument is that if the indexes did what they purported to do, then all five of them would rank the states similarly.

Fisher’s conclusion holds little weight because the five indexes serve such dissimilar purposes and each group has a different area of expertise. There is no reason to believe that the Tax Foundation’s Index, which depends entirely on state tax laws, would rank the states in the same or similar order as an index that includes crime rates, electricity costs and health care (Small Business and Entrepreneurship Council’s Small Business Survival Index), or infant mortality rates and the percentage of adults in the workforce (Beacon Hill’s State Competitiveness Report), or charter schools, tort reform and minimum wage laws (Pacific Research Institute’s Economic Freedom Index).

The Tax Foundation’s State Business Tax Climate Index is an indicator of which states’ tax systems are the most hospitable to business and economic growth. The Index does not purport to measure economic opportunity or freedom, or even the broad business climate, but the narrower business tax climate. We do so not only because the Tax Foundation’s expertise is in taxes, but because every component of the Index is subject to immediate change by state lawmakers. It is by no means clear what the best course of action is for state lawmakers who want to thwart crime, for example, either in the short or long term, but they can change their tax codes now. Contrary to Fisher’s contrarian 1970s view that the effects of taxes are “small or non-existent,” our study reflects overwhelming evidence that business decisions are significantly impacted by tax considerations.

Although Fisher does not feel tax climates are important to states’ economic growth, other authors contend the opposite. Bittlingmayer, Eathington, Hall and Orazem (2005) find in their analysis of several business climate studies that a state’s tax climate does affect its economic growth rate, and that several indexes are able to predict growth. In fact, they found, “The State Business Tax Climate Index explains growth consistently.” This finding was recently confirmed by Anderson (2006) in a study for the Michigan House of Representatives.

Bittlingmayer, et al, also found that relative tax competitiveness matters, especially at the borders, and therefore, indexes that place a high premium on tax policies better explain growth. Also, they observed that studies focused on a single topic do better at explaining economic growth at borders. Lastly, the article concludes that the most important elements of the business climate are tax and regulatory burdens on business (Bittlingmayer et al. 2005). These findings support the argument that taxes impact business decisions and economic growth, and they support the validity of the Index.

Fisher and Bittlingmayer et al. hold opposing views about the impact of taxes on economic growth. Fisher finds support from Robert Tannenwald, formerly of the Boston Federal Reserve, who argues that taxes are not as important to businesses as public expenditures. Tannenwald compares 22 states by measuring the after-tax rate of return to cash flow of a new facility built by a representative firm in each state. This very different approach attempts to compute the marginal effective tax rate (METR) of a hypothetical firm and yields results that make taxes appear trivial.

The taxes paid by businesses should be a concern to everyone because they are ultimately borne by individuals through lower wages, increased prices, and decreased shareholder value. States do not institute tax policy in a vacuum. Every change to a state’s tax system makes its business tax climate more or less competitive compared to other states, and makes the state more or less attractive to business. Ultimately, anecdotal and empirical evidence, along with the cohesion of recent literature around the conclusion that taxes matter a great deal to business, show that the Index is an important and useful tool for policymakers who want to make their states’ tax systems welcoming to business.

Methodology

The Tax Foundation’s 2012 State Business Tax Climate Index is a hierarchical structure built from five components:

Corporate Tax
Individual Income Tax
Sales Tax
Property Tax
Unemployment Insurance Tax

Using the economic literature as our guide, we designed these five components to score each state’s business tax climate on a scale of zero (worst) to 10 (best). Each component is devoted to a major area of state taxation and includes numerous variables. Overall, there are 118 variables measured in this report.

The five components are not weighted equally, as they are in many indexes. Rather, each component is weighted based on the variability of the 50 states’ scores from the mean. The standard deviation of each component is calculated and a weight for each component is created from that measure. The result is a heavier weighting of those components with greater variability. The weighting of each of the five major components is:

33.1% — Individual Income Tax

21.4% — Sales Tax

20.3% — Corporate Tax

14.1% — Property Tax

11.1% — Unemployment Insurance Tax

This improves the explanatory power of the State Business Tax Climate Index as a whole because components with higher standard deviations are those areas of tax law where some states have significant competitive advantages. Businesses that are comparing states for new or expanded locations must give greater emphasis to tax climates when the differences are large. On the other hand, components in which the 50 state scores are clustered together, closely distributed around the mean, are those areas of tax law where businesses are more likely to de-emphasize tax factors in their location decisions. For example, Delaware is known to have a significant advantage in sales tax competition because its tax rate of zero attracts businesses and shoppers from all over the mid-Atlantic region. That advantage and its drawing power increase every time a state in the region raises its sales tax.

In contrast with this variability in state sales tax rates, unemployment insurance tax systems are similar around the nation, so a small change in one state’s law could change its component ranking dramatically.

Within each component are two equally weighted sub-indexes devoted to measuring the impact of the tax rates and the tax base. Each sub-index is composed of one or more variables. There are two types of variables: scalar variables and dummy variables. A scalar variable is one that can have any value between 0 and 10. If a sub-index is composed only of scalar variables, then they are weighted equally. A dummy variable is one that has only a value of 0 or 1. For example, a state either indexes its brackets for inflation or does not. Mixing scalar and dummy variables within a sub-index is problematic because the extreme valuation of a dummy can overly influence the results of the sub-index. To counter this effect, the Index weights scalar variables 80 percent and dummy variables 20 percent.

Relative versus Absolute Indexing

The State Business Tax Climate Index is designed as a relative index rather than an absolute or ideal index. In other words, each variable is ranked relative to the variable’s range in other states. The relative scoring scale is from 0 to 10, with zero meaning not “worst possible” but rather worst among the 50 states.

Many states’ tax rates are so close to each other that an absolute index would not provide enough information about the differences between the states’ tax systems, especially to pragmatic business owners who want to know what states have the best tax system in each region.

Comparing States without a Tax. One problem associated with a relative scale, however, is that it is mathematically impossible to compare states with a given tax to states that do not have the tax. As a zero rate is the lowest possible rate and the most neutral base since it creates the most favorable tax climate for economic growth, those states with a zero rate on individual income, corporate income or sales gain an immense competitive advantage. Therefore, states without a given tax generally receive a 10, and the Index measures all the other states against each other.

Normalizing Final Scores. Another problem with using a relative scale within the components is that the average scores across the five components vary. This alters the value of not having a given tax across major indexes. For example, the unadjusted average score of the corporate income tax component is 7.0 while the average score of the sales tax component is 5.32.

In order to solve this problem, scores on the five major components are “normalized,” which brings the average score for all of them to 5.00— excluding states that do not have the given tax. This is accomplished by multiplying every state’s score by a constant value.

Once the scores are normalized, it is possible to compare states across indexes. For example, because of normalization it is possible to say that Connecticut’s score of 5.12 on corporate income tax is better than its score of 2.88 on property tax.

Time Frame Measured by the Index (Snapshot Date)

Starting with the 2006 edition, the Index has measured each state’s business tax climate as it stands at the beginning of the standard state fiscal year, July 1. Therefore, this edition is the 2012 Index and represents the tax climate of each state as of July 1, 2011, the first day of fiscal year 2012 for most states.

District of Columbia

The District of Columbia (DC) is only included as an exhibit and does not affect the relative scores among states.

Changes to Methodology

The marriage penalty section of the individual income tax sub-index was changed to a dummy variable which indicates states that have a marriage penalty built into their tax brackets and do not allow married taxpayers to file separately to avoid this penalty. In previous editions of the Index the marriage penalty was a scalar variable.

The Index generally penalizes states that have top income tax rates that kick in at high income levels and thus only apply to a relatively small proportion of taxpayers. However, previous editions of the Index included an exception that did not penalize states if the top individual or corporate income tax rate kicked in at an income level more than one standard deviation above the average for all states. The 2012 edition removes this exception.

The Index includes an estimate of local individual income tax rates that are levied in addition to the state rate. In previous editions of the Index this had been calculated as a weighted average of statutory rates in large counties and municipalities. In the 2012 edition the average local rate has been changed to an effective rate equal to total local income tax collections divided by state personal income.

2011 Rankings & Scores

This report includes 2011 Index rankings and scores that can be used for comparison with the 2012 rankings and scores. These can differ from previously published 2011 Index rankings and scores, due to backcasting of the above methodological changes and corrections to variables brought to our attention since the last report was published. The 2011 scores and rankings in this report are definitive.

Corporate Income Tax

Table 3 Corporate Tax Component of the State Business Tax Climate Index, 2011-2012
	FY 2012		FY 2011		Change From 2011 to 2012
State	Score	Rank	Score	Rank	Score	Rank
Alabama	5.39	16	5.08	24	0.31	8
Alaska	5.08	27	5.06	27	0.03	0
Arizona	5.02	28	4.99	29	0.03	1
Arkansas	4.73	36	4.71	35	0.02	-1
California	4.42	43	4.39	44	0.02	1
Colorado	5.31	20	5.58	14	-0.27	-6
Connecticut	5.12	25	5.26	19	-0.15	-6
Delaware	3.15	50	3.13	50	0.02	0
Florida	5.58	12	5.55	15	0.03	3
Georgia	5.88	9	5.93	8	-0.05	-1
Hawaii	6.07	4	5.84	10	0.23	6
Idaho	5.33	19	5.30	18	0.03	-1
Illinois	4.07	45	5.02	28	-0.96	-17
Indiana	5.33	18	5.19	22	0.14	4
Iowa	3.78	48	3.76	48	0.02	0
Kansas	4.73	35	4.70	36	0.04	1
Kentucky	5.10	26	5.07	26	0.03	0
Louisiana	5.38	17	5.36	17	0.03	0
Maine	3.97	47	3.95	47	0.02	0
Maryland	5.53	14	5.59	13	-0.06	-1
Massachusetts	4.78	34	4.63	37	0.15	3
Michigan	3.35	49	3.36	49	-0.01	0
Minnesota	4.46	42	4.35	45	0.11	3
Mississippi	5.78	11	5.63	11	0.14	0
Missouri	5.91	8	6.07	6	-0.17	-2
Montana	5.53	15	5.50	16	0.03	1
Nebraska	4.81	33	4.78	33	0.02	0
Nevada	10.00	1	10.00	1	0.00	0
New Hampshire	4.02	46	4.00	46	0.02	0
New Jersey	4.58	39	4.55	40	0.02	1
New Mexico	4.60	38	4.77	34	-0.17	-4
New York	5.24	23	5.22	21	0.03	-2
North Carolina	5.02	29	5.07	25	-0.06	-4
North Dakota	5.30	21	4.96	30	0.34	9
Ohio	5.26	22	5.23	20	0.03	-2
Oklahoma	5.91	7	5.96	7	-0.05	0
Oregon	4.96	31	4.59	39	0.38	8
Pennsylvania	4.36	44	4.62	38	-0.26	-6
Rhode Island	4.55	40	4.53	41	0.02	1
South Carolina	5.81	10	5.86	9	-0.05	-1
South Dakota	10.00	1	10.00	1	0.00	0
Tennessee	5.56	13	5.62	12	-0.06	-1
Texas	4.67	37	4.45	43	0.22	6
Utah	6.05	5	6.21	4	-0.17	-1
Vermont	4.55	41	4.53	42	0.02	1
Virginia	5.96	6	6.13	5	-0.17	-1
Washington	4.98	30	4.79	32	0.19	2
West Virginia	5.18	24	5.15	23	0.03	-1
Wisconsin	4.87	32	4.96	31	-0.09	-1
Wyoming	10.00	1	10.00	1	0.00	0

DC	4.78		4.58		0.19

Note: The higher the score, the more favorable a state's tax system is for business. All scores are for fiscal years. Source: Tax Foundation

This component measures the impact of each state’s principal tax on business activities and accounts for 20.3 percent of each state’s total score. It is well established that the extent of business taxation can affect a business’s level of economic activity within a state. For example, Newman (1982) found that differentials in state corporate income taxes were a major factor influencing the movement of industry to southern states. Two decades later, with global investment greatly expanded, Agostini and Tulayasathien (2001) determined that a state’s corporate tax rate is the most relevant tax in the investment decisions of foreign investors.

Most states levy standard corporate income taxes on profit. profit (gross receipts minus expenses). A growing number of states, however, impose taxes on the gross receipts of businesses with few or no deductions for expenses. Between 2005 and 2010, for example, Ohio phased in the commercial activities tax (CAT) which has a rate of 0.26 percent. Washington has the business and occupation (B&O) tax, which is a multi-rate tax (depending on industry) on the gross receipts of Washington businesses. Delaware has a similar Manufacturers’ and Merchant’s License Tax, as does Virginia, with its locally-levied Business/Professional/Occupational License (BPOL) tax. Texas also added a complicated gross receipts “margin” tax in 2007. However, in 2011, Michigan passed a significant corporate tax reform that eliminates the state’s modified gross receipts tax and replaces it with a 6 percent corporate income tax, effective January 1, 2012.⁹ The previous tax had been in place since 2007 and Michigan’s repeal follows others in Kentucky (2006) and New Jersey (2006).

Since gross receipts taxes and corporate income taxes are levied on different bases, we separately compare gross receipts taxes to each other, and corporate income taxes to each other, in the Index.

For states with corporate income taxes, the corporate tax rate sub-index is computed by assessing three key areas: the top tax rate, the level of taxable income at which the top rate kicks in, and the number of brackets. States that levy neither a corporate income tax nor a gross receipts tax achieve a perfectly neutral system in regard to business income and so receive a perfect score.

For states with gross receipts taxes—or their functional equivalent—the state’s corporate tax rate sub-index is computed by assessing two key areas: the gross receipts tax rate, and whether the gross receipts rate is an alternative assessment or a generally applicable tax. The latter variable was included so the states that levy a gross receipts tax as an alternative to the corporate income tax are not unduly penalized.

States that do impose a corporate tax generally will score well if they have a low rate. States with a high rate or a complex and multiple-rate system score poorly.

To compute the parallel sub-index for the corporate tax base, three broad areas are assessed: tax credits, treatment of net operating losses, and an “other” category that includes variables such as conformity to the Internal Revenue Code, protections against double taxation, and the taxation of “throwback” income provisions, among others. States that score well on the corporate tax base sub-index generally will have few business tax credits, generous carry-back and carry-forward provisions, deductions for net operating losses, conformity to the Internal Revenue Code, and provisions for alleviating double taxation.

Corporate Tax Rate

The corporate tax rate sub-index is designed to gauge how a state’s corporate income tax top rate, bracket structure, and gross receipts rate affect its competitiveness compared to other states, as the extent of taxation can affect a business’s level of economic activity within a state (Newman 1982).

A state’s corporate tax is levied in addition to the federal corporate income tax rate, which varies from 15 percent on the first dollar of income to a top rate of 35 percent. This top rate is the second-highest corporate income tax rate among industrial nations. In many states, federal and state corporate tax rates combine to levy the highest corporate tax rates in the world.¹⁰

On the other hand, there are three states that levy neither a corporate income tax nor a gross receipts tax: Nevada, South Dakota and Wyoming. These states automatically score a perfect 10 for this sub-index. Therefore, this section ranks the remaining 47 states relative to each other.

Top Tax Rate. Iowa’s 12 percent corporate income tax rate qualifies for the worst ranking among states that levy one, followed by Pennsylvania’s 9.99 percent rate. Other states with comparatively high corporate income tax rates are the District of Columbia (9.975 percent), Minnesota (9.8 percent), Illinois (9.5 percent), Alaska (9.4 percent), and New Jersey and Rhode Island(9 percent). By contrast, Colorado’s 4.63 percent is the lowest nationally. Other states with comparatively low top corporate tax rates are Mississippi, South Carolina, and Utah (all at 5 percent).

