On October 26, the Tax Foundation issued its State Business Tax Climate Index. Authored by economist Kail Padgitt, the Index evaluates and provides a competitive ranking of all fifty states according to how they tax businesses. Maryland ranks near the bottom. Officials and citizens in Maryland should consider the state's abysmal Index ranking a pointed reminder of the need to foster an economic atmosphere more conducive to innovation, investment, and jobs. Right now, Maryland needs some business tax climate change.
Just as businesses compete with other businesses for customers, states compete with other states for businesses and job creation. By creating economic climates favorable to start-ups and business migrations, states benefit from increased investment, jobs, and, ultimately, state tax revenues. One significant way that states compete with each other economically is through their respective tax systems. As the State Business Tax Climate Index puts it, "[t]ax competition is an unpleasant reality for state revenue and budget officials, but it is an effective restraint on state and local taxes." Interstate tax competition, including business tax competition, is especially important in difficult economic times: "[t]his means that state lawmakers must be aware of how their states' business climates match up to their immediate neighbors and to other states."
The State Business Tax Climate Index is based on five weighted components: state corporate tax, state individual income tax, state sales tax, state unemployment tax, and state property tax.
Overall, Maryland ranks 44th in the Index for state business tax competitiveness. Although Maryland's corporate tax and sales taxes put it in a relatively competitive position relative to other states, Maryland's individual income tax index puts it near the cellar, at 49th place. A state's individual income tax factors into a state's overall business climate, as the Index relates, because "a significant number of businesses, including sole proprietorships, partnerships and S-corporations, report their income through the individual income tax code." And, "[t]axes can have significant impact on an individual's decision to become a self-employed entrepreneur." Also, "[c]omplex, poorly designed tax systems that extract an inordinate amount of tax revenue are known to reduce both the quantity and the quality of the labor pool," thereby raising business costs. Maryland likewise lands near the bottom of the pack due to its unemployment insurance tax burdens (#47) and its property tax burdens (#40).
The need for Maryland to establish and maintain a competitive position is particularly challenging considering the relative positions of its neighboring states. Virginia, for instance, stands at #12 in the state business tax climate standings. As the title of an October 21 Baltimore Business Journal op-ed reads, "Maryland will keep losing business to Virginia if lawmakers don't change." Tax reform is crucial for Maryland to attract or keep businesses that have recently opted for Northern Virginia. Overall, #44 Maryland also falls behind Delaware (#8), Pennsylvania (#26), and West Virginia (#37). And while Maryland does compare favorably to New Jersey (#48), it should be kept in mind that New Jersey may be poised to become more competitive in the future. Recent state income tax reforms in that state have moved it out of last place on the Index list—a distinction New Jersey had held for a handful of years running.
The State Business Tax Climate Index does provide a positive point for Maryland to build on:
Maryland will want to do better than a poor ranking if it hopes to prevent business relocations as well as job and other economic investment opportunity losses to its more competitive neighbor states. The path to a more favorable business tax climate, however, should not be based on special tax breaks and exemptions for select companies or industry segments. Unfair favoritism and manipulation of the tax system could bring some short-term benefits to well-lobbied interests, but it can also make a state's tax system more complex, increase compliance costs, and – most importantly – do nothing to address the underlying business tax climate problem. As the Index puts it:
In 2008, Maryland added four individual income tax brackets, one of which will expire at the end of 2010. With expiration of the 6.25% rate on income over $1 million, Maryland's top state-level income tax rate in 2011 will be 5.5% on income over $500,000. In combination with its highest in-the-nation county-level income taxes, Maryland's personal income tax system will still rank poorly, but its Individual Income Tax Index score will improve.
Maryland should keep that ideal tax system in mind when evaluating its own tax system. For the sake of Maryland's economic future, the Legislature needs to take a serious look at bringing further reforms to the way it taxes individual incomes, and also take a hard look at reforming its unemployment insurance and property tax systems. Maryland shouldn't be satisfied with losing out on jobs and economic growth because of a bottom-tier business tax climate.
The ideal tax system—whether at the local, state or federal level—is simple, transparent, stable, neutral to business activity, and pro-growth. In such an ideal system, individuals and businesses would spend a minimum amount of resources to comply with the tax system, understand the true cost of the tax system, base their economic decisions solely on the merits of the transactions without regard to tax implications, and not have the tax system impede their growth and prosperity.