2023 State Business Tax Climate Index

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Executive Summary

The Tax Foundation’s State Business Tax Climate Index enables business leaders, government policymakers, and taxpayers to gauge how their states’ tax systems compare. While there are many ways to show how much is collected in taxes by state governments, the Index is designed to show how well states structure their tax systems and provides a road map for improvement.

The 10 best states in this year’s Index are:

1. Wyoming

2. South Dakota

3. Alaska

4. Florida

5. Montana

6. New Hampshire

7. Nevada

8. Utah

9. Indiana

10. North Carolina

The absence of a major tax is a common factor among many of the top 10 states. 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 income tax, the individual income tax, or the sales tax. Nevada, South Dakota, and Wyoming have no corporate or individual income tax (though Nevada imposes gross receipts taxes); 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.

This does not mean, however, that a state cannot rank in the top 10 while still levying all the major taxes. Indiana and Utah, for example, levy all the major tax types but do so with low rates on broad bases.

The 10 lowest-ranked, or worst, states in this year’s Index are:

41. Alabama
42. Rhode Island
43. Hawaii
44. Vermont
45. Minnesota
46. Maryland
47. Connecticut
48. California
49. New York
50. New Jersey

The states in the bottom 10 tend to have a number of afflictions in common: complex, nonneutral taxes with comparatively high rates. New Jersey, for example, is hampered by some of the highest property tax burdens in the country, has the highest-rate corporate income taxes in the county, and has one of the highest-rate individual income taxes. Additionally, the state has a particularly aggressive treatment of international income, levies an inheritance tax, and maintains some of the nation’s worst-structured individual income taxes.

Notable Ranking Changes in this Year’s Index

Arizona

Arizona transitioned from a four-bracket individual income tax with a top rate of 4.5 percent to a two-bracket system with a top rate of 2.98 percent, a waypoint on the state’s transition to a 2.5 percent single-rate tax. Initially scheduled for 2024, robust revenue growth has led to the certification of the 2.5 percent rate for January 1, 2023, a significant development that will further improve Arizona’s ranking in next year’s Index. This year’s changes, however, were sufficient for Arizona to improve five places overall, from 24th to 19th.

Arkansas

Like many states, Arkansas adopted both corporate and individual income tax rate reductions. In Arkansas’s case, these rate reductions—to a top individual income tax rate of 4.9 percent, down from 5.9 percent, and a corporate rate reduced from 6.2 to 5.9 percent—went into effect for the 2022 tax year. The corporate income tax rate reduction also resulted in the consolidation of an existing bracket. These changes were the primary driver of the state’s improvement from 43rd to 40th overall.

Georgia

Under legislation adopted in 2022, Georgia will adopt a 5.49 percent flat-rate income tax in 2024 and ultimately phase that rate down to 4.99 percent. These changes, however, lie in the future, and for now, improvements in the tax policies of three other states—Mississippi, Nebraska, and South Carolina—saw Georgia slide three places by standing still.

Idaho

Idaho improved two places overall, from 17th to 15th, due to the implementation of individual and corporate income tax rate reductions which took the individual income tax’s top rate, and the corporate income tax’s flat rate, from 6.5 to 6.0 percent. A ballot measure that would have created a new top rate of 10.925 percent to raise additional revenue for public education was taken off the ballot, and a deal was struck instead to provide additional education funding while implanting a 5.8 percent flat individual income tax rate in 2023. This change, which will be reflected in next year’s Index, will result in a further improvement in Idaho’s ranking.

Louisiana

The Bayou state implemented a package of tax reforms resulting in an improvement of three places on the Index, from 42nd to 39th, while improving the state’s individual income tax component by nine places and the corporate and property tax components by two places each. Reforms approved by voters in November 2021 yielded the repeal of the deduction for federal taxes paid, replaced by lower statutory tax rates. The top rate of the individual income tax was cut from 6.0 to 4.25 percent, while the state’s five corporate income tax brackets were consolidated into three, with a reduction in the top rate from 8 to 7.5 percent. Additionally, the capital stock tax rate was reduced from 0.3 percent to 0.275 percent, with the goal of eventual repeal through tax triggers.