Graduated Rate Structure. Two variables are used to assess the economic drag created by multiple-rate corporate income tax systems: the income level at which the highest tax rate starts to apply and the number of tax brackets. Thirty-two states and the District of Columbia have flat, single-rate systems, and they score best. Flat-rate systems are consistent with the sound tax principles of simplicity and neutrality. In contrast to the individual income tax, there is no meaningful “ability to pay” concept in corporate taxation. Jeffery Kwall, the Kathleen and Bernard Beazley Professor of Law at Loyola University Chicago School of Law, notes that

[G]raduated corporate rates are inequitable—that is, the size of a corporation bears no necessary relation to the income levels of the owners. Indeed, low-income corporations may be owned by individuals with high incomes, and high-income corporations may be owned by individuals with low incomes.¹¹

A flat system minimizes the incentive for firms to engage in expensive, counterproductive tax planning to mitigate the damage of higher marginal tax rates that some states levy as taxable income rises.

The Top Bracket. This variable measures how soon a state’s tax system applies its highest corporate income tax rate. The highest score is awarded to a single-rate system that has one bracket that applies to the first dollar of taxable income. Next best is a two-bracket system where the top rate kicks in at a low level of income, since the lower the top rate kicks in, the more the system is like a flat tax. States with multiple brackets spread over a broad income spectrum are given the worst score.

Number of Brackets. An income tax system creates changes in behavior when the taxpayer’s income reaches the end of one tax rate bracket and moves into a higher bracket. At such a break point, incentives change, and as a result, numerous rate changes are more economically harmful than a single-rate structure. This variable is intended to measure the disincentive effect the corporate income tax has on rising incomes. States that score the best on this variable are the 29 states—and the District of Columbia—that have a single-rate system. Alaska’s 10-bracket system earns the worst score in this category. Other states with multi-bracket systems include Arkansas (six brackets), and Louisiana (five brackets).

Corporate Tax Base

This sub-index measures the economic impact of each state’s definition of what should be subject to corporate taxation.

Under a corporate income tax, three criteria used to measure the competitiveness of each state’s tax base are given equal weight: the availability of certain credits, deductions and exemptions; the ability of taxpayers to deduct net operating losses; and a host of smaller tax base issues that combine to make up the other third of the corporate tax base.

Under a gross receipts tax, some of these tax base criteria (net operating losses and some corporate income tax base variables) are replaced by the availability of deductions from gross receipts for employee compensation costs and cost of goods sold. States are rewarded for granting these deductions because they diminish the greatest disadvantage of using gross receipts as the base for corporate taxation: the uneven effective tax rates that various industries pay, depending on how many levels of production are hit by the tax.

Net Operating Losses. The corporate income tax is designed to tax only the profits of a corporation. However, a yearly profit snapshot may not fully capture a corporation’s true profitability. For example, a corporation in a highly cyclical industry may look very profitable during boom years but lose substantial amounts during bust years. When examined over the entire business cycle, the corporation may actually have an average profit margin.

The deduction for net operating losses (NOL) helps ensure that, over time, the corporate income tax is a tax on average profitability. Without the NOL deduction, corporations in cyclical industries pay much higher taxes than those in stable industries, even assuming identical average profits over time. Put simply, the NOL deduction helps level the playing field among cyclical and non-cyclical industries. The federal government currently allows a two-year carry-back cap and a 20-year carry-forward cap, and these two variables are taken into account.

Number of Years Allowed for Carry-Back and Carry-Forward. This variable measures the number of years allowed on a carry-back or carry-forward of an NOL deduction. The longer the overall time span, the higher the probability that the corporate income tax is being levied on the corporation’s average profitability. Generally, states entered 2012 with better treatment of the carry-forward (up to a maximum of 20 years) than the carry-back (maximum of three years).

Caps on the Amount of Carry-Back and Carry-Forward. When companies have a bigger NOL than they can deduct in one year, most states permit them to carry deductions of any amount back to previous years’ returns or forward to future returns. States that limit those amounts are downgraded in the Index. Five states limit the amount of carry-backs: Delaware, Idaho, New York, Utah and West Virginia. Of states that allow a carry-forward of losses, only Pennsylvania and New Hampshire limit carry-forwards, and Colorado has limited them temporarily for 2011-2013. As a result, these states score poorly in this variable.

Gross Receipts Tax Deductions. Proponents of gross receipts taxation invariably praise the steadier flow of tax receipts into government coffers in comparison with the fluctuating revenue generated by corporate income taxes, but this stability comes at a great cost. The attractively low statutory rates associated with gross receipts taxes are an illusion. Since gross receipts taxes are levied many times in the production process, the effective tax rate on a product is much higher than the statutory rate would suggest. Effective tax rates under a gross receipts tax vary dramatically by product. Firms with few steps in production are relatively lightly taxed under a gross receipts tax, and vertically-integrated, high-margin firms prosper. The pressure of this economic imbalance often leads lawmakers to enact separate rates for each industry, an inevitably unfair and inefficient process.

Two reforms that states can make to mitigate this damage are to permit deductions from gross receipts for employee compensation costs and cost of goods sold, effectively moving toward a regular corporate income tax.

Delaware, Ohio, and Washington score the worst because their gross receipts taxes do not offer full deductions for either the cost of goods sold or employee compensation. Texas offers a deduction for either the cost of goods sold or compensation, but not both.

Federal Income Used as State Tax Base. States that use federal definitions of income reduce the tax compliance burden on their taxpayers.¹² Two states do not conform to federal definitions of corporate income—Arkansas and Mississippi—and they score poorly.

Allowance of Federal ACRS and MACRS Depreciation. The vast array of federal depreciation schedules is, by itself, a tax complexity nightmare for businesses. The specter of having 50 different schedules would be a disaster from a tax complexity standpoint. This variable measures the degree to which states have adopted the federal ACRS and MACRS depreciation schedules.¹³ One state (California) adds complexity by failing to fully conform to the federal system.

Deductibility of Depletion. The deduction for depletion works similarly to depreciation, but it applies to natural resources. As with depreciation, tax complexity would be staggering if all 50 states imposed their own depletion schedules. This variable measures the degree to which states have adopted the federal depletion schedules.¹⁴ Seventeen states are penalized because they do not fully conform to the federal system: Alabama, Alaska, California, Delaware, Indiana, Iowa, Louisiana, Maryland, Minnesota, Mississippi, New Hampshire , North Carolina, Oklahoma, Oregon, South Carolina, Tennessee, and Wisconsin.

Alternative Minimum Tax. The federal Alternative Minimum Tax (AMT) was created to ensure that all taxpayers paid some minimum level of taxes every year. Unfortunately, it does so by creating a parallel tax system to the standard corporate income tax code. Evidence shows that the AMT does not increase efficiency or improve fairness in any meaningful way. It nets little money for the government, imposes compliance costs that in some years are actually larger than collections, and encourages firms to cut back or shift their investments (Chorvat and Knoll, 2002). As such, states that have mimicked the federal AMT put themselves at a competitive disadvantage through needless tax complexity.

Nine states have an AMT on corporations and thus score poorly: Alaska, California, Florida, Iowa, Kentucky, Maine, Minnesota, New Hampshire and New York.

Deductibility of Taxes Paid. This variable measures the extent of double taxation on income used to pay foreign taxes, i.e., paying a tax on money the taxpayer has already mailed to foreign taxing authorities. States can avoid this double taxation by allowing the deduction of taxes paid to foreign jurisdictions. 21 states allow deductions for foreign taxes paid and score well. The remaining 26 states with corporate income taxation do not allow deductions for foreign taxes paid and thus score poorly.

Indexation of the Tax Code. For states that have multiple-bracket income tax codes, it is important to index the brackets for inflation. That prevents de facto tax increases on the nominal increase in income due to inflation. Put simply, this “inflation tax” results in higher tax burdens on taxpayers, usually without their knowledge or consent. All 16 states with graduated corporate income taxes fail to index their tax brackets: Alaska, Arkansas, Hawaii, Iowa, Kansas, Kentucky, Louisiana, Maine, Mississippi, Nebraska, New Jersey, New Mexico, North Dakota, Ohio, Oregon and Vermont.

Throwback. To reduce the double taxation of corporate income, states use an apportionment system that seeks to determine how much of a company’s income a state can properly tax. Generally, states require a company with nexus (that is, sufficient connection to the state to justify the state’s power to tax its income) to apportion its income to the state based on some ratio of the company’s in-state property, payroll and sales compared to its total property, payroll and sales.

Among the 50 states, there is little harmony in apportionment formulas. Many states weight the three factors equally while others weight the sales factor more heavily (a recent trend in state tax policy). Since many businesses make sales into states where they do not have nexus, businesses can end up with “nowhere income,” income that is not taxed by any state. To counter this phenomenon, many states have adopted what are called throwback rules because they identify nowhere income and throw it back into a state where it will be taxed, even though it was not earned in that state.

Throwback rules add yet another layer of tax complexity. Since two or more states can theoretically lay claim to “nowhere” income, rules have to be created and enforced to decide who gets to tax it. States with corporate income taxation are almost evenly divided between those with and without throwback rules. 24 states do not have them and 23 states and the District of Columbia do.

Tax Credits

Many states provide tax credits which lower the effective tax rates for certain industries and/or investments, often for large firms from out of state that are considering a move. Policymakers create these deals under the banner of job creation and economic development, but the truth is that if a state needs to offer such packages, it is most likely covering for a bad business tax climate. Economic development and job creation tax credits complicate the tax system, narrow the tax base, drive up tax rates for companies that do not qualify, distort the free market, and often fail to achieve economic growth.¹⁵

A more effective approach is to systematically improve the business tax climate for the long term. Thus, this component rewards those states that do not offer the following tax credits, and states that offer them score poorly.

Investment Tax Credits. Investment tax credits typically offer an offset against tax liability if the company invests in new property, plants, equipment, or machinery in the state offering the credit. Sometimes, the new investment will have to be “qualified” and approved by the state’s economic development office. Investment tax credits distort the free market by rewarding investment in new property as opposed to the renovation of old property.

Job Tax Credits. Job tax credits typically offer an offset against tax liability if the company creates a specified number of jobs over a specified period of time. Sometimes, the new jobs will have to be “qualified” and approved by the state’s economic development office, allegedly to prevent firms from claiming that jobs shifted were jobs added. Even if administered efficiently, which is uncommon, job tax credits can misfire in a number of ways. They push businesses whose economic position would be best served by spending more on new equipment or marketing to hire new employees instead. They favor businesses that are expanding anyway, punishing firms that are already struggling. Thus, states that offer such credits score poorly on the Index.

Research and Development (R&D) Tax Credits. R&D tax credits reduce the amount of tax due by a company that invests in “qualified” research and development activities. The theoretical argument for R&D tax credits is that they encourage the kind of basic research that is not economically justifiable in the short run but that is better for society in the long run. In practice, their negative side effects—greatly complicating the tax system and establishing a government agency as the arbiter of what types of research meet a criterion so difficult to assess—far outweigh the potential benefits. To the extent that there is a public good justification for R&D credits, it is likely that a policy implemented at the federal level will be the most efficient since the public good aspects of R&D are not bound by state lines. Thus, states that offer such credits score poorly on the Index.

Individual Income Tax

Table 4. Individual Income Tax Component of the State Business Tax Climate Index
	FY 2012		FY 2011		Change From 2011 to 2012
State	Score	Rank	Score	Rank	Score	Rank
Alabama	5.62	18	5.66	18	-0.04	0
Alaska	10.00	1	10.00	1	0.00	0
Arizona	5.73	17	5.79	17	-0.05	0
Arkansas	5.23	27	5.24	27	-0.01	0
California	1.72	50	1.77	50	-0.05	0
Colorado	6.65	16	6.70	16	-0.05	0
Connecticut	4.80	31	4.46	31	0.34	0
Delaware	5.19	28	5.19	29	0.01	1
Florida	10.00	1	10.00	1	0.00	0
Georgia	3.95	40	3.97	39	-0.02	-1
Hawaii	3.88	41	3.92	40	-0.05	-1
Idaho	5.24	26	5.28	26	-0.04	0
Illinois	6.83	13	7.34	10	-0.51	-3
Indiana	7.06	10	7.13	11	-0.07	1
Iowa	4.57	32	4.35	34	0.22	2
Kansas	5.51	21	5.55	20	-0.04	-1
Kentucky	5.29	25	5.33	25	-0.04	0
Louisiana	5.31	24	5.36	23	-0.04	-1
Maine	4.97	30	5.02	30	-0.04	0
Maryland	3.07	46	2.43	47	0.64	1
Massachusetts	6.75	15	6.80	15	-0.05	0
Michigan	6.97	11	7.02	12	-0.04	1
Minnesota	3.51	44	3.55	42	-0.04	-2
Mississippi	5.62	19	5.66	19	-0.04	0
Missouri	5.32	23	5.35	24	-0.04	1
Montana	5.51	20	5.55	21	-0.04	1
Nebraska	5.17	29	5.21	28	-0.04	-1
Nevada	10.00	1	10.00	1	0.00	0
New Hampshire	7.78	9	7.85	9	-0.07	0
New Jersey	2.13	48	2.20	48	-0.07	0
New Mexico	4.33	33	4.36	33	-0.02	0
New York	2.03	49	2.04	49	-0.02	0
North Carolina	3.60	43	3.42	44	0.18	1
North Dakota	4.20	35	4.07	36	0.13	1
Ohio	3.63	42	3.61	41	0.03	-1
Oklahoma	4.04	38	4.06	37	-0.02	-1
Oregon	4.31	34	4.38	32	-0.07	-2
Pennsylvania	6.92	12	6.96	13	-0.04	1
Rhode Island	4.11	36	3.54	43	0.57	7
South Carolina	3.96	39	3.99	38	-0.03	-1
South Dakota	10.00	1	10.00	1	0.00	0
Tennessee	8.00	8	8.08	8	-0.08	0
Texas	8.90	7	8.98	7	-0.08	0
Utah	6.82	14	6.87	14	-0.05	0
Vermont	3.03	47	3.11	46	-0.08	-1
Virginia	4.09	37	4.11	35	-0.02	-2
Washington	10.00	1	10.00	1	0.00	0
West Virginia	5.41	22	5.45	22	-0.04	0
Wisconsin	3.24	45	3.29	45	-0.05	0
Wyoming	10.00	1	10.00	1	0.00	0

DC	4.80		4.84		-0.05

Note: The higher the score, the more favorable a state's tax system is for business. All scores are for fiscal years. Source: Tax Foundation

The individual income tax component, which accounts for 33.1 percent of each state’s total Index score, is important to business because a significant number of businesses, including sole proprietorships, partnerships and S-corporations, report their income through the individual income tax code. The number of individuals filing federal tax returns with business income has more than doubled over the past 30 years, from 13.3 million in 1980 to 30 million in 2009.¹⁶ The structure of the individual income tax is thus critical.

Taxes can have a significant impact on an individual’s decision to become a self-employed entrepreneur. Gentry and Hubbard (2004) found, “While the level of the marginal tax rate has a negative effect on entrepreneurial entry, the progressivity of the tax also discourages entrepreneurship, and significantly so for some groups of households.” (p. 21) Using education as a measure of potential for innovation, Gentry and Hubbard found that a progressive tax system “discourages entry into self-employment for people of all educational backgrounds.” Moreover, citing Carroll, Holtz-Eakin, Rider and Rosen (2000), Gentry and Hubbard contend, “Higher tax rates reduce investment, hiring, and small business income growth.” (p. 7) Less neutral individual income tax systems, therefore, hurt entrepreneurship and a state’s business tax climate.

Another important reason individual income tax rates are critical for business is the cost of labor. Labor typically constitutes a major business expense, so anything that hurts the labor pool will also affect business decisions and the economy. Complex, poorly designed tax systems that extract an inordinate amount of tax revenue are known to reduce both the quantity and quality of the labor pool. This finding was supported by Wasylenko and McGuire (1985), who found that individual income taxes affect businesses indirectly by influencing the location decisions of individuals. A progressive, multi-rate income tax exacerbates this problem by increasing the marginal tax rate at higher levels of income. Thus the tax system continually reduces the value of work vis-à-vis the value of leisure.

