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How Smart State Tax Policies Help Businesses Thrive


Bronwyn Flores, Specialist, Policy Communications, Consumer Technology Association (CTA)

While we wait for the United States Congress to pass comprehensive tax reform, we spoke to an expert on U.S. state tax policies. Here’s what The Tax Foundation’s Senior Policy Analyst Jared Walczak had to say about favorable tax policies to support innovation and attract tech startups.

What is the ideal business climate for a new company?

Every business has different tax exposure based on industry, size, location, vertical integration and a host of other factors. Which tax types a business cares about the most can vary widely. Some things, however, hold constant: businesses care about predictability; they want a tax code that keeps them and their business partners competitive; and they don't want the tax code to make it more difficult for them to grow, invest and expand.

New businesses often take advantage of targeted tax credits, and of course there's nothing wrong with utilizing whatever legitimate tax abatement strategies are available – but businesses that plan to be around for the long haul have to consider not only what their tax exposure will be while they can receive preferential tax treatment as a new business, but what sort of taxes they will face 10 years down the road.

Last year’s top states for Tax Friendliness were not overall champions in CTA's Innovation Scorecard. Why do you think this is? Do you think startups will start to consider these states as the next "Silicon Valley"?

Businesses make their location decisions on a wide range of factors. The tax climate is one of them — often an important one — but businesses also care about the cost of living, a qualified workforce, local amenities and even the actual climate. Some industries also tend to cluster together, as the tech industry has in Silicon Valley and Seattle.

States like Wyoming have a great tax climate, which can help entice businesses that might not otherwise consider the state – but there are still things that a California or New York can offer, despite high tax burdens and poor tax structure, that appeal to many businesses. If you superimposed California's tax code on South Dakota, the state would empty out. But although California isn't going to see its population disappear, if the state were to adopt a more competitive tax code, that could stem the tide of businesses relocating to other states throughout the region.

Every year, the Tax Foundation puts out a report measuring a state's business climate. Are you tracking "Netflix taxes" or taxes on self-driving vehicle technologies that stifle new innovation?

At this juncture, taxes imposed on self-driving cars are not tracked in any of our signature publications, but we do pay attention to the taxation of digital goods and services, and our State Business Tax Climate Index penalizes states which tax business inputs, including digital services. A well-structured sales tax features broad bases and low rates with the goal of taxing every final consumer transaction once, and only once. Taxes on business-to-business transactions lead to tax pyramiding, where the final good or service is taxed at more than 100 percent of its sale price, introducing economic distortions and stifling innovation and growth.

What changes in state tax policy are on your radar? 

With sales tax bases eroding as the U.S. transitions into an ever more service-oriented economy, states are looking for ways to broaden their bases to include previously untaxed goods and services. This can be good policy, introducing greater neutrality in the tax code, so long as care is taken to avoid the taxation of additional business inputs.

Also, in response to the volatility and declining revenue generation of corporate income taxes, some states are looking to an antiquated form of taxation: gross receipts taxes. These taxes all but disappeared a century ago, and for good reason: they're imposed without regard to a company's profitability or margins, and can yield extremely high, effective rates for low-margin companies with little vertical integration. They can also impose high and sometimes prohibitive burdens on new firms that have substantial receipts but have yet to achieve profitability. The reemergence of this once nearly extinct form of taxation is a cause for concern, and could be significant for many businesses.

Curious to see how your state scored? Check out the Innovation Scorecard to learn whether your state’s tax code supports tech startup and small business growth.

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