Nebraska

Legislative Bill 432, signed into law in 2021, reduced Nebraska’s top marginal corporate income tax rate from 7.81 percent to 7.5 percent on January 1, 2022, and will further reduce the rate to 7.25 percent in January 2023. Additional legislation (LB 873) enacted in 2022 will reduce the state’s top marginal individual income tax rate from 6.84 to 5.84 percent over five years, beginning in 2023. This year’s corporate tax reduction contributed to Nebraska improving one place overall, from 30th to 29th.

New Mexico

Alone among states, New Mexico used recent revenue growth to facilitate a state sales tax rate reduction, from 5.125 to 5.0 percent. New Mexico’s sales tax is a hybrid tax, which the state calls a gross receipts tax, with an overly broad base that includes more business-to-business transactions than most states’ sales taxes. Combined with a modest improvement in unemployment insurance taxes relative to changes in other states, this rate cut propelled New Mexico five places on the Index, from 27th to 22nd overall.

Oklahoma

In a tax package that may be just the beginning, Oklahoma trimmed its top marginal individual income tax rate from 5 to 4.75 percent, cut the corporate rate from 6 to 4 percent (tied for second lowest), and became the first state to make its full expensing policy permanent. Since Oklahoma already had full expensing, the latter policy does not impact the state’s score for now, but with federal bonus depreciation scheduled to phase down beginning in 2023, if other states do not make their own adjustments, their provisions will become less generous while Oklahoma’s pro-investment policies remain Oklahoma improved five places on the Index, from 28th to 23rd.

South Carolina

South Carolina income the top rate from 7.0 to 6.5 percent while consolidating several brackets. The state has long had the highest top rate in the southeast, and while it maintains that distinction under this recent rate reduction, the gap between South Carolina and its neighbors has narrowed. The state improved two places on the Index, from 33rd to 31st, with further improvements anticipated in future years as the tax rate continues to phase down.

Washington

Washington experienced the worst slide in Index ranking this year, falling 13 places from 15th to 28th, primarily due to giving up its status as a state without an income tax. The state adopted a capital gains income tax on high earners which contains a sizeable marriage penalty and is not adjusted for inflation. Washington, with its unenviably aggressive gross receipts tax and high-rate sales tax, has always been buoyed on the Index by forgoing an income tax. With the loss of this distinctive, the state plummeted in our rankings.

Table 2. State Business Tax Climate Index (2014–2023)