For example, suppose a worker has to choose between one hour of additional work worth $10 and one hour of leisure which to him is worth $9.50. A rational person would choose to work for another hour. But if a 10 percent income tax rate reduces the after-tax value of labor to $9.00, then a rational person would stop working and take the hour to pursue leisure. Additionally, workers earning higher wages— $30 per hour, for example—that face progressively higher marginal tax rates—20 percent, for instance—are more likely to be discouraged from working additional hours. In this scenario, the worker’s after-tax wage is $24 per hour; therefore, those workers who value leisure more than $24 per hour will choose not to work. Since the after-tax wage is $6 lower than the pre-tax wage in this example, compared to only $1 lower in the previous example, more workers will choose leisure. In the aggregate, the income tax reduces the available labor supply.¹⁷

The individual income tax rate sub-index measures the impact of tax rates on the marginal dollar of individual income using three criteria: the top tax rate, the graduated rate structure, and the standard deductions and exemptions which are treated as a zero percent tax bracket. The rates and brackets used are for a single taxpayer, not a couple filing a joint return.

The individual income tax base sub-index takes into account how the tax code treats married couples compared to singles, the measures enacted to prevent double taxation, and whether the code is indexed for inflation. States that score well protect married couples from being taxed more severely than if they had filed as two single people. They also protect taxpayers from double taxation by recognizing LLCs and S-corps under the individual tax code and indexing their brackets, exemptions and deductions for inflation.

States that do not impose an individual income tax generally receive a perfect score, and states that do will generally score well if they have a flat, low tax rate with few deductions and exemptions. States that score poorly have complex, multiple-rate systems.

The seven states without an individual income tax are, not surprisingly, the highest-scoring states on this component: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. New Hampshire and Tennessee also score well because, while they levy a significant tax on individual income in the form of interest and dividends, they do not tax wages and salaries. Of the 41 states that do have a broad-based individual income tax, Illinois, Indiana, Michigan, Massachusetts, Pennsylvania, Utah and Colorado score highly because they have a single, low tax rate.

The bottom 10 states are Hawaii, North Carolina, Minnesota, Ohio, Wisconsin, Maryland, Vermont, New Jersey, New York, and California. The individual income tax systems in these states tend to have high tax rates and very progressive bracket structures. They generally fail to index their brackets, exemptions and deductions for inflation, do not allow for deductions of foreign or other state taxes, penalize married couples filing jointly, and do not recognize LLCs and S-Corps.

Individual Income Tax Rate

The rate sub-index compares the 43 states that tax individual income after setting aside the seven states that levy no individual income tax and therefore receive perfect scores: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.

Top Marginal Tax Rate. At the start of fiscal year 2011 Oregon¹⁸ and Hawaii impose the highest top statutory rate, 11 percent. In Oregon it applies to taxable income over $250,000, in Hawaii on taxable income over $200,000. Other states with high top tax rates include California (10.3 percent), New York (8.97), New Jersey (8.97), and Vermont (8.95 percent).

States with the lowest top statutory rates are Pennsylvania (3.07 percent), Indiana (3.4 percent of federal AGI), Michigan (4.35 percent of federal AGI), Arizona (4.54 percent); Colorado (4.63 percent of federal taxable income), and Mississippi, Illinois, Alabama, and Utah (all at 5 percent).¹⁹

In addition to statewide income tax rates, some states allow municipal- and county-level income taxes. The Tax Foundation calculates an average effective local option income tax rate for these states and finds that Maryland has the highest average effective local rate, at 1.56 percent of state personal income.²⁰ Other states with local option income taxes levied in addition to the state rate include Ohio (1.06 percent average effective local income tax rate), New York (0.85 percent), Pennsylvania (0.78 percent), Kentucky (0.74 percent), Indiana (0.64 percent), Delaware (0.16 percent), Missouri (0.14 percent), Michigan (0.13 percent), Alabama (0.08 percent), Iowa (0.08 percent), Kansas (less than 0.01 percent), and Oregon (less than 0.01 percent).

Even though Alabama, Indiana, Michigan and Pennsylvania allow local income add-ons, they are still among the states with the lowest overall rates.

Top Tax Bracket Threshold. This variable assesses the degree to which businesses are subject to reduced after-tax return on investment as net income rises. States are rewarded for a top rate that kicks in at lower levels of income, because doing so approximates a less distortionary flat-rate system. For example Alabama has a progressive income tax structure, with three income tax rates. However, because Alabama’s top rate of 5 percent applies to all taxable income over $3,000, the state’s income tax rate structure is nearly flat.

States with flat-rate systems score the best on this variable because their top rate kicks in at the first dollar of income (after accounting for the standard deduction and personal exemption). They include New Hampshire, Tennessee, Pennsylvania, Illinois, Indiana, Michigan, and Massachusetts. States with high kick-in levels score the worst. These include California ($1,000,000 of taxable income), New Jersey ($500,000 of taxable income), Maryland ($500,000 of taxable income), Vermont ($379,150 of taxable income), and North Dakota ($379,150 of taxable income).

Number of Brackets. The Index converts exemptions and standard deductions to a zero bracket before tallying income tax brackets. From an economic perspective, standard deductions and exemptions are equivalent to an additional tax bracket with a zero tax rate.

For example, Kansas has a standard deduction of $3,000 and a personal exemption of $2,250 for a combined value of $5,250. Statutorily, Kansas has a top rate on all taxable income over $30,000 and two lower brackets that have an average width of $15,000. But because of its deduction and exemption, Kansas’s top rate actually kicks in at $35,250 of income, and it has three tax brackets below that with an average width of $11,750. The size of allowed standard deductions and exemptions varies considerably.²¹

Pennsylvania scores the best in this variable by having only one tax bracket. States with only two brackets are Colorado, Illinois, Indiana, Massachusetts, Michigan, New Hampshire and Tennessee. On the other end of the spectrum, Hawaii scores the worst in this variable by having 13 tax brackets. Other states with many brackets include Missouri (with 11 brackets), Iowa and Ohio (10 brackets) and Idaho (nine brackets).

Average Width of Brackets. Many states have several narrow tax brackets close together at the low end of the income scale, including a zero bracket created by standard deductions and exemptions. Most taxpayers never notice them because they pass so quickly through those brackets and pay the top rate on most of their income. On the other hand, some states continue placing ever increasing rates throughout the income spectrum, causing individuals and non-corporate businesses to alter their income-earning and tax-planning behavior. This sub-index penalizes the latter group of states by measuring the average width of the brackets, rewarding those states where the average width is small, since in these states the top rate is levied on most income, acting more like a flat rate on all income.

Individual Income Tax Base

States have different definitions of taxable income, and some create greater impediments to economic activity. The base sub-index gives equal weight, 33 percent, to two major issues in base definition: marriage penalty and double taxation of capital income. Then it gives a 33 percent weight to an accumulation of more minor base issues.

The seven states with no individual income tax of any kind achieve perfect neutrality. Texas, however, receives a slight deduction because it does not recognize LLCs or S-Corps. Of the other 43 states, Tennessee, Idaho, Michigan, Montana, Oregon, and Utah have the best scores. They avoid the marriage penalty and other problems with the definition of taxable income. Meanwhile, states where the tax base is found to cause an unnecessary drag on economic activity are New Jersey, New York, Wisconsin, California, Georgia, Maryland, Minnesota, and Virginia.

Marriage Penalty. A marriage penalty exists when a state’s standard deduction and tax brackets for married taxpayers filing jointly are not double those for single filers. As a result, two singles (if combined) can have a lower tax bill than a married couple filing jointly with the same income. This is discriminatory and has serious business ramifications. The top-earning 20 percent of taxpayers is dominated (85 percent) by married couples. This same 20 percent also has the highest concentration of business owners of all income groups (Hodge 2003A, Hodge 2003B). Because of these concentrations, marriage penalties have the potential to affect a significant share of businesses. Twenty-four states have marriage penalties built into their income tax brackets.

Some states get around the marriage penalty problem by allowing married couples to file as if they were singles. While helpful in offsetting the marriage penalty, it comes at the expense of added tax complexity. Despite the complexity, the sub-index rewards states that have this provision.

Double Taxation of Capital Income. Since several states with an individual income tax system mimic the federal income tax code, they also possess its greatest flaw: the double taxation of capital income. Double taxation is brought about by the interaction between the corporate income tax and the individual income tax. The ultimate source of most capital income—interest, dividends and capital gains—is corporate profits. The corporate income tax reduces the level of profits that can eventually be used to generate interest or dividend payments or capital gains.²² This capital income must then be declared by the receiving individual and taxed. The result is the double taxation of this capital income—first at the corporate level and again on the individual level.

All states with an individual wage income tax score poorly by this criterion. Tennessee and New Hampshire, which tax individuals on interest and dividends, score somewhat better because they do not tax capital gains.

Federal Income Used as State Tax Base. Despite the shortcomings of the federal government’s definition of income, states that use it reduce the tax compliance burden on taxpayers. Five states score poorly because they do not conform to federal definitions of individual income: Alabama, Arkansas, Mississippi, New Jersey, and Pennsylvania.

The Federal Alternative Minimum Tax (AMT). The Alternative Minimum Tax (AMT) was created in 1969 to ensure that all taxpayers paid some minimum level of taxes every year. Unfortunately, it does so by creating a parallel tax system to the standard individual income tax code. Evidence shows that the AMT is an inefficient way to prevent tax deductions and credits from totally eliminating tax liability. As such, states that have mimicked the federal AMT put themselves at a competitive disadvantage through needless tax complexity. Nine states score poorly for having an AMT on individuals: California, Colorado, Connecticut, Iowa, Maine, Minnesota, Nebraska, New York, and Wisconsin.

Credit for Taxes Paid

This variable measures the extent of double taxation on income used to pay foreign and state taxes, i.e., paying the same taxes twice. States can avoid double taxation by allowing a credit for state taxes paid to other jurisdictions.

Recognition of Limited Liability Corporation and S-Corporation Status

One important development in the federal tax system is the creation of the limited liability corporation (LLC) and the S-corporation (S-corp). LLCs and S-corps provide businesses some of the benefits of incorporation, such as limited liability, without the overhead of becoming a regular C-corporation. The profits of these entities are taxed under the individual income tax code, which avoids the double taxation problems that plague the corporate income tax system. Every state with a full individual income tax recognizes LLCs or S-corporations to at least some degree.

Indexation of the Tax Code

Indexing the tax code for inflation is critical in order to prevent de facto tax increases on the nominal increase in income due to inflation. Put simply, this “inflation tax” results in higher tax burdens on taxpayers, usually without their knowledge or consent. Three areas of the individual income tax are commonly indexed for inflation: the standard deduction, personal exemptions and tax brackets. Twenty-one states index all three; 19 states and the District of Columbia index at least one of the three; and 10 states do not index at all.

Sales Tax

Table 5. Sales Tax Component of the State Business Tax Climate Index, 2011-2012
	FY 2012		FY 2011		Change From 2011 to 2012
State	Score	Rank	Score	Rank	Score	Rank
Alabama	3.98	41	4.37	36	-0.38	-5
Alaska	7.90	5	8.02	5	-0.11	0
Arizona	2.80	50	2.87	50	-0.07	0
Arkansas	4.12	38	4.16	40	-0.04	2
California	4.03	40	3.57	44	0.47	4
Colorado	3.54	44	3.58	43	-0.04	-1
Connecticut	4.65	30	4.81	28	-0.16	-2
Delaware	8.97	2	9.07	2	-0.11	0
Florida	5.04	19	4.83	26	0.21	7
Georgia	5.37	12	5.20	15	0.17	3
Hawaii	4.63	31	4.50	33	0.12	2
Idaho	4.92	23	4.84	24	0.08	1
Illinois	4.45	33	4.47	34	-0.03	1
Indiana	5.42	11	5.38	11	0.04	0
Iowa	4.88	25	4.75	29	0.13	4
Kansas	4.62	32	4.90	23	-0.29	-9
Kentucky	5.71	8	5.70	8	0.01	0
Louisiana	3.15	49	3.13	47	0.02	-2
Maine	5.64	10	5.44	10	0.20	0
Maryland	5.70	9	5.64	9	0.07	0
Massachusetts	5.07	17	5.00	17	0.07	0
Michigan	5.74	7	5.71	7	0.03	0
Minnesota	4.20	36	4.20	38	0.00	2
Mississippi	4.71	28	4.69	30	0.02	2
Missouri	4.77	26	5.32	13	-0.55	-13
Montana	8.81	3	8.92	3	-0.10	0
Nebraska	4.72	27	4.83	25	-0.11	-2
Nevada	3.96	42	3.92	41	0.04	-1
New Hampshire	9.01	1	9.12	1	-0.10	0
New Jersey	3.44	46	3.38	46	0.05	0
New Mexico	3.50	45	3.49	45	0.01	0
New York	4.19	37	4.19	39	0.00	2
North Carolina	3.39	47	2.91	49	0.48	2
North Dakota	5.11	15	5.04	16	0.06	1
Ohio	4.69	29	4.64	31	0.05	2
Oklahoma	4.09	39	4.26	37	-0.17	-2
Oregon	8.68	4	8.86	4	-0.18	0
Pennsylvania	4.99	21	4.91	22	0.08	1
Rhode Island	4.88	24	4.82	27	0.06	3
South Carolina	5.00	20	4.92	21	0.07	1
South Dakota	4.44	34	4.61	32	-0.18	-2
Tennessee	3.70	43	3.83	42	-0.13	-1
Texas	4.22	35	4.46	35	-0.24	0
Utah	4.98	22	4.97	19	0.01	-3
Vermont	5.20	14	5.24	14	-0.04	0
Virginia	6.21	6	6.28	6	-0.08	0
Washington	3.33	48	2.92	48	0.41	0
West Virginia	5.04	18	4.96	20	0.08	2
Wisconsin	5.08	16	4.97	18	0.11	2
Wyoming	5.36	13	5.36	12	0.00	-1

DC	3.99		3.93		0.06	0

Note: The higher the score, the more favorable a state's tax system is for business. All scores are for fiscal years. Source: Tax Foundation

Sales tax makes up 21.4 percent of each state’s Index score. The type of sales tax familiar to all taxpayers is a tax levied on the purchase price of a good at the point of sale. This tax can hurt the business tax climate because as the sales tax rate climbs, customers make fewer purchases or seek out low-tax alternatives. As a result, business is lost to lower-tax locations, causing lost profits, lost jobs and lost tax revenue.²³ The effect of differential sales tax rates between states or localities is apparent when a traveler crosses from a high-tax state to a neighboring low-tax state. Typically, a vast expanse of shopping malls springs up along the border in the low-tax jurisdiction.

On the positive side, sales taxes levied on goods and services at the point of sale to the end user have at least two virtues. First, they are transparent: the tax is never confused with the price of goods by customers. Second, since they are levied at the point of sale, they are less likely to cause economic distortions than taxes levied at some intermediate stage of production (such as a gross receipts tax or sales taxes on business-to-business transactions).

The negative impact of sales taxes is well documented in the economic literature and through anecdotal evidence. For example, Bartik (1989) found that high sales taxes, especially sales taxes levied on equipment, had a negative effect on small business start-ups. Moreover, companies have been known to avoid locating factories or facilities in certain states because the factory’s machinery would be subject to the state’s sales tax.²⁴

States that create the most tax pyramiding and economic distortion, and therefore score the worst, are states that levy a sales tax that generally allows no exclusions for business inputs.²⁵ Hawaii, New Mexico, Washington and South Dakota are examples of states that tax many business inputs. The ideal base for sales taxation is all goods and services at the point of sale to the end user.²⁶

Excise taxes are sales taxes levied on specific goods. Goods subject to excise taxation are typically perceived to be luxuries or vices, and thus less likely to see drops in demand when the tax increases their price. Examples typically include tobacco, liquor, and gasoline. The sales tax component of the Index takes into account the excise tax rates each state levies.

