The two indices with the best record for predicting economic progress were the Economic Freedom of North America index by Fraser (“the strongest and most robust evidence”) and the State Business Tax Climate by the Tax Foundation. Looking at the Fraser index, they found that moving a state from the 40th to the 10th place in terms of economic freedom “would increase the rate of growth of employment by 0.317 percentage point.” Given that the mean employment growth rate is 1.15 percent, this amounts to about 30 percent faster employment growth.
Not to toot my own horn . . . OK, I’m going to toot my own horn, but my wife and I were the original co-creators of the Tax Foundation’s State Business Tax Climate Index. The vast majority of which has remained unchanged from the first few editions that we published.
For those of you who may be wondering why my blog posts have been a bit irregular, you can blame my latest study: “The Great Tax Divide: New Hampshire’s Retail Oasis vs. Maine’s Retail Desert.” There are two versions of the study, one focused on Maine (published by The Maine Heritage Policy Center) and one focused on New Hampshire. (published by the New Hampshire Center for Economic Policy)
Here is the Executive Summary from the Maine version:
It is well-known that Maine and New Hampshire are polar opposites when it comes to tax policy. Maine has one of the highest tax burdens in the country at 12.6 percent of personal income (6th highest) while New Hampshire has one of the lowest tax burdens at 8.7 percent of personal income (49th highest). These 3.9 percentage points represent one of, if not the, largest tax differentials between any two states in the country and is the basis for “The Great Tax Divide.”
The close geographic proximity of the two states leads to numerous arbitrage opportunities for Mainers to escape their significantly higher tax burden. The most obvious way is through direct cross-border shopping which previous MHPC studies have shown to be occurring up and down the Maine-New Hampshire border. This study builds on this research by utilizing comprehensive retail data from the U.S. Census Bureau over the last 60 years.
More specifically, Mainers are engaging in cross-border shopping in New Hampshire in response to Maine’s higher sales tax, cigarette tax, gasoline tax, bottle tax and alcohol taxes (beer, wine and liquor). Additionally, retailing in New Hampshire was given a significant boost in the early 1990’s when they reformed their tax code instituting the Business Enterprise Tax in place of other job-killing taxes.
Overall, Chart 1 shows that per capita retail sales in the adjacent bordering counties in Maine (Oxford and York) and New Hampshire (Coos, Carroll, Strafford and Rockingham) have been diverging ever since Maine adopted the sales tax in 1951. By 2007, the retail gap was $8,660 per person ($19,976 versus $11,316). If Maine had the same level of retail activity as New Hampshire, retail sales would have been up to $2.2 billion higher—from $2.9 billion to $5.1 billion—and created thousands of retail jobs.
Additionally,the big-box retailers are well aware of this retail sales gap. The map below shows the placement of the major big-box stores (Walmart, Home Depot, Lowes and Target) along the Maine-New Hampshire border. Note that there is a 40+ mile “retail desert” on the Maine side while the big-box stores on the New Hampshire side cluster as close to the border as is physically possible. Think they know something that Maine’s policymakers don’t?
Unfortunately, the Fair tax has one glaring weakness in that a broad-based sales tax inevitably leads to tax pyramiding–the taxation of business-to-business transactions. Pyramiding leads to all kinds of distortions in the marketplace. Finding solutions to pyramiding either requires shrinking the tax base–and raising the rate–or dramatically increasing tax compliance costs.
For businesses the flat tax works on a subtractive principle (start with receipts and subtract expenses) while the BET works on an additive principle (salaries and wages, interest and dividends). While New Hampshire does not have a personal component like the flat tax, there is no reason why you couldn’t have one to compliment the business-side tax–that is for any other state but New Hampshire. 🙂
A distressing new study by well-respected Canadian tax economist–Duanjie Chen and Jack Mintz–for CATO found that the effective U.S. Corporate Tax was 34.6 percent in 2010 (pdf). The U.S. corporate rate is the 4th highest among all OECD countries and on par with Uzbekistan (34.9 percent). That’s what it says . . . Uzbekistan!
Also, I’m glad to see them recognize the destructiveness of state sales taxes:
State governments also play an important role in business tax policy. Unfortunately, the average state corporate tax rate has not been cut in at least three decades, despite major reductions around the world since then. Furthermore, state retail sales taxes impose substantial burdens on capital purchases, which undermines investment and productivity. Thus, sales taxes should be reformed to remove taxation on business inputs.
This may seem to be a minor point, but there is a clear movement among state-based policymakers that it is OK tax reform to raise sales taxes and cut other taxes. I disagree and did so time and time again in the recent debate over reforming Maine’s tax system which included a cut in the income tax rate in exchange for a broader sales tax base. I argued that the sales tax is a job-killer. (pdf)
While cutting the federal corporate income tax rate may seem like a distant dream because of high budget deficit, state can get in on the game by reducing their own corporate income tax rate and/or sales tax rate. The benefits of doing so are very large.
A growing number of policymakers are recognizing that the U.S. corporate tax system is a major barrier to economic growth. The aim of corporate tax reforms should be to create a system that has a competitive rate and is neutral between different business activities. A sharp reduction to the federal corporate rate of 10 percentage points or more combined with tax base reforms would help generate higher growth and ultimately more jobs and income. Such reforms would likely lose the government little, if any, revenue over the long run.
In my previous blog post, “Prepare for 900% Increase in 1099 Workload,” I estimated that the expanded requirements for filing a 1099 (on everything over $600 in value) could increase tax compliance as high as the estimated increase in revenue of $17 billion. So the economy would suffer a net loss of $34 billion ($17 billion in new tax revenue and $17 billion in higher tax compliance costs).
Congress in 2010 expanded the information return reporting requirements contained in Code Sec. 6041. Generally, Code Sec. 6041 requires payments of $600 or more to a single recipient in the course of a trade or business to be reported by the payor to the IRS and the payee, usually on Form 1099-MISC. There are exceptions to the general reporting requirements but these exceptions begin to disappear in 2011.
One of these disappearing exceptions to the reporting requirements involves landlords. The Small Business Jobs Act of 2010 (2010 Jobs Act) (P.L. 111-240) amended the definition of trade or business to include renting real property. Before 2011, most landlords were not subject to the reporting requirements because renting real property was not considered to be a trade or business. Under the new version of Code Sec. 6041, real property rental is now considered a trade or business but only for purposes of the reporting requirements.
Of course, as with many government regulations, there will also be unintended consequences. In this case, the 1099 requirements could make landlords vulnerable to identity theft:
Since landlords have not, until now, been “engaged in a trade or business,” the reporting requirements create a problem. According to the instructions for Form 1099, sole proprietors and others, like landlords, who are not otherwise required to have an employer identification number (EIN) should use their Social Security number (SSN) for reporting purposes. Moreover, the instructions state that the filer’s name and TIN should be consisted with the name and TIN used on the filer’s other returns. This opens up the opportunity for identity theft.
So I wonder whose going to be scooped up next in the 1099 dragnet as more of these exceptions disappear?