	Prior Year Ranks								2022		2023		2022-2023 Change
State	2014	2015	2016	2017	2018	2019	2020	2021	Rank	Score	Rank	Score	Rank	Score
Alabama	40	40	41	38	39	41	40	40	39	4.57	41	4.56	-2	-0.01
Alaska	4	4	3	3	3	3	3	3	3	7.25	3	7.23	0	-0.02
Arizona	27	26	23	24	24	23	22	23	24	5.10	19	5.26	5	0.16
Arkansas	41	42	45	42	43	46	44	46	43	4.50	40	4.57	3	0.07
California	48	48	48	48	49	48	48	48	48	3.58	48	3.56	0	-0.02
Colorado	23	22	21	21	20	18	20	19	20	5.23	21	5.17	-1	-0.06
Connecticut	47	47	47	47	47	47	47	47	47	4.10	47	4.08	0	-0.02
Delaware	18	15	15	22	22	14	15	16	16	5.33	16	5.32	0	-0.01
Florida	5	5	4	4	4	4	4	4	4	6.91	4	6.85	0	-0.06
Georgia	28	30	33	31	30	34	31	28	29	5.01	32	4.99	-3	-0.02
Hawaii	38	38	36	32	33	39	38	38	41	4.53	43	4.51	-2	-0.02
Idaho	15	18	18	18	18	20	19	20	17	5.28	15	5.33	2	0.05
Illinois	33	36	28	25	29	35	36	36	36	4.77	36	4.78	0	0.01
Indiana	10	10	10	9	9	10	10	9	9	5.64	9	5.63	0	-0.01
Iowa	45	45	46	46	46	45	45	42	38	4.67	38	4.66	0	-0.01
Kansas	22	24	26	27	28	31	34	33	23	5.14	25	5.13	-2	-0.01
Kentucky	35	35	34	37	37	19	18	17	18	5.27	18	5.27	0	0.00
Louisiana	32	33	38	45	45	42	43	41	42	4.50	39	4.62	3	0.12
Maine	30	34	35	36	35	28	29	32	34	4.96	35	4.90	-1	-0.06
Maryland	39	39	40	41	40	40	42	44	46	4.25	46	4.28	0	0.03
Massachusetts	26	28	27	28	25	30	35	35	35	4.93	34	4.95	1	0.02
Michigan	11	12	13	13	13	13	12	13	12	5.58	12	5.57	0	-0.01
Minnesota	46	46	44	44	44	44	46	45	45	4.37	45	4.35	0	-0.02
Mississippi	25	27	29	29	27	27	28	30	31	5.00	30	5.00	1	0.00
Missouri	14	16	19	15	15	15	14	11	11	5.60	11	5.59	0	-0.01
Montana	6	6	6	6	6	5	5	5	5	6.07	5	6.08	0	0.01
Nebraska	36	29	30	30	34	25	27	29	30	5.00	29	5.02	1	0.02
Nevada	3	3	5	5	5	6	7	7	6	5.94	7	5.93	-1	-0.01
New Hampshire	8	7	7	7	7	7	6	6	7	5.93	6	5.96	1	0.03
New Jersey	49	49	50	49	50	50	50	50	50	3.36	50	3.37	0	0.01
New Mexico	21	23	24	26	26	24	24	21	27	5.07	22	5.16	5	0.09
New York	50	50	49	50	48	49	49	49	49	3.50	49	3.45	0	-0.05
North Carolina	31	11	12	11	10	11	11	10	10	5.61	10	5.60	0	-0.01
North Dakota	19	19	17	17	17	16	17	18	19	5.26	17	5.29	2	0.03
Ohio	42	41	42	39	41	37	37	37	37	4.72	37	4.72	0	0.00
Oklahoma	20	21	22	20	21	26	26	25	28	5.06	23	5.15	5	0.09
Oregon	9	9	9	10	11	9	8	15	22	5.15	24	5.14	-2	-0.01
Pennsylvania	37	37	37	33	36	36	33	34	32	5.00	33	4.99	-1	-0.01
Rhode Island	44	43	39	40	38	38	39	39	40	4.54	42	4.54	-2	0.00
South Carolina	29	31	31	34	32	32	32	31	33	4.97	31	5.00	2	0.03
South Dakota	2	2	2	2	2	2	2	2	2	7.48	2	7.49	0	0.01
Tennessee	24	25	25	23	23	29	30	26	14	5.45	14	5.44	0	-0.01
Texas	12	13	11	12	12	12	13	12	13	5.55	13	5.51	0	-0.04
Utah	7	8	8	8	8	8	9	8	8	5.64	8	5.64	0	0.00
Vermont	43	44	43	43	42	43	41	43	44	4.47	44	4.44	0	-0.03
Virginia	16	17	20	19	19	21	23	24	25	5.09	26	5.07	-1	-0.02
Washington	13	14	14	14	14	17	16	14	15	5.38	28	5.03	-13	-0.35
West Virginia	17	20	16	16	16	22	21	22	21	5.18	20	5.21	1	0.03
Wisconsin	34	32	32	35	31	33	25	27	26	5.07	27	5.07	-1	0.00
Wyoming	1	1	1	1	1	1	1	1	1	7.77	1	7.76	0	-0.01
District of Columbia	47	48	47	48	48	47	47	48	48	3.86	48	3.75	0	-0.11
Note: A rank of 1 is best, 50 is worst. All scores are for fiscal years. DC’s score and rank do not affect other states. Source: Tax Foundation.