The five states without a state sales tax—Alaska, Delaware, New Hampshire, Oregon, and Montana—achieve the best sales tax component scores. For states with a sales tax, Virginia has the best score because it has a low general sales tax rate, avoids tax pyramiding, and maintains low excise tax rates. Other states that score well include Kentucky, Maine, Michigan, and Maryland.

At the other end of the spectrum, Arizona, Louisiana, and Washington levy sales tax on many business inputs—such as utilities, services, manufacturing, and leases—and maintain relatively high excise taxes. Tennessee has the highest combined state and local rate of 9.4 percent. In general, these states levy high sales tax rates that apply to most or all business input items.

Sales Tax Rate

The tax rate itself is important, and a state with a high sales tax rate reduces demand for in-state retail sales. Consumers will turn more frequently to cross-border, catalog, or online purchases, leaving less business activity in-state. This sub-index measures the highest possible sales tax rate applicable to in-state retail shopping and taxable business-to-business transactions. Four states—Delaware, Montana, New Hampshire and Oregon—do not have state or local sales taxes and thus are given a rate of zero. Alaska is sometimes counted among states with no sales tax since it does not levy a statewide sales tax. However, Alaska localities are allowed to levy sales taxes and the weighted statewide average of these taxes is 1.74 percent.

The Index measures the state and local sales tax rate in each state. A combined rate is computed by adding the general state rate to the weighted average of the county and municipal rates.

State Sales Tax Rate. Of the 45 states with a statewide sales tax, Colorado’s 2.9 percent rate is lowest. Seven states have a 4 percent state-level sales tax: Alabama, Georgia, Hawaii, Louisiana, New York, South Dakota, and Wyoming. At the other end is California with a 7.25 percent state sales tax, including a mandatory statewide local add-on tax of 1 percent. Tied for second-highest are Indiana, Mississippi, New Jersey, Rhode Island and Tennessee (all at 7 percent). Other states with high statewide rates include Minnesota (6.875 percent) and Nevada (6.85 percent).

Local Option Sales Tax Rates. State-level sales taxes are only part of the story. Thirty-three states authorize the use of local option sales taxes at the county and/or municipal level, and in some states, the local option sales tax significantly increases the tax rate faced by consumers.²⁷ Local jurisdictions in Colorado, for example, add an average of 4.58 percent in local sales taxes to the state’s 2.9 percent state-level rate, bringing the total average sales tax rate to 7.48 percent. This may be an understatement in some localities with much higher local add-ons, but by weighting each locality’s rate, the Index computes a statewide average of local rates that is comparable to the average in other states.

Alabama and Louisiana have the highest average local option sales taxes (4.64 and 4.84 percent, respectively) and both states’ average local option sales tax is higher than the state sales tax rate of 4 percent. Other states with high local option sales taxes include Colorado (4.58 percent), New York (4.48 percent), Oklahoma (4.16 percent) and Missouri (3.45 percent).

States with the highest combined state and average local sales tax rates are Tennessee (9.43 percent), Arizona (9.12 percent), Louisiana (8.84 percent), and Washington (8.79 percent). At the low end are Alaska (1.74 percent), Hawaii (4.35 percent), and Maine and Virginia (both 5 percent).

Sales Tax Base

The sales tax base sub-index is computed according to three features of each state’s sales tax:

whether the base includes a variety of business-to-business transactions such as agricultural products, services, machinery, computer software, and leased/rented items;
whether the base includes goods and services typically purchased by consumers; and
the excise tax rate on products such as gasoline, diesel fuel, tobacco, spirits and beer.

The top five states on this sub-index are those without a general sales tax: New Hampshire, Delaware, Montana, Alaska and Oregon. However, none receives a perfect score because they all levy gasoline, diesel, tobacco, and beer excise taxes. For the states that do have a general sales tax, Indiana, Idaho, Georgia, Virginia, and Michigan have the highest scores. These states avoid the problems of tax pyramiding and have low excise tax rates. States with the worst scores on the base sub-index are Hawaii, New Mexico, Washington, South Dakota and North Carolina. Their tax systems hamper economic growth by including too many business inputs, excluding too many consumer goods and services, and/or excessive rates of excise taxation.

Sales Tax on Business-to-Business Transactions (Business Inputs). When a business must pay sales taxes on manufacturing equipment and raw materials, then that tax becomes part of the price of whatever the business makes with that equipment and those materials. The business must then collect sales tax on its own products, with the result that a tax is being charged on a tax. This “tax pyramiding” invariably results in some industries’ being taxed more heavily than others, which causes economic distortions.

These variables are often inputs to other business operations. For example, a manufacturing firm will count the cost of transporting its final goods to retailers as a significant cost of doing business. Most firms, small and large alike, hire accountants, lawyers, and other professional service firms. If these services are taxed, then it is more expensive for every business to operate.

To understand how business-to-business sales taxes can distort the market, suppose a sales tax were levied on the sale of flour to a bakery. The bakery is not the end-user because the flour will be baked into bread and sold to consumers. Economic theory is not clear as to which party will ultimately bear the burden of the tax. The tax could be “passed forward” onto the customer or “passed backward” onto the bakery.²⁸ Where the tax burden falls depends on how sensitive the demand for bread is to price changes. If customers tend not to change their bread-buying habits when the price rises, then the tax can be fully passed forward onto consumers. However, if the consumer reacts to higher prices by buying less, then the tax will have to be absorbed by the bakery as an added cost of doing business.

The hypothetical sales tax on all flour sales would distort the market because different businesses that use flour have customers with varying price sensitivity. Suppose the bakery is able to pass the entire tax on flour forward to the consumer, but the pizza shop down the street cannot. The owners of the pizza shop would face a higher cost structure and profits would drop. Since profits are the market signal for opportunity, the tax would tilt the market away from pizza-making. Fewer entrepreneurs would enter the pizza business, and existing businesses would hire fewer people. In both cases, the sales tax charged to purchasers of bread and pizza would be partly a tax on a tax because the tax on flour would be built into the price. Economists call this tax pyramiding.

Besley and Rosen (1998) found that for many products, the after-tax price of the good increased by the same amount as the tax itself. That means a sales tax increase was passed along to consumers on a one-for-one basis. For other goods, however, they found that the price of the good rose by twice the amount of the tax, meaning that the tax increase translates into an even larger burden for consumers than is typically thought.

Consider the following quote from David Brunori, Executive Vice President of Editorial Operations for Tax Analysts:

Everyone who has ever studied the issue will tell you that the sales tax should not be imposed on business purchases. That is, when a business purchases a product or service, it should not pay tax on the purchase. There is near unanimity among public finance scholars on the issue. The sales tax is supposed to be imposed on the final consumer. Taxing business purchases causes the tax to be passed on to consumers without their knowledge. There is nothing efficient or fair about that. But business purchases are taxed widely in every state with a sales tax. Some studies have estimated that business taxes make up nearly 50 percent of total sales tax revenue. Why? Two reasons. First, because business sales taxes raise so much money that the states cannot repeal them. The states would have to either raise other taxes or cut services. Second, many politicians think it is only fair that “businesses” pay taxes because individuals pay them. That ridiculous belief is unfortunately shared by many state legislators; it’s usually espoused by liberals who don’t understand that businesses aren’t the ones who pay taxes. People do. Every time a business pays sales tax on a purchase, people are burdened. They just don’t know it.²⁹

Note that these inputs should only be exempt from sales tax if they are truly inputs into the production process. If they are consumed by an end user, they are properly includable in the state’s sales tax base.

States that create the most tax pyramiding and economic distortion, and therefore score the worst, are states that levy a sales tax that generally allows no exclusions for business inputs.³⁰ Hawaii, New Mexico, South Dakota, and Washington are examples of states that tax many business inputs.

Sales Tax on Services. An economically neutral sales tax base includes all final retail sales of goods and services purchased by the end users. Exempting any goods or services narrows the tax base, drives up the sales tax rate on those items still subject to tax, and introduces unnecessary distortions into the market.

Sales Tax on Gasoline. There is no economic reason to exempt gasoline from the sales tax, as it is a final retail purchase by consumers. However, all but five states do so. While all states levy an excise tax on gasoline, these funds are often dedicated for transportation purposes: a form of user tax distinct from the general sales tax. The five states that fully include gasoline in their sales tax base (California, Georgia, Illinois, Indiana, and Michigan) get a better score. Connecticut and New York get partial credit for applying an ad valorem tax to gasoline sales, but at a different rate than for the general sales tax.

Sales Tax on Groceries. A principled approach to sales tax policy calls for all end-user goods to be included in the tax base, to keep the base broad, rates low, and prevent distortions in the marketplace. Should groceries be the exception?

Many state officials will say that they exempt groceries in order to make the sales tax system easier on low-income people. In reality, exempting groceries from the sales tax mostly benefits grocers and higher-income people, not the poor, although even grocers have occasion to complain because the maintenance of complex, ever-changing lists of exempt and non-exempt products constitutes an administrative burden for all concerned. Most importantly, though, widespread availability of public assistance for the purchase of groceries—from the Women, Infants and Children (WIC) program or the food-stamp program—makes the argument for such exemptions unpersuasive. If the poor need more assistance to afford groceries, these more targeted approaches should be used. Fourteen states include or partially include groceries in their sales tax base.

Excise Taxes

Excise taxes are single-product sales taxes. Many of them are intended to reduce consumption of the product bearing the tax. Others, like the gasoline tax, are often used to fund specific projects like road construction.

Gasoline and diesel excise taxes (levied per gallon) are usually justified as a form of user tax paid by those who benefit from road construction and maintenance. Since gasoline represents a large input for most businesses, states that levy higher rates have a less competitive business tax climate. State excise taxes on gasoline range from 37.7 cents per gallon in California to 7.4 cents per gallon in Georgia.

Tobacco, spirits, and beer excise taxes are problematic because they discourage in-state consumption and encourage consumers to seek lower prices in neighboring jurisdictions (Moody and Warcholik, 2004). This impacts a wide swath of retail outlets, such as convenience stores, that move large volumes of tobacco and beer products. The problem is exacerbated for those retailers located near the border of states with lower excise taxes as consumers move their shopping out of state—referred to as cross-border shopping.

There is also the growing problem of cross-border smuggling of products from states and areas that levy low excise taxes on tobacco into states that levy high excise taxes on tobacco. This both increases criminal activity and reduces taxable sales by legitimate retailers (Fleenor 1998).

States with the highest tobacco taxes per pack of 20 cigarettes are New York ($4.35), Rhode Island ($3.46), Connecticut ($3.40), Hawaii ($3.20), and Washington ($3.03) while states with the lowest tobacco taxes are Missouri (17 cents), Virginia (30 cents), Louisiana (36 cents), and Georgia (37 cents).

States with the highest beer taxes on a per gallon basis are Alaska ($1.07), Alabama ($1.05), Georgia ($1.01), and Hawaii ($0.93) while states with the lowest beer taxes are Wyoming (2 cents), Missouri (6 cents) and Wisconsin (6 cents). States with the highest spirits taxes per gallon are Washington ($26.70), Oregon ($23.03) and Virginia ($20.91).

Property Tax

Table 6. Property Tax Component of the State Business Tax Climate Index, 2011-2012
	FY 2012		FY 2011		Change from 2011 to 2012
State	Score	Rank	Score	Rank	Score	Rank
Alabama	6.27	6	6.28	6	-0.01	0
Alaska	5.58	13	5.74	9	-0.16	-4
Arizona	6.27	5	6.28	5	-0.01	0
Arkansas	5.42	18	5.48	17	-0.06	-1
California	5.42	17	5.38	18	0.04	1
Colorado	5.72	9	5.71	10	0.01	1
Connecticut	2.88	50	3.03	49	-0.15	-1
Delaware	5.58	14	5.59	15	-0.01	1
Florida	5.10	24	4.94	28	0.17	4
Georgia	4.39	39	4.36	40	0.04	1
Hawaii	5.56	15	5.53	16	0.03	1
Idaho	6.68	2	6.73	2	-0.05	0
Illinois	3.84	44	4.58	32	-0.75	-12
Indiana	5.69	11	5.69	11	0.00	0
Iowa	4.47	36	4.50	35	-0.04	-1
Kansas	4.97	28	4.53	34	0.44	6
Kentucky	5.40	19	5.38	19	0.03	0
Louisiana	5.26	23	5.35	20	-0.08	-3
Maine	4.39	38	4.27	41	0.12	3
Maryland	4.37	40	4.46	38	-0.10	-2
Massachusetts	3.61	47	3.64	46	-0.03	-1
Michigan	4.90	30	4.87	29	0.03	-1
Minnesota	5.06	26	5.12	24	-0.06	-2
Mississippi	4.96	29	4.96	27	0.00	-2
Missouri	6.05	7	6.02	7	0.03	0
Montana	5.93	8	6.00	8	-0.07	0
Nebraska	4.46	37	4.47	37	-0.01	0
Nevada	5.48	16	5.59	14	-0.12	-2
New Hampshire	3.99	41	4.03	42	-0.04	1
New Jersey	2.91	49	2.87	50	0.04	1
New Mexico	7.06	1	7.11	1	-0.04	0
New York	3.74	45	3.72	45	0.02	0
North Carolina	4.49	35	4.48	36	0.01	1
North Dakota	6.30	4	6.30	4	-0.01	0
Ohio	4.69	33	4.54	33	0.15	0
Oklahoma	5.67	12	5.68	12	-0.01	0
Oregon	5.70	10	5.67	13	0.03	3
Pennsylvania	3.97	42	3.91	44	0.07	2
Rhode Island	3.65	46	3.10	48	0.55	2
South Carolina	5.31	21	5.31	22	0.01	1
South Dakota	5.35	20	5.33	21	0.02	1
Tennessee	3.59	48	3.56	47	0.03	-1
Texas	4.78	31	4.84	30	-0.06	-1
Utah	6.64	3	6.62	3	0.01	0
Vermont	3.86	43	3.99	43	-0.13	0
Virginia	4.99	27	5.02	26	-0.03	-1
Washington	5.27	22	5.26	23	0.02	1
West Virginia	5.09	25	5.08	25	0.01	0
Wisconsin	4.72	32	4.71	31	0.01	-1
Wyoming	4.51	34	4.38	39	0.13	5

DC	3.57		3.49		0.08

Note: The higher the score, the more favorable a state's tax system is for business. All scores are for fiscal years. Source: Tax Foundation

The property tax component, which is comprised of taxes on real and personal property, net worth, and the transfer of assets, accounts for 14.1 percent of each state’s Index score.

In the recent economic downturn, real and personal property taxes have been a contentious subject as individuals and businesses protest higher taxes on residential and business property even though property values have fallen. That occurs because local governments generally respond to falling property values not by maintaining current tax rates and enduring lower revenue, but by raising tax rates to make up the revenue. The Tax Foundation’s Survey of Tax Attitudes found that local property taxes are perceived as the second-most unfair state or local tax.³¹

Property taxes matter to businesses because the tax rate on commercial property is often higher than the tax on comparable residential property. Additionally, many localities and states often levy taxes on the personal property or equipment owned by a business. They can be on assets ranging from cars to machinery and equipment to office furniture and fixtures, but are separate from real property taxes which are taxes on land and buildings.

Businesses remitted $619 billion in state and local taxes in fiscal year 2010, of which 40 percent or $250 billion was for property taxes. The property taxes included tax on real, personal, and utility property owned by business (Cline et al 2011). Coupled with the academic findings that property taxes are the most influential tax in terms of impacting location decisions by businesses, the evidence supports the conclusion that property taxes are a significant factor in a state’s business tax climate. Since property taxes can be a large burden to business, they can have a significant effect on location decisions.

Mark, McGuire and Papke (2000) find taxes that vary from one location to another within a region could be more important determinants of intraregional location decisions. They find that higher rates of two business taxes—the sales tax and the personal property tax—are associated with lower employment growth. They estimate that a tax hike on personal property of one percentage point reduces annual employment growth by 2.44 percentage points (Mark et al. 2000).

