Every state budget is funded through a system of taxes and fees. It’s important for each legislator to understand how those taxes and fees affect current and future constituents. Businesses are competing across state and national lines, and with technological innovations, individuals can work for a company based in one state and live in another. The rates and brackets of corporate and individual income taxes as well as the rates of sales taxes, property taxes, and others all have an impact on the decision-making of businesses and individuals.
Research has shown that states with low and flat – or no – rates of personal income tax or corporate net income tax are growing in population, while states with high rates and complicated tax systems are losing population.
What is taxed?
The core beneficial role of state government is to protect the foundational rights necessary for people to control their own destiny. State budgets should prioritize residents’ ability to be entrepreneurial to earn their success. When government spending and taxes exceed this positive role, it harms economic performance and diminishes opportunities for all citizens.
While no state is perfect, growing states have low and flat—or no—personal income tax or corporate net income tax. This encourages current employers to stay in the state and appropriately entices businesses to relocate within the state, minus distortionary tax credits – those that pick specific industries to reward at the expense of all others.
Many states also have sales taxes on products and possibly services and various excise taxes. It’s important to understand how reliant your state budget is upon each source of revenue. Is the budget funded by more stable sales taxes or taxes on specific products or industries that are sensitive to fluctuations?
How high are the rates?
Tax rates vary as much as the types of tax levied by a state. Many states have a progressive personal income tax, nine have a flat rate, and nine states do not have an individual income tax at all.
Just as diverse as the rates are the various tax credits and deductions. While standard deductions are equally applied to all taxpayers, joint and individual filers alike, credits are selective. Small business owners who file an individual income tax are particularly sensitive to increases or decreases in this tax.
Forty-eight states levy a corporate net income tax. States that do not have a corporate net income tax often impose a gross receipts tax on business income. The rest have various rates ranging from 2.5 to nearly 12 percent, the majority being a flat rate. Unfortunately, all corporate tax codes are ripe with examples of rewarding certain industries through complex tax credits or deductions at the expense of others.
Sales and use tax rates are large sources of income for state budgets. One of the most transparent taxes, the sales tax, raises substantial revenue because of the variety of items being sold or services being rendered in the state.
Ideally, sales taxes would only be levied on the final sale of an item or service. When certain products or services are exempted, a higher rate is required to raise the same amount of revenue. Likewise, if the rate is decreased and assessed on a greater variety of items or services, the rates should be lower for all purchasers. It’s also important to know whether your local governments can assess sales taxes as that will contribute to an overall higher rate.
What is not taxed?
Just as important as what is taxed is what is not. When tax credits are given to one subset of the population or industry, it shifts that burden onto other individuals or businesses. This is another example of the government rewarding or punishing certain behaviors, which is inappropriate.
The tax code is appropriate to raise revenue for necessary government functions, not control behavior. When taxes are low and flat, they are applied on many services and items to raise the same amount of revenue, thus benefitting all residents.
Why are certain items taxed differently than others?
Excise taxes are levied on certain products to discourage their use, such as marijuana, alcohol, and cigarettes.
Excise taxes are usually assessed in addition to the sales tax, leading to an increased final purchase price. This forces purchasers to pay the higher price, go elsewhere to purchase the item, or encourage black markets.
What should an ideal tax state look like?
Ideally, a state should rely on sales taxes which are low and applied to as many items as possible, avoiding business inputs which lead to tax pyramiding and an increased final purchase price.
States should reform or eliminate corporate net income taxes and individual income taxes by consolidating brackets, reducing rates, and eliminating corporate welfare and other waste where possible. Other economically harmful taxes such as gross receipts taxes and franchise taxes should be eliminated.