Bartik (1985), finding that property taxes are a significant factor in business location decisions, estimates that a 10 percent increase in business property taxes decreases the number of new plants opening in a state by between 1 and 2 percent. Bartik (1989) backs up his earlier findings by concluding that higher property taxes negatively affect small business starts. He elaborates that the particularly strong negative effect of property taxes occurs because they are paid regardless of profits, and many small businesses are not profitable in their first few years, so high property taxes would be more influential than profit-based taxes on the start-up decision.

States competing for business would be well served to keep statewide property taxes low so as to be more attractive to business investment. Localities competing for business can put themselves at greater competitive advantage by keeping personal property taxes low.

Taxes on capital stock, intangible property, inventory, real estate transfers, estates, inheritance, and gifts are also included in the property tax component of the Index.

The states that score the best on property tax are New Mexico, Idaho, Utah, North Dakota, and Arizona. These states generally have low rates of property tax, whether measured per capita or as a percentage of income. They also avoid distortionary taxes like estate, inheritance, gift and other wealth taxes. States that score poorly on the property tax are Connecticut, New Jersey, Tennessee, Massachusetts, and Rhode Island. These states generally have high property tax rates and levy several wealth-based taxes.

The property tax portion of the Index is comprised of two equally weighted sub-indexes devoted to measuring the economic damage of the rates and the tax bases. The rate sub-index consists of property tax collection (measured both per capita and as a percentage of personal income) and capital stock taxes. The base portion consists of dummy variables detailing whether each state levies wealth taxes such as inheritance, estate, gift, inventory, intangible property and other similar taxes.

Property Tax Rate

The property tax rate sub-index consists of property tax collections per capita (40 percent of the sub-index score), property tax collections as a percent of personal income (40 percent of the sub-index score), and capital stock tax (20 percent of the sub-index score). The heavy weighting of tax collections is due their importance to businesses and individuals and their increasing size and visibility to all taxpayers. Both are included to gain a better understanding of how much each state collects in proportion to its population and its income. Tax collections as a percentage of personal income forms an effective rate that gives taxpayers a sense of how much of their income is devoted to property taxes, and the per capita figure lets them know how much in actual dollar terms they pay in property taxes compared to residents of other states.

While these measures are not ideal—having effective tax rates of personal and real property for both businesses and individuals would be ideal—they are the best measures available due to the significant data constraints posed by property tax collections. Since a high percentage of property taxes are levied on the local level, there are countless jurisdictions. The sheer number of different localities makes data collection almost impossible. The few studies that tackle the subject use representative towns or cities instead of the entire state. Thus, the best source for data on property taxes is the Census Bureau since it can compile the data and reconcile definitional problems.

States that maintain low effective rates and low collections per capita are more likely to promote growth than states with high rates and collections.

Property Tax Collections Per Capita. Property tax collections per capita are calculated by dividing property taxes collected in each state (obtained from the Census Bureau) by population. The states with the highest property tax collections per capita are New Jersey ($2,671), Connecticut ($2,498), New Hampshire ($2,424), Wyoming ($2,321), and New York ($2,105).The states that collect the least per capita are Alabama ($506), Arkansas ($548), Oklahoma ($598), New Mexico ($611), and Kentucky ($662).

Effective Property Tax Rate. Property tax collections as a percent of personal income are derived by dividing the Census Bureau’s figure for total property tax collections by personal income in each state. This provides an effective property tax rate. States with the highest effective rates and therefore the worst scores are New Hampshire (5.68 percent), New Jersey (5.34 percent), Vermont (5.27 percent), Rhode Island (4.88 percent), and Wyoming (4.81 percent). States that score well with low effective tax rates are Alabama (1.52 percent), Oklahoma (1.67 percent), Arkansas (1.70 percent), Delaware (1.80 percent), and New Mexico (1.84 percent).

Capital Stock Tax Rate. Capital stock taxes (sometimes called franchise taxes) are levied on the wealth of a corporation, usually defined as net worth. They are often levied in addition to corporate income taxes, adding a duplicate layer of taxation and compliance for many corporations. Corporations that find themselves in financial trouble must use precious cash flow to pay their capital stock tax. In assessing capital stock taxes, the sub-index accounts for three variables: the capital stock tax rate, maximum payment, and capital stock tax versus corporate income tax dummy variable. The capital stock tax sub-index is 20 percent of the total rate sub-index.

This variable measures the rate of taxation as levied by the 20 states with a capital stock tax. Legislators have come to realize the damaging effects of capital stock taxes, and a handful of states are reducing or repealing them. West Virginia is in the middle of a 10-year phase-out of its previous 0.7 percent tax (currently levied at 0.34 percent), with full repeal taking effect in 2015. Pennsylvania will phase out its tax by 2014 and Kansas completed the phase-out of its tax in 2011. States with the highest capital stock tax rates include West Virginia (0.34 percent), Connecticut (0.31 percent), Louisiana and Arkansas (0.3 percent), and Pennsylvania (0.289 percent).

Maximum Capital Stock Tax Payment. Eight states mitigate the negative economic impact of the capital stock tax by placing a cap on the maximum capital stock tax payment. These states include Alabama, Connecticut, Delaware, Georgia, Illinois, Nebraska, New York, , and Oklahoma, and they receive the highest score on this variable.

Capital Stock Tax versus Corporate Income Tax. Some states mitigate the negative economic impact of the capital stock tax by allowing corporations to pay the higher of the two taxes. These states (Connecticut, New York and Rhode Island) are given credit for this provision. States that do not have a capital stock tax get the best scores in this sub-index while the states that force companies to pay both score the lowest.

Property Tax Base

This sub-index is composed of dummy variables listing the different types of property taxes each state levies. Seven taxes are included and each is equally weighted. Alaska, Arizona, Idaho, Missouri, Montana, New Mexico, North Dakota, Utah and Wyoming receive perfect scores because they do not levy any of the seven taxes. Tennessee and Maryland score worst because they impose many of the taxes.

Intangible Property Tax. This dummy variable gives low scores to those states that impose taxes on intangible personal property. Intangible personal property includes stocks, bonds and other intangibles such as trademarks. This tax can be highly detrimental to businesses that hold large amounts of their own or other companies’ stock and that have valuable trademarks. Twelve states levy this tax in various degrees: Alabama, Georgia, Iowa, Kansas, Louisiana, Mississippi, North Carolina, Ohio, Pennsylvania, South Dakota, Tennessee and Texas.

Inventory Tax. Levied on the value of a company’s inventory, the inventory tax is especially harmful to large retail stores and other businesses that store large amounts of merchandise. Inventory taxes are highly distortionary because they force companies to make decisions about production that are not entirely based on economic principles, but rather on how to pay the least amount of tax on goods produced. Inventory taxes also create strong incentives for companies to locate inventory in states where they can avoid these harmful taxes. Fourteen states levy some form of inventory tax.

Asset Transfer Taxes (Estate, Inheritance, and Gift Taxes). Five taxes levied on the transfer of assets are part of the property tax base. These taxes, levied in addition to the federal estate tax, all increase the cost and complexity of transferring wealth and hurt a state’s business climate. These harmful effects can be particularly acute in the case of small, family-owned businesses if they do not have the liquid assets necessary to pay the estate’s tax liability.³² The five taxes are real estate transfer taxes, estate taxes (or death taxes), inheritance taxes, generation-skipping taxes and gift taxes. Thirty-five states and the District of Columbia levy taxes on the transfer of real estate, adding to the cost of purchasing real property and increasing the complexity of real estate transactions. This tax is harmful to businesses that transfer real property often.

The federal Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) lowered the federal estate tax rate through 2009 and eliminated it entirely in 2010. Prior to 2001, most states levied an estate tax that piggy-backed on the federal system because the federal tax code allowed individuals to take a dollar-for-dollar tax credit for state estate taxes paid. In other words, states essentially received free tax collections from the estate tax, and individuals did not object because their total tax liability was unchanged. EGTRRA eliminated this dollar-for-dollar credit system, replacing it with a tax deduction.

Consequently, over the past decade, some states enacted their own estate tax while others repealed their estate taxes. Some states have provisions re-introducing the estate tax if the federal dollar-for-dollar credit system is revived. This would have happened in 2011, as EGTRRA expired and the federal estate tax returned to pre-2001 levels. However, in late 2010, Congress re-enacted the estate tax for 2011 and 2012 but with higher exemptions and a lower rate than pre-2001 law, and maintained the deduction for state estate taxes. Thirty-four states receive a high score for either (1) remaining coupled to the federal credit and allowing their state estate tax to expire or (2) not enacting their own estate tax. Sixteen states have maintained an estate tax either by linking their tax to the pre-EGTRRA credit or by creating their own stand-alone system. These states score poorly.

Each year some businesses, especially those that have not spent a sufficient sum on estate tax planning and on large insurance policies, find themselves unable to pay their estate taxes, either federal or state. Usually they are small-to-medium sized family-owned businesses where the death of the owner occasions a surprisingly large tax liability.

Inheritance taxes are similar to estate taxes, but they are levied on the heir of an estate, instead of on the estate itself. Therefore, a person could inherit a family-owned company from his or her parents and be forced to downsize it, or sell part or all of it in order to pay the heir’s inheritance tax. Eight states have inheritance taxes and are punished in the Index because the inheritance tax causes economic distortions.

Connecticut and Tennessee have a gift tax and score poorly. Gift taxes are designed to stop individuals’ attempts to avoid the estate tax by giving their estates away before they die. Gift taxes are negatives to a state’s business tax climate because they also heavily impact individuals who have sole proprietorships, S-corps and LLCs.

Unemployment Insurance Tax

Table 7. Unemployment Insurance Tax Component of the State Business Tax Climate Index, 2011-2012
	FY 2012		FY 2011		Change From 2011 to 2012
State	Score	Rank	Score	Rank	Score	Rank
Alabama	5.62	11	5.67	11	-0.05	0
Alaska	4.90	28	5.23	21	-0.33	-7
Arizona	6.39	1	6.38	2	0.01	1
Arkansas	5.43	17	5.29	19	0.14	2
California	5.54	13	5.46	15	0.08	2
Colorado	5.09	23	5.32	17	-0.23	-6
Connecticut	4.81	32	4.76	32	0.05	0
Delaware	6.16	3	5.90	8	0.26	5
Florida	5.92	5	6.14	3	-0.22	-2
Georgia	5.11	22	5.20	22	-0.09	0
Hawaii	4.87	30	5.16	23	-0.30	-7
Idaho	3.83	48	3.76	47	0.07	-1
Illinois	4.22	43	4.27	41	-0.05	-2
Indiana	5.51	16	5.62	12	-0.11	-4
Iowa	4.68	35	4.68	35	0.00	0
Kansas	5.91	6	5.90	7	0.01	1
Kentucky	3.83	47	3.62	48	0.22	1
Louisiana	5.94	4	5.93	5	0.02	1
Maine	4.50	40	4.18	43	0.32	3
Maryland	4.06	45	3.93	46	0.13	1
Massachusetts	3.36	49	3.21	49	0.15	0
Michigan	4.15	44	4.14	44	0.01	0
Minnesota	4.69	34	4.52	37	0.17	3
Mississippi	5.83	8	6.02	4	-0.19	-4
Missouri	5.79	9	5.79	10	0.00	1
Montana	5.19	20	5.27	20	-0.08	0
Nebraska	5.60	12	5.60	13	0.00	1
Nevada	4.44	42	4.39	40	0.05	-2
New Hampshire	4.53	39	4.52	38	0.01	-1
New Jersey	4.99	25	5.02	27	-0.02	2
New Mexico	5.53	14	5.44	16	0.09	2
New York	3.86	46	4.03	45	-0.17	-1
North Carolina	5.87	7	5.93	6	-0.05	-1
North Dakota	4.82	31	4.94	29	-0.11	-2
Ohio	5.66	10	5.79	9	-0.13	-1
Oklahoma	6.37	2	6.63	1	-0.25	-1
Oregon	4.69	33	4.68	36	0.01	3
Pennsylvania	4.64	37	4.40	39	0.24	2
Rhode Island	3.02	50	2.88	50	0.14	0
South Carolina	4.56	38	4.18	42	0.37	4
South Dakota	4.44	41	4.69	34	-0.25	-7
Tennessee	4.91	27	4.70	33	0.21	6
Texas	5.53	15	5.48	14	0.05	-1
Utah	5.05	24	5.10	26	-0.06	2
Vermont	5.25	19	5.31	18	-0.06	-1
Virginia	4.67	36	4.86	31	-0.20	-5
Washington	5.29	18	5.12	24	0.16	6
West Virginia	4.96	26	4.89	30	0.07	4
Wisconsin	5.12	21	5.12	25	-0.01	4
Wyoming	4.89	29	4.97	28	-0.08	-1

DC	5.05		5.06		-0.01

Note: The higher the score, the more favorable a state's tax system is for business. All scores are for fiscal years. Source: Tax Foundation

Unemployment insurance (UI) is a social insurance program jointly operated by the federal and state governments. Taxes are paid by employers into the UI program to finance benefits for workers recently unemployed. Unlike the other major taxes assessed in the State Business Tax Climate Index, UI taxes are much less well known. Every state has one, and all 50 of them are complex, variable-rate systems that impose different rates on different industries and different bases depending upon such factors as the health of the state’s UI trust fund.³³

One of the worst aspects of the UI tax system is that financially troubled businesses, where layoffs may be a matter of survival, actually pay higher marginal rates as they are forced into higher tax rate schedules. In the academic literature, this has long been called the “shut-down effect” of UI taxes: failing businesses face climbing UI taxes, with the result that they fail sooner.

The unemployment insurance tax Index component consists of two equally weighted sub-indexes, one that measures each state’s rate structure and one that focuses on the tax base. Unemployment insurance taxes comprise 11.1 percent of a state’s final Index score.

Overall, the states with the least damaging UI taxes are Arizona, Oklahoma, Delaware, Louisiana, and Florida. Comparatively speaking, these states have rate structures with lower minimum and maximum rates and a wage base at the federal level. In addition, they have simpler experience formulas and charging methods, and they have not complicated their systems with benefit add-ons and surtaxes.

On the other hand, the states with the worst UI taxes are Rhode Island, Massachusetts, Idaho, Kentucky, and New York. These states tend to have rate structures with high minimum and maximum rates and wage bases above the federal level. Moreover, they have more complicated experience formulas and charging methods, and they have added benefits and surtaxes to their systems.

Unemployment Insurance Tax Rate

UI tax rates in each state are based on a schedule of rates ranging from a minimum rate to a maximum rate. The rate for any particular business is dependent upon the business’s experience rating: businesses with the best experience ratings will pay the lowest possible rate on the schedule while those with the worst ratings pay the highest. The rate is applied to a taxable wage base (a predetermined fraction of an employee’s wage) to determine UI tax liability.

Multiple rates and rate schedules can affect neutrality as states attempt to balance the dual UI objectives of spreading the cost of unemployment to all employers and ensuring high-turnover employers pay more.

Overall, the states with the best score on this sub-index are Arizona, Louisiana, Georgia, Nebraska, and Florida. Generally, these states have low minimum and maximum tax rates on each schedule and a wage base at or near the federal level. The states with the worst scores are Massachusetts, Maryland, Rhode Island, Oregon, and Pennsylvania.

The sub-index gives equal weight to two factors: the actual rate schedules in effect in the most recent year, and the statutory rate schedules that can potentially be implemented at any time depending on the state of the economy and the UI fund.

Tax Rates Imposed in the Most Recent Year

Minimum Tax Rate. States with lower minimum rates score better. The minimum rates in effect in the most recent year range from zero percent (in Iowa, Missouri, Nebraska, and South Dakota) to 2.68 percent (in Pennsylvania).
Maximum Tax Rate. States with lower maximum rates score better. The maximum rates in effect in the most recent year range from 5.4 percent (in Alaska, Colorado, Florida, Georgia, Hawaii, Mississippi, Nevada, New Mexico, Oregon) to 13.5 percent (in Maryland).
Taxable Wage Base. Three states receive the best score in this variable with a taxable wage base of $7,000—in line with the federal taxable wage base: Arizona, California, and Florida. The states with the highest taxable bases and, thus, the worst scores in this variable are Washington ($37,300), Hawaii ($34,200), Alaska ($34,600), Idaho ($33,300) and Oregon ($32,300).

Potential Rates
Due to the effect of business and seasonal cycles on UI funds, states will sometimes change UI tax rate schedules. When UI trust funds are flush, states will trend toward their lower rate schedules (“most favorable schedules”); however, when UI trust funds are low, states will trend toward their higher rate schedules (“least favorable schedules”).

Most Favorable Schedule: Minimum Tax Rate. States receive the best score in this variable with a minimum tax rate of zero, which they levy when unemployment is low and the UI fund is flush. The minimum rate on the most favorable schedule ranges from zero in 23 states to 1.0 percent in Alaska.
Most Favorable Schedule: Maximum Tax Rate. Twenty-three states receive high scores in this variable with a comparatively low maximum tax rate of 5.4 percent. Louisiana has the best rate with 4.9 percent. The states with the highest maximum tax rates and thus the worst maximum tax scores are Michigan (10.3 percent), Tennessee and North Dakota (10 percent), South Dakota (9.5 percent) and Kentucky, Minnesota and Utah (9.0 percent).
Least Favorable Schedule: Minimum Tax Rate. Ten states receive the best score in this variable with a minimum tax rate of zero percent. The states with the highest minimum tax rates and, thus, the worst minimum tax scores are New Mexico (2.7 percent), Hawaii (2.4 percent), Maryland (2.2 percent), Oregon (2.11 percent) and Rhode Island and Connecticut (1.9 percent).
Least Favorable Schedule: Maximum Tax Rate. Twelve states receive the best score in this variable with a comparatively low maximum tax rate of 5.4 percent. The states with the highest maximum tax rates and, thus, the worst maximum tax scores are Massachusetts (15.4 percent), Maryland (13.5 percent), Michigan (10.3 percent), Indiana (10.2 percent) and Tennessee (10 percent).

Unemployment Insurance Tax Base

The UI base sub-index scores states on how they determine which businesses should pay the UI tax and how much, as well as other UI-related taxes for which businesses may also be liable.

The states that receive the best scores on this sub-index are Oklahoma, Delaware, Ohio, Arizona, and Vermont. In general, these states have relatively simple experience formulas, they exclude more factors from the charging method, and they enforce fewer surtaxes.

States that receive the worst scores are New York, Rhode Island, New Hampshire, Idaho and Virginia. In general, they have more complicated experience formulas, exclude fewer factors from the charging method, and have complicated their systems with add-ons and surtaxes. The three factors considered in this sub-index are experience rating formulas (40 percent of sub-index score), charging methods (40 percent of sub-index score), and a host of smaller factors aggregated into one variable (20 percent of sub-index score).

Experience Rating Formula. A business’s experience rating formula determines the rate the firm must pay—whether it will lean towards the minimum rate or maximum rate of the particular rate schedule in effect in the state at that time.

There are four basic experience formulas: contribution, benefit, payroll and state experience. The first three experience formulas—the contribution, benefit and payroll—are based solely on the business’s experience and are therefore non-neutral by design.³⁴ However, the final variable—state experience—is a positive mitigating factor because it is based on statewide experience. In other words, the state experience is not tied to the experience of any one business; therefore, it is a more neutral factor. This sub-index penalizes states that depend on the contribution, benefit and payroll experience variables while rewarding states with the state experience variable.

Charging Methods and Benefits Excluded from Charging.

A business’s experience rating will vary depending on which charging method the state government uses. When a former employee applies for unemployment benefits, the benefits paid to the employee must be charged to a previous employer. There are three basic charging methods:

Charging Most Recent or Principal Employer: Thirteen states charge all the benefits to one employer, usually the most recent.
Charging Base-Period Employers in Inverse Chronological Order: Six states charge all base-period employers in inverse chronological order. This means that all employers within a base period of time (usually the last year, sometimes longer) will have the benefits charged against them with the most recent employer being charged the most.
Charging in Proportion to Base-Period Wages: Thirty-one states charge in proportion to base period wages. This means that all employers within a base-period of time (usually the last year, sometimes longer) will have the benefits charged against them in proportion to the wages they paid.

None of these charging methods could be called neutral, but at the margin, charging the most recent or principal employer is the least neutral because the business faced with the necessity of laying off employees knows it will bear the full benefit charge. The most neutral of the three is the “charging in proportion to base-period wages” since there is a higher probability of sharing the benefit charges with previous employers.

As a result, the 32 states that charge in proportion to base-period wages receive the best score. The 12 states that charge the most recent or principal employer receive the worst score. The five that charge base-period employers in inverse chronological order receive a median score.

Many states also recognize that certain benefit costs should not be charged to employers, especially if the separation is beyond the employer’s control. Therefore, this sub-index also accounts for six types of exclusions from benefit charges.

Benefit award reversed
Reimbursements on combined wage claims
Voluntary leaving
Discharge for misconduct
Refusal of suitable work
Continues to work for employer on part-time basis

States are rewarded for each of these exclusions because they nudge a UI system toward neutrality. For instance, if benefit charges were levied for employees who voluntarily quit, then industries with high turnover rates, such as retail, would be hit disproportionately harder. States that receive the best scores in this category are Ohio, Utah, Vermont, Oregon, Louisiana, Delaware, Missouri and Arizona. Ohio receives a perfect score by charging in proportion to base-period wages and including all six benefit exclusions. On the other hand, the states that receive the worst scores are New Hampshire, Kentucky, Michigan, Nevada, New York, Rhode Island and Virginia. All charge the most recent or principal employer and forbid most benefit exclusions

Solvency Tax. These taxes are levied on employers when a state’s unemployment fund falls below some defined level. Twenty states have a solvency tax on the books though they fall under different names, such as solvency adjustment tax (Alaska), supplemental assessment tax (Delaware), subsidiary tax (New York) and fund balance factor (Virginia).

Taxes for Socialized Costs or Negative Balance Employer. These are levied on employers when the state desires to recover benefit costs above and beyond the UI tax collections based on the normal experience rating process. Ten states have these taxes on the books though they fall under different names: shared cost assessment tax (Alabama) and social cost factor tax (Washington).

Loan and Interest Repayment Surtaxes. Levied on employers when a loan is taken from the federal government or when bonds are sold to pay for benefit costs, these taxes are of two general types. The first is a tax to pay off the federal loan or bond issue. The second is a tax to pay the interest on the federal loan or bond issue. States are not allowed to pay interest costs directly from the state’s unemployment trust fund. Twenty-four states have these taxes on the books though they fall under several names such as: advance interest tax and bond assessment tax (Colorado), temporary emergency assessment tax (Delaware) and unemployment obligation assessment (Texas), to name a few.

Reserve Taxes. Reserve taxes are levied on employers to be deposited in a reserve fund separate from the unemployment trust fund. Since the fund is separate, the interest earned on it is often used to create other funds for purposes such as job training and/or paying the costs of the reserve tax’s collection. Four states have these taxes on the books: Nebraska (state UI tax), Idaho (reserve tax), Iowa (reserve tax) and North Carolina (reserve fund tax).

Surtaxes for UI Administration or Non-UI Purposes. Thirty states levy surtaxes on employers, usually to fund administration but sometimes for job training or special improvements in technology. They are often deposited in a fund outside of the state’s unemployment fund. Some of the names they go by are job training tax (Arizona), social charge rate tax (Louisiana), reemployment service fund tax (New York), wage security tax (Oregon), and investment in South Dakota future fee (South Dakota).

Temporary Disability Insurance (TDI). A handful of states—California, New Jersey, Hawaii and New York—have established a temporary disability insurance (TDI) program that augments the UI program by extending benefits to those unable to work because of sickness or injury. No separate tax funds them; the money comes right out of the state’s unemployment fund, and because the balance of the fund triggers various taxes, the TDIs are included as a negative factor in the calculation of this sub-index.

Voluntary Contributions. Twenty-nine states allow businesses to make voluntary contributions to the unemployment trust fund. In most cases, these contributions are rewarded with a lower rate schedule, often saving the business more money in taxes than was paid through the contribution. The Index rewards states that allow voluntary contributions because firms are able to pay when they can best afford to instead of when they are struggling. This provision helps to mitigate the non-neutralities of the UI tax.

Time-Period to Qualify for Experience Rating. Newly formed businesses, naturally, do not qualify for an experience rating because they have no significant employment history on which to base the rating. Federal rules stipulate that states can levy a “new employer” rate for one to three years, but no less than one year. From a neutrality perspective, however, this new employer rate is non-neutral in almost all cases since the rate is higher than the lowest rate schedule. The longer this rate is in effect, the worse the non-neutrality. As such, the Index rewards states with the minimum one year required to earn an experience rating and penalizes states that require the full three years.

Recent and Proposed Changes Not Reflected in the 2012 State Business Tax Climate Index

Connecticut
Connecticut’s corporate income tax surcharge will increase from 10 percent to 20 percent for calendar years 2012 and 2013, effectively raising the statutory rate from 8.25 percent to 9 percent. This will reduce Connecticut’s score on corporate income tax.

Delaware
Delaware’s various gross receipts tax rates are cut by 3 percent for calendar years 2012 and 2013. This will slightly improve Delaware’s score on corporate income tax.

Massachusetts
Massachusetts’s individual income tax rate will fall from 5.3 percent to 5.25 percent beginning in calendar year 2012. This automatic cut is a result of a rule adopted in 2002 at the same time that a scheduled phase-down of the income tax rate was frozen at 5.3 percent. The rule dictates that if certain revenue growth conditions are met the rate would fall in subsequent years. Since these conditions were met the rate will fall by 0.05 percentage points for 2012 and thereafter. This change will slightly improve Massachusetts’ score on individual income tax.

Michigan
Michigan passed corporate and individual tax changes in 2011. The flat individual tax rate will be reduced slightly beginning in calendar year 2013 and some credits and deductions will be eliminated. The corporate reforms are more significant from the perspective of the Index. Most importantly, beginning in calendar year 2012 the state’s two-part Michigan Business Tax (MBT), which includes a 6.04 percent net income tax and a 0.98 percent gross receipts tax (both rates include a 21.99 percent surtax), will be replaced with a 6 percent corporate income tax on net income. The elimination of the state’s damaging gross receipts tax will improve the state’s score on corporate income tax.

New Jersey
Although New Jersey has consistently ranked at the bottom of the Index, recent actions by the state show the beginnings of improvement in business tax climate. These include reducing minimum tax on S corporations and reducing restrictions on the ability of taxpayers to carry forward net operating losses. While these changes will not be captured by the current methodology of the Index, they would help to offset some of the negative components of the state’s tax system for those businesses affected. New Jersey still ranks behind New York (49th) and California (48th), but pending proposals in the three states could see New Jersey rising.

New York
New York’s two temporary top individual income tax rates of 7.85 percent and 8.97 percent, applying to income over $200,000 and $500,000 respectively, were set to expire at the end of 2011, leaving the top rate at 6.85 percent of income over $40,000 (for joint filers). However, Gov. Cuomo signed legislation that will temporarily alter the state’s tax rates. The new rates will begin at 4 percent, increasing to 4.5 percent over $16,000, 5.25 percent over $22,000, 5.9 percent over 26,000, 6.45 percent over $40,000, 6.65 percent over $150,000, 6.85 percent over $300,000, and 8.82 percent over $2 million (all brackets are for joint filers). While the somewhat lower rates will improve New York’s score on the individual income tax rate sub-index, the new higher $2 million threshold for the highest tax rate will lower the state’s score in top tax bracket threshold and average bracket width. The two effects will somewhat offset each other. The new rates will apply through 2014, after which the top two rates are scheduled to expire and the top rate will be 6.85 percent over $40,000 (for joint filers).

Ohio
Ohio Gov. Kasich in June 2011 signed the state’s biennial budget which included the repeal of the estate tax, effective January 1, 2013. This change will improve the state’s score on property tax once it takes effect.

Oklahoma
Oklahoma’s top individual income tax rate will fall from 5.5 percent to 5.25 percent (on income over $8,700) for calendar year 2012. This change will slightly improve Oklahoma’s score on individual income tax.

Oregon
Oregon’s top individual income tax rate will fall from 11 percent to 9.9 percent in calendar year 2012 and thereafter. This reduction is a result of Measure 66, which was voted on in January 2010 and temporarily increased income tax rates on high-income taxpayers from the previous rate of 9 percent to 11 percent for 2009 through 2011, and 9.9 percent in calendar year 2012 and thereafter. This change will improve Oregon’s score on individual income tax. In addition, the threshold level for Oregon’s top corporate income tax rate will increase beginning in calendar year 2013, as a result of 2010’s ballot measure 67.

Pennsylvania
Pennsylvania continues the phase-out of the capital stock tax. The rate will be 0.189 percent in calendar year 2012 and is scheduled to fall to 0.089 percent in 2013 and 0 percent in 2014 and thereafter. The continued phase-out and eventual elimination of the damaging and outdated tax will improve Pennsylvania’s score on property tax.

West Virginia
West Virginia is one of the few states that ended fiscal year 2011 with a budget surplus. As a result the state’s corporate income tax rate will automatically fall from 8.5 percent to 7.75 percent in calendar year 2012. If the budget surpluses continue and the rainy day fund balance is greater than 10 percent of the general fund, the rate could fall to 7.0 percent for 2013 and 6.5 percent after 2013.

District of Columbia
The Council of the District of Columbia in 2011 approved a new temporary income tax rate of 8.95 percent (up from 8.5 percent) for taxpayers with income above $350,000, effective 2012. This change will harm DC’s score on individual income tax.

Endnotes

1 U.S. Department of Labor, “Extended Mass Layoffs in the First Quarter of 2007,” August 9, 2007, http://www.bls.gov/opub/ted/2007/may/wk2/art04.htm. In the press release, DOL reported that, “In the 61 actions where employers were able to provide more complete separations information, 84 percent of relocations (51 out of 61) occurred among establishments within the same company. In 64 percent of these relocations, the work activities were reassigned to place elsewhere in the U.S. Thirty six percent of the movement-of-work relocations involved out-of-country moves (22 out of 50).”

2 Dana Hedgpeth and Rosalind Helderman “Northrop Grumman decides to move headquarters to Northern Virginia” Washington Post, April 27, 2010.

3 Austin Mondine, “Dell cuts North Carolina plant despite $280m sweetener,” The Register, October 8, 2009.

4 Dennis Cauchon, “Business Incentives Lose Luster for States,” USA Today, August 22, 2007.

5 State Policy Reports. 1994, Vol. 12, No. 11 (June), Issue 1 of 2, p.9.

6 Both rate increases have a temporary component. After four years, the individual income tax will decrease to 3.75%. Then in 2025, the individual income tax rate will drop to 3.5%. The corporate tax will follow a similar schedule of rate decreases: in four years the rate will be 7.75% and then in 2025 it will go back to the current rate of 7.3%.

7 Benjamin Yount, “Tax increase, impact, dominate Illinois Capitol in 2011,” Illinois Statehouse News, December 27, 2011.

8 A trend in tax literature throughout the 1990s has been the increasing use of indexes to measure a state’s general business climate. These include the Center for Policy and Legal Studies’ “Economic Freedom in America’s 50 States: A 1999 Analysis” and the Beacon Hill Institute’s “State Competitiveness Report 2001.” Such indexes even exist on the international level, including the Heritage Foundation and Wall Street Journal’s “2004 Index of Economic Freedom.” Plaut and Pluta (1983) examined the use of business climate indexes as explanatory variables for business location movements. They found that such general indexes do have a significant explanatory power, helping to explain, for example, why businesses have moved from the Northeast and Midwest towards the South and Southwest. In turn, they also found that high taxes have a negative effect on employment growth.

9 This change takes effect in calendar year 2012 and therefore is not captured by the July 1, 2011 snapshot date for the 2012 edition of the Index.

10 Scott Hodge and Andre Dammert, “U.S. Lags While Competitors Accelerate Corporate Income Tax Reform,” Tax Foundation Fiscal Fact, No.184.

11 Jeffrey L. Kwall, “The Repeal of Graduated Corporate Tax Rates,” Tax Notes, June 27, 2011, p. 1395, Doc 2011-12306.

12 This is not an endorsement of the economic efficiency of the federal definition of corporate income.

13 This is not an endorsement of the federal ACRS/MACRS depreciation system. It is well known that federal tax depreciation schedules often bear little resemblance to actual economic depreciation rates.

14 This is not an endorsement of the economic efficiency of the federal depletion system.

15 For example, see: Alan Peters and Peter Fisher, “The Failure of Economic Development Incentives,” Journal of the American Planning Association, Vol. 70, No. 1, Winter 2004; and William F. Fox and Matthew N. Murray, “Do Economic Effects Justify the Use of Fiscal Incentives?,” Southern Economic Journal, Southern Economic Association, 2004, vol. 71(1), pages 78-92.

16 Scott A. Hodge, “Over One-Third of New Tax Revenue Would Come from Business Income If High-Income Personal Tax Cuts Expire,” Tax Foundation Special Report, No. 185, September 13, 2010.

17 Scott A. Hodge and J. Scott Moody, “Wealthy Americans and Business Activity,” Tax Foundation Special Report, No. 131, August 1, 2004.

18 Oregon’s top income tax rate is reduced to 9.9% on income over $125,000 ($250,000 married) in 2012 and after. This change takes effect in calendar year 2012 and therefore is not captured by the July 1, 2011 snapshot date for the 2012 edition of the Index.

19 New Hampshire and Tennessee both tax only interest and dividends. To account for this, the Index converts the statutory tax rate in both states into an effective rate as measured against the typical state income tax base that includes wages. Under a typical income tax base with a flat rate and no tax preferences, this is the statutory rate that would be required to raise the same amount of revenue as the current system. Nationally, dividends and interest account for 19.6 percent of income. For New Hampshire, its 5 percent rate was multiplied by 19.6 percent, yielding the equivalent rate of 0.98 percent. For Tennessee, with a tax rate of 6 percent, this calculation yields an equivalent rate of 1.18 percent.

20 Average effective local income tax rates are calculated by dividing statewide local income tax collections (from the U.S. Census Bureau) by state personal income (from the Bureau of Economic Analysis).

21 Some states offer tax credits in lieu of standard deductions or personal exemptions. Rather than reducing a taxpayer’s taxable income before the tax rates are applied, tax credits are subtracted from a taxpayer’s tax liability. Like deductions and exemptions, the result is a lower final income tax bill. In order to maintain consistency within the sub-index, tax credits are converted into equivalent income exemptions or deductions.

22 Equity-related capital gains are not created directly by a corporation. Rather, they are the result of stock appreciations due to corporate activity such as increasing retained earnings, increasing capital investments or issuing dividends. Stock appreciation becomes taxable realized capital gains when the stock is sold by the holder.

23 States have sought to limit this sales tax competition by levying a “use tax” on goods purchased out of state and brought into the state, typically at the same rate as the sales tax. Few consumers comply with use tax obligations.

24 For example, in early 1993, Intel Corporation was considering California, New Mexico and four other states as the site of a new billion dollar factory. California was the only one of the six states that levied its sales tax on machinery and equipment, a tax that would have cost Intel roughly $80 million. As Intel’s Bob Perlman put it in testimony before a committee of the California state legislature, “There are two ways California’s not going to get the $80 million, with the factory or without it.” California would not repeal the tax on machinery and equipment; New Mexico got the plant.

25 Sales taxes, which are ideally levied only on sales to final-users, are a form of consumption tax. Consumption taxes that are levied instead at each stage of production are known as value-added taxes (VAT) and are popular internationally. Theoretically a VAT can avoid the economically damaging tax pyramiding effect. The VAT has never gained wide acceptance in the U.S., and only two states (Michigan and New Hampshire) have even attempted a VAT-like tax.

26 In some cases, transactions that appear to be business-to-business turn out to be business-to-consumer. For example, a hobby farmer needs many of the same products as a commercial farmer. In the case of the commercial farmer these purchases are business inputs. Thus, the hobby farmer may be able to take advantage of the same sales tax exclusions as the commercial farmer. Such cases are rare, however.

27 The average local option sales tax rate is calculated as an average of local statutory rates, weighted by population.

28 See Besley and Rosen, op. cit.

29 David Brunori, “An Odd Admission of Gambling,” State Tax Notes, Jan. 30, 2005, p. 332-339.

30 Sales taxes, which are ideally levied only on sales to final-users, are a form of consumption tax. Consumption taxes that are levied instead at each stage of production are known as value-added taxes (VAT) and are popular internationally. Theoretically a VAT can avoid the economically damaging tax pyramiding effect. The VAT has never gained wide acceptance in the U.S., and only two states (Michigan and New Hampshire) have even attempted a VAT-like tax.

31 Matt Moon, “How do Americans Feel about Taxes Today? Tax Foundation’s 2009 Survey of U.S. Attitudes on Taxes, Government Spending and Wealth Distribution,” Tax Foundation Special Report, No 199, April 2009.

32 For a summary of the effects of the estate tax on business, see “Effects of the Federal Estate Tax on Farms and Small Businesses,” Congressional Budget Office, July 2005. For a summary on the failures of the estate tax in general see David Logan, “The Economic Effects of the Estate Tax,” Tax Foundation, October 17, 2011.

33 See generally Joseph Henchman, “Unemployment Insurance Taxes: Options for Program Design and Insolvent Trust Funds,” Tax Foundation Background Paper No. 61, October 2011.

34 Alaska is the only state to use the payroll experience method. This method does not use benefit payments in the formula but instead the variation in an employer’s payroll from quarter to quarter. This is a violation of tax neutrality since any decision by the employer or employee that would affect payroll may trigger higher UIT rates.

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States Vary Widely in Number of Taxpayers Deducting State or Local Sales Taxes

Wed, 11 Jan 2012 00:00:00 EST

Texas Has Highest Percent of Taxpayers Choosing Sales Tax Deduction

Fiscal Fact No. 288

Introduction

Taxpayers who itemize deductions have the option of deducting state and local taxes from their income. In doing so, each individual taxpayer must decide to deduct either the income tax withheld from his or her wages, or the total sales tax he or she paid during the tax year. Individuals who choose to deduct sales taxes have the additional option of reporting the exact amount (if they saved all their receipts) or using an estimate from the IRS that depends on their state and their income level. The option to deduct sales tax, rather than income tax, is a temporary provision that must be extended each year.

States vary widely in the percentage of taxpayers who use each deduction. In general, more taxpayers elect to deduct income taxes than sales taxes. However, as one might expect, states that have no (or low) income taxes tend to see most taxpayers deducting sales taxes instead. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming are all states in which over half of the taxpayers elect to deduct state and local sales taxes, rather than income taxes, on their federal return, and these are all states that have either a very limited income tax (in the case of Tennessee) or no income tax at all. (The small number of taxpayers who do deduct income taxes in these states likely owe them to a different state than the one listed as their home on their federal return.) Taxpayers in these states therefore have the most to lose should this option not be extended each year.

The eight tables below summarize the latest data from the IRS, for tax year 2009.

Table 1. Percentage of Tax Filers Claiming State/Local Tax Deduction Choosing Sales Tax

State	Percentage	Rank
Texas	90%	1
Florida	89%	2
Tennessee	87%	3
Nevada	86%	4
Wyoming	84%	5
South Dakota	83%	6
Washington	83%	7
Alaska	51%	8
Arizona	26%	9
Mississippi	23%	10
North Dakota	20%	11
Alabama	16%	12
New Mexico	15%	13
Idaho	15%	14
California	15%	15
Illinois	15%	16
Oklahoma	15%	17
Kansas	15%	18
Arkansas	15%	19
New Jersey	14%	20
Louisiana	14%	21
Michigan	13%	22
Hawaii	12%	23
Georgia	12%	24
South Carolina	11%	25
Colorado	11%	26
Nebraska	11%	27
North Carolina	10%	28
New York	10%	29
Missouri	10%	30
Utah	10%	31
Iowa	9%	32
Kentucky	9%	33
Pennsylvania	9%	34
Connecticut	8%	35
Maine	7%	36
Ohio	7%	37
Vermont	7%	38
Rhode Island	7%	39
Wisconsin	7%	40
Minnesota	7%	41
Virginia	6%	42
West Virginia	6%	43
Maryland	5%	44
District of Columbia	5%	44
Massachusetts	5%	45
Indiana	5%	46
New Hampshire	4%	47
Montana	1%	48
Delaware	1%	49
Oregon	1%	50
United States	23%

Table 2. Sales Tax Deduction Amount as Percentage of Both Deductions

State	Percentage	Rank
Texas	76%	1
Tennessee	72%	2
Washington	72%	3
Nevada	59%	4
South Dakota	58%	5
Florida	55%	6
Alaska	50%	7
Wyoming	44%	8
Arizona	9%	9
Mississippi	7%	10
New Mexico	5%	11
Alabama	5%	12
Louisiana	5%	13
Illinois	5%	14
North Dakota	5%	15
Oklahoma	4%	16
Arkansas	4%	17
Idaho	3%	18
Kansas	3%	19
Michigan	3%	20
Colorado	3%	21
Utah	3%	22
Georgia	3%	23
Missouri	3%	24
California	2%	25
Nebraska	2%	26
South Carolina	2%	27
Hawaii	2%	28
Iowa	2%	29
North Carolina	2%	30
New Jersey	2%	31
Pennsylvania	2%	32
Ohio	2%	33
Kentucky	1%	34
New York	1%	35
Indiana	1%	36
Vermont	1%	37
Virginia	1%	38
Wisconsin	1%	39
Rhode Island	1%	40
Minnesota	1%	41
West Virginia	1%	42
Connecticut	1%	43
Maine	1%	44
New Hampshire	1%	45
Maryland	1%	46
District of Columbia	1%	46
Massachusetts	0%	47
Montana	0%	48
Delaware	0%	49
Oregon	0%	50
United States	6%

Table 3. Percentage of Taxpayers Deducting State and/or Local Income Taxes, 2009

Stat	Number of returns	Returns Claiming Deduction	% of total	Rank
Maryland	2,751,233	1,262,005	46%	1
Connecticut	1,711,715	677,005	40%	2
Massachusetts	3,171,888	1,193,487	38%	3
District of Columbia	312,067	117,799	38%	3
Virginia	3,685,674	1,382,878	38%	4
New Jersey	4,236,533	1,569,393	37%	5
Minnesota	2,541,797	929,304	37%	6
Oregon	1,732,774	630,687	36%	7
Utah	1,124,569	394,199	35%	8
Colorado	2,331,974	795,253	34%	9
Delaware	420,472	142,121	34%	10
Rhode Island	501,586	168,972	34%	11
Wisconsin	2,728,034	897,243	33%	12
New York	9,116,699	2,938,724	32%	13
Georgia	4,447,966	1,390,784	31%	14
California	16,384,130	5,064,964	31%	15
North Carolina	4,144,875	1,263,566	30%	16
Illinois	6,008,183	1,722,444	29%	17
Ohio	5,409,661	1,522,872	28%	18
Maine	624,567	173,858	28%	19
Idaho	657,773	181,564	28%	20
Hawaii	648,846	179,067	28%	21
Michigan	4,534,729	1,245,675	27%	22
Pennsylvania	6,058,513	1,660,553	27%	23
Iowa	1,392,004	380,977	27%	24
Montana	472,039	128,703	27%	25
Vermont	316,053	85,819	27%	26
Missouri	2,683,562	720,126	27%	27
South Carolina	2,024,495	540,092	27%	28
Nebraska	846,101	221,596	26%	29
Kentucky	1,841,152	471,922	26%	30
Arizona	2,670,661	684,486	26%	31
Indiana	2,951,362	751,207	25%	32
Kansas	1,310,164	333,037	25%	33
Alabama	2,048,831	494,472	24%	34
Oklahoma	1,585,616	358,617	23%	35
New Mexico	912,316	194,109	21%	36
Arkansas	1,211,644	249,591	21%	37
Louisiana	1,960,107	399,900	20%	38
Mississippi	1,241,390	223,061	18%	39
West Virginia	778,130	133,050	17%	40
North Dakota	322,972	49,919	15%	41
New Hampshire	659,001	101,135	15%	42
Alaska	357,870	23,817	7%	43
Washington	3,144,952	171,914	5%	44
Nevada	1,243,552	52,939	4%	45
Wyoming	269,357	9,564	4%	46
South Dakota	385,157	11,364	3%	47
Tennessee	2,794,712	80,685	3%	48
Florida	8,910,654	241,766	3%	49
Texas	10,784,887	244,373	2%	50
United States	141,458,638	34,911,115	25%

Table 4. State/Local Income Tax Deductions as Percentage of State AGI, 2009

State	AGI (thousands)	Amount of Income Tax Deducted	% of AGI	Rank
New York	$602,715,414	$36,662,094	6.1%	1
Maryland	$183,270,842	$10,109,347	5.5%	2
California	$996,255,774	$47,226,396	4.7%	3
District of Columbia	$23,248,705	$1,222,580	5.3%	3
Oregon	$85,985,693	$4,072,541	4.7%	4
Connecticut	$135,992,688	$6,136,564	4.5%	5
New Jersey	$299,573,872	$13,076,205	4.4%	6
Minnesota	$145,272,483	$5,933,338	4.1%	7
Massachusetts	$217,427,330	$8,693,696	4.0%	8
Wisconsin	$139,548,333	$5,498,462	3.9%	9
North Carolina	$201,872,716	$7,906,998	3.9%	10
Virginia	$234,321,329	$8,474,600	3.6%	11
Maine	$29,156,528	$1,052,425	3.6%	12
Rhode Island	$27,102,430	$977,989	3.6%	13
Kentucky	$84,008,606	$3,003,576	3.6%	14
Ohio	$257,359,400	$8,683,793	3.4%	15
Georgia	$211,990,964	$7,128,103	3.4%	16
Hawaii	$33,438,301	$1,117,306	3.3%	17
Idaho	$29,903,301	$997,034	3.3%	18
Utah	$58,507,710	$1,919,396	3.3%	19
South Carolina	$91,092,430	$2,971,172	3.3%	20
Delaware	$23,454,311	$752,935	3.2%	21
Kansas	$68,320,734	$2,132,346	3.1%	22
Iowa	$69,594,645	$2,076,026	3.0%	23
Vermont	$15,391,243	$455,680	3.0%	24
Montana	$21,250,414	$622,474	2.9%	25
Missouri	$131,801,960	$3,838,068	2.9%	26
Nebraska	$42,705,522	$1,240,308	2.9%	27
Arkansas	$54,627,697	$1,583,598	2.9%	28
Pennsylvania	$324,848,944	$9,282,945	2.9%	29
Colorado	$137,052,679	$3,818,162	2.8%	30
Mississippi	$51,046,523	$1,369,496	2.7%	31
Michigan	$218,495,392	$5,616,785	2.6%	32
Indiana	$138,570,251	$3,545,285	2.6%	33
West Virginia	$34,933,974	$859,081	2.5%	34
Oklahoma	$77,280,743	$1,887,258	2.4%	35
Arizona	$135,328,404	$3,044,931	2.3%	36
Alabama	$95,601,574	$2,115,105	2.2%	37
Louisiana	$96,308,288	$2,074,033	2.2%	38
Illinois	$350,438,403	$7,184,095	2.1%	39
New Mexico	$40,772,124	$800,714	2.0%	40
North Dakota	$16,662,417	$225,141	1.4%	41
New Hampshire	$39,360,849	$427,618	1.1%	42
Nevada	$67,548,185	$322,515	0.5%	43
Florida	$452,703,287	$2,142,516	0.5%	44
Wyoming	$16,035,428	$74,778	0.5%	45
Washington	$186,216,727	$717,763	0.4%	46
Tennessee	$130,485,371	$430,998	0.3%	47
South Dakota	$18,983,043	$58,182	0.3%	48
Texas	$588,289,807	$1,253,727	0.2%	49
Alaska	$20,209,830	$26,664	0.1%	50
United States	$7,801,040,718	$243,410,355	3.1%

Table 5. Percentage of Taxpayers Deducting State and/or Local Sales Taxes, 2009

State	Number of returns	State and local general sales tax: Returns Claiming Deduction	% of total	Rank
Washington	3,144,952	848,756	27%	1
Nevada	1,243,552	316,038	25%	2
Florida	8,910,654	1,967,191	22%	3
Texas	10,784,887	2,109,412	20%	4
Tennessee	2,794,712	526,687	19%	5
Wyoming	269,357	49,619	18%	6
South Dakota	385,157	56,999	15%	7
Arizona	2,670,661	240,670	9%	8
Alaska	357,870	24,899	7%	9
New Jersey	4,236,533	257,376	6%	10
California	16,384,130	898,505	5%	11
Mississippi	1,241,390	66,945	5%	12
Illinois	6,008,183	299,722	5%	13
Idaho	657,773	32,350	5%	14
Alabama	2,048,831	92,913	5%	15
Kansas	1,310,164	57,163	4%	16
Georgia	4,447,966	192,664	4%	17
Colorado	2,331,974	98,642	4%	18
Michigan	4,534,729	185,781	4%	19
Hawaii	648,846	25,530	4%	20
Oklahoma	1,585,616	62,179	4%	21
North Dakota	322,972	12,637	4%	22
Utah	1,124,569	43,075	4%	23
New Mexico	912,316	34,593	4%	24
New York	9,116,699	337,729	4%	25
Connecticut	1,711,715	61,432	4%	26
Arkansas	1,211,644	42,798	4%	27
North Carolina	4,144,875	145,512	4%	28
South Carolina	2,024,495	69,840	3%	29
Louisiana	1,960,107	64,131	3%	30
Nebraska	846,101	27,131	3%	31
Missouri	2,683,562	79,606	3%	32
Iowa	1,392,004	39,765	3%	33
Kentucky	1,841,152	48,560	3%	34
Pennsylvania	6,058,513	156,888	3%	35
Minnesota	2,541,797	65,380	3%	36
Virginia	3,685,674	92,548	3%	37
Rhode Island	501,586	12,200	2%	38
Maryland	2,751,233	65,095	2%	39
Wisconsin	2,728,034	63,681	2%	40
Ohio	5,409,661	119,171	2%	41
Maine	624,567	13,692	2%	42
Vermont	316,053	6,323	2%	43
District of Columbia	312,067	6,351	2%	43
Massachusetts	3,171,888	60,359	2%	44
Indiana	2,951,362	37,972	1%	45
West Virginia	778,130	7,782	1%	46
New Hampshire	659,001	3,694	1%	47
Delaware	420,472	1,405	0%	48
Montana	472,039	1,542	0%	49
Oregon	1,732,774	4,993	0%	50
United States	141,458,638	10,193,380	7%

Table 6. State/Local Sales Tax Deductions as Percentage of State AGI, 2009

State	AGI (thousands)	Amount of Sales Tax Deducted (thousands)	% of AGI	Rank
Washington	$186,216,727	$1,815,054	0.97%	1
Tennessee	$130,485,371	$1,099,088	0.84%	2
Texas	$588,289,807	$3,975,121	0.68%	3
Nevada	$67,548,185	$456,216	0.68%	4
Florida	$452,703,287	$2,569,025	0.57%	5
South Dakota	$18,983,043	$80,480	0.42%	6
Wyoming	$16,035,428	$59,362	0.37%	7
Arizona	$135,328,404	$299,638	0.22%	8
Mississippi	$51,046,523	$96,442	0.19%	9
Alaska	$20,209,830	$26,470	0.13%	10
Alabama	$95,601,574	$121,720	0.13%	11
Louisiana	$96,308,288	$118,077	0.12%	12
Arkansas	$54,627,697	$65,824	0.12%	13
California	$996,255,774	$1,160,294	0.12%	14
Idaho	$29,903,301	$34,688	0.12%	15
Illinois	$350,438,403	$400,041	0.11%	16
New Mexico	$40,772,124	$46,420	0.11%	17
Oklahoma	$77,280,743	$86,740	0.11%	18
Kansas	$68,320,734	$73,527	0.11%	19
Utah	$58,507,710	$52,308	0.09%	20
Georgia	$211,990,964	$185,557	0.09%	21
New York	$602,715,414	$484,621	0.08%	22
Colorado	$137,052,679	$110,020	0.08%	23
New Jersey	$299,573,872	$239,736	0.08%	24
Michigan	$218,495,392	$165,024	0.08%	25
Missouri	$131,801,960	$98,414	0.07%	26
South Carolina	$91,092,430	$67,678	0.07%	27
North Carolina	$201,872,716	$147,077	0.07%	28
Hawaii	$33,438,301	$24,304	0.07%	29
Nebraska	$42,705,522	$29,754	0.07%	30
North Dakota	$16,662,417	$11,383	0.07%	31
Iowa	$69,594,645	$38,659	0.06%	32
Ohio	$257,359,400	$137,343	0.05%	33
Kentucky	$84,008,606	$42,959	0.05%	34
Pennsylvania	$324,848,944	$157,437	0.05%	35
Minnesota	$145,272,483	$62,494	0.04%	36
Wisconsin	$139,548,333	$59,942	0.04%	37
Virginia	$234,321,329	$99,385	0.04%	38
Rhode Island	$27,102,430	$10,445	0.04%	39
Vermont	$15,391,243	$5,867	0.04%	40
Connecticut	$135,992,688	$49,656	0.04%	41
Indiana	$138,570,251	$46,646	0.03%	42
Maryland	$183,270,842	$56,538	0.03%	43
Maine	$29,156,528	$8,142	0.03%	44
District of Columbia	$23,248,705	$7,136	0.03%	44
West Virginia	$34,933,974	$8,682	0.02%	45
Massachusetts	$217,427,330	$40,603	0.02%	46
Oregon	$85,985,693	$8,621	0.01%	47
Delaware	$23,454,311	$2,268	0.01%	48
Montana	$21,250,414	$1,916	0.01%	49
New Hampshire	$39,360,849	$3,000	0.01%	50
United States	$7,801,040,718	$15,287,544	0.20%

Table 7. Percentage of Taxpayers Deducting Either Tax, 2009

State	Number of Return	Returns Deducting Either Tax	% of total	Rank
Maryland	2,751,233	1,327,100	48%	1
Connecticut	1,711,715	738,437	43%	2
New Jersey	4,236,533	1,826,769	43%	3
Virginia	3,685,674	1,475,426	40%	4
Massachusetts	3,171,888	1,253,846	40%	5
District of Columbia	312,067	124,150	40%	5
Minnesota	2,541,797	994,684	39%	6
Utah	1,124,569	437,274	39%	7
Colorado	2,331,974	893,895	38%	8
Oregon	1,732,774	635,680	37%	9
California	16,384,130	5,963,469	36%	10
Rhode Island	501,586	181,172	36%	11
New York	9,116,699	3,276,453	36%	12
Georgia	4,447,966	1,583,448	36%	13
Wisconsin	2,728,034	960,924	35%	14
Arizona	2,670,661	925,156	35%	15
Delaware	420,472	143,526	34%	16
North Carolina	4,144,875	1,409,078	34%	17
Illinois	6,008,183	2,022,166	34%	18
Idaho	657,773	213,914	33%	19
Washington	3,144,952	1,020,670	32%	20
Michigan	4,534,729	1,431,456	32%	21
Hawaii	648,846	204,597	32%	22
Ohio	5,409,661	1,642,043	30%	23
Iowa	1,392,004	420,742	30%	24
South Carolina	2,024,495	609,932	30%	25
Maine	624,567	187,550	30%	26
Pennsylvania	6,058,513	1,817,441	30%	27
Missouri	2,683,562	799,732	30%	28
Kansas	1,310,164	390,200	30%	29
Nevada	1,243,552	368,977	30%	30
Nebraska	846,101	248,727	29%	31
Vermont	316,053	92,142	29%	32
Alabama	2,048,831	587,385	29%	33
Kentucky	1,841,152	520,482	28%	34
Montana	472,039	130,245	28%	35
Indiana	2,951,362	789,179	27%	36
Oklahoma	1,585,616	420,796	27%	37
New Mexico	912,316	228,702	25%	38
Florida	8,910,654	2,208,957	25%	39
Arkansas	1,211,644	292,389	24%	40
Louisiana	1,960,107	464,031	24%	41
Mississippi	1,241,390	290,006	23%	42
Wyoming	269,357	59,183	22%	43
Texas	10,784,887	2,353,785	22%	44
Tennessee	2,794,712	607,372	22%	45
North Dakota	322,972	62,556	19%	46
West Virginia	778,130	140,832	18%	47
South Dakota	385,157	68,363	18%	48
New Hampshire	659,001	104,829	16%	49
Alaska	357,870	48,716	14%	50
United States	141,458,638	45,104,495	32%

Table 8. Combined Deductions as Percentage of AGI

State	AGI (thousands)	Total Amount of Either Tax Deducted (thousands)	% of total	Rank
New York	$602,715,414	$37,146,715	6.2%	1
Maryland	$183,270,842	$10,165,885	5.5%	2
California	$996,255,774	$48,386,690	4.9%	3
District of Columbia	$23,248,705	$1,229,716	5.3%	3
Oregon	$85,985,693	$4,081,162	4.7%	4
Connecticut	$135,992,688	$6,186,220	4.5%	5
New Jersey	$299,573,872	$13,315,941	4.4%	6
Minnesota	$145,272,483	$5,995,832	4.1%	7
Massachusetts	$217,427,330	$8,734,299	4.0%	8
North Carolina	$201,872,716	$8,054,075	4.0%	9
Wisconsin	$139,548,333	$5,558,404	4.0%	10
Virginia	$234,321,329	$8,573,985	3.7%	11
Rhode Island	$27,102,430	$988,434	3.6%	12
Maine	$29,156,528	$1,060,567	3.6%	13
Kentucky	$84,008,606	$3,046,535	3.6%	14
Idaho	$29,903,301	$1,031,722	3.5%	15
Georgia	$211,990,964	$7,313,660	3.4%	16
Ohio	$257,359,400	$8,821,136	3.4%	17
Hawaii	$33,438,301	$1,141,610	3.4%	18
Utah	$58,507,710	$1,971,704	3.4%	19
South Carolina	$91,092,430	$3,038,850	3.3%	20
Kansas	$68,320,734	$2,205,873	3.2%	21
Delaware	$23,454,311	$755,203	3.2%	22
Iowa	$69,594,645	$2,114,685	3.0%	23
Arkansas	$54,627,697	$1,649,422	3.0%	24
Vermont	$15,391,243	$461,547	3.0%	25
Missouri	$131,801,960	$3,936,482	3.0%	26
Nebraska	$42,705,522	$1,270,062	3.0%	27
Montana	$21,250,414	$624,390	2.9%	28
Pennsylvania	$324,848,944	$9,440,382	2.9%	29
Mississippi	$51,046,523	$1,465,938	2.9%	30
Colorado	$137,052,679	$3,928,182	2.9%	31
Michigan	$218,495,392	$5,781,809	2.6%	32
Indiana	$138,570,251	$3,591,931	2.6%	33
Oklahoma	$77,280,743	$1,973,998	2.6%	34
West Virginia	$34,933,974	$867,763	2.5%	35
Arizona	$135,328,404	$3,344,569	2.5%	36
Alabama	$95,601,574	$2,236,825	2.3%	37
Louisiana	$96,308,288	$2,192,110	2.3%	38
Illinois	$350,438,403	$7,584,136	2.2%	39
New Mexico	$40,772,124	$847,134	2.1%	40
North Dakota	$16,662,417	$236,524	1.4%	41
Washington	$186,216,727	$2,532,817	1.4%	42
Tennessee	$130,485,371	$1,530,086	1.2%	43
Nevada	$67,548,185	$778,731	1.2%	44
New Hampshire	$39,360,849	$430,618	1.1%	45
Florida	$452,703,287	$4,711,541	1.0%	46
Texas	$588,289,807	$5,228,848	0.9%	47
Wyoming	$16,035,428	$134,140	0.8%	48
South Dakota	$18,983,043	$138,662	0.7%	49
Alaska	$20,209,830	$53,134	0.3%	50
United States	$7,801,040,718	$258,697,899	3.3%

Tax Foundation - Publications > Overview

Maryland Considers Proposal to Extend "Millionaires Tax" to $100,000 Income Level

Scholastic Books Faces State Tax Overreaching

Taxation of Online Travel Services: Lawsuits Generally Not Succeeding In Effort to Expand Hotel Taxes

Key Findings

Introduction

Table 1 Status of Local Government Litigation Against Online Travel Companies as of March 2012

Booking a Hotel Room: The "Merchant" Model and Online Travel Services

Online Travel Services Are Generally Outside the Scope of Hotel Tax Statutes

City Lawsuits Seek New Tax Revenue by Expanding Hotel Tax Base to OTC services

Cities’ Lawsuits Have Not Succeeded but Have Produced Extended Litigation and Negative Impacts on Tourism Industry

Court Rulings on Whether Online Travel Companies Are Hotel Operators

Court Rulings on What Is Taxed by a Hotel Occupancy Tax

Court Rulings on Cities' Claim that Not Taxing OTC services Would Undermine the Hotel Occupancy Tax

Federal Action Could Bar Discriminatory Taxation, Similar to Other Precedents Restraining State Damage to Interstate Commerce

Conclusion

Appendix: Cases

Federal Appellate Courts

Other Courts

Endnotes

Americans Paying More in Taxes than for Food, Clothing, and Shelter

Movie Production Incentives in the Last Frontier

Key Findings

Introduction

Film incentives

Developing a self-sustaining film industry and a diversified economy?

Counting the Cost of Film Tax Credits

Economic Distortions

Issues with Estimating Economic Impact

Subjectivity and Censorship

Conclusion

Endnotes

Testimony on the Proper Role of Congress in State Taxation

State Tax Collections Rising in Post-Recession Recovery

Taxmageddon Looms, Potentially Pushing Tax Freedom Day Later than Ever

Sales Tax Rates in Major U.S. Cities

City

State

State Rate

Local Rate

Total Rate

Rank

Special Report No. 198: Tax Freedom Day 2012

Tax Freedom Day Arrives on April 17th, 2012

Historical Tax Freedom Day

Tax Freedom Day By State

The Countdown is Over. We're #1

Country

2012 Tax Rate

2012 Ranking

2002 Tax Rate

2002 Ranking

Change in Tax Rate 2002-2012

Change in Ranking 2002-2012

Beyond Congress�s Power to Tax: Constitutional Questions Surrounding the Health Care Law�s Individual Mandate

Lottery Tax Rates Vary Greatly By State

State

Withholding Tax Rate (%)

State

Implicit TaxRevenue PerCapita

Rank

Important Questions to Ask in Evaluating a Film Tax Incentive Program

Meals Taxes in Major U.S. Cities

Population Rank

City

State

Sales Tax

Additional Meals Tax

Combined Tax on Meals

Combined Tax Rank

Location Matters

Recommendations for North Dakota�s Tax System

Facts & Figures Handbook: How Does Your State Compare?

State and Local Sales Taxes in 2012

State

State Tax Rate

Rank

Avg. Local Tax Rate (a)

Combined Rate

Rank

Table 1
Status of Local Government Litigation Against Online Travel Companies as of March 2012

Implicit Tax
Revenue Per
Capita