Recent and Scheduled Changes Not Reflected in the 2023 Index

Georgia

On January 1, 2024, Georgia will transition from a graduated individual income tax with a top rate of 5.75 percent to a flat tax structure with a rate of 5.49 percent. Per HB 1437, the rate could decrease to 4.99 percent by January 1, 2029, if certain revenue conditions are met, paired with substantial increases in personal exemptions.

Indiana

The Hoosier State will cut its flat individual income tax rate from 3.23 to 3.15 percent in 2023. If subsequent triggers are met, the rate could be reduced to 2.9 percent by 2029.

Iowa

In Iowa, a comprehensive tax reform package will see the state’s high graduated rate income tax transformed into a flat tax of 3.9 percent, with the corporate income tax declining to 5.5 percent, among other reforms. These changes are not in effect in 2022, though 2023 will usher in a consolidation of the income tax to four brackets with a top marginal rate of 6.0 percent, heading toward a flat rate tax in 2026. These changes, which accelerate and build upon two previous rounds of tax reform, will dramatically improve Iowa’s ranking.

Kentucky

With the passage of HB 8, Kentucky will use revenue triggers to reduce its individual income tax by 0.5 percentage points in years in which the triggers are met. The use of these triggers could theoretically lead to the phaseout of the individual income tax in its entirety. However, even absent the elimination of the tax, rate reductions will bolster Kentucky’s score in future years.

Mississippi

Under HB 531, Mississippi will eliminate its current 4 percent individual income tax bracket on January 1, 2023. This will transition the state from a graduated income tax structure to a flat rate of 5 percent. The flat rate is scheduled to decrease to 4.7 percent in 2024, 4.4 percent in 2025, and finally 4 percent in 2026.

Montana

Montana adopted structural reforms to both its individual and corporate income taxes in 2021, with the individual income tax rate seeing a modest reduction on January 1, 2022, which was not enough to change the state’s rank on the Index—particularly given similar or larger cuts in many other states. In 2024, however, the seven brackets will be consolidated into two with a top rate of 6.5 percent, which is likely to yield a favorable ranking change. Although the lowest rate will rise to 4.7 percent in 2024, conforming to the federal standard deduction in 2025 will yield tax savings for lower-income taxpayers. This law also doubles the bracket widths for married filers, thereby removing the marriage penalty that currently exists in the state’s income tax code.

New Hampshire

Currently, New Hampshire is the only state that does not impose a tax on wage or salary income but does levy a tax on interest and dividend income. Beginning in tax year 2023, the state will phase out this interest and dividends tax by one percentage point per year until it is fully repealed by 2027. This year, the state reduced the Business Profits Tax (BPT) from 7.7 to 7.6 percent and the Business Enterprise Tax (BET, a value-added tax) from 0.6 to 0.55 percent, though these changes were insufficient to result in an improvement in the state’s rank. The BPT will decline further, to 7.5 percent, in 2024.

Pennsylvania

Under legislation paired with the state budget, Pennsylvania will reduce the corporate net income tax rate from 9.99 percent to 8.99 percent on January 1, 2023. Each year thereafter the rate will decrease 0.5 percentage points until it reaches 4.99 percent at the beginning of 2031, transforming the nation’s second-highest corporate income tax rate into something much more competitive.

Introduction

Taxation is inevitable, but the specifics of a state’s tax structure matter greatly. The measure of 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 State Business Tax Climate Index distills many complex considerations to an easy-to-understand ranking.

The modern market is characterized by mobile capital and labor, with all types of businesses, 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 at 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 also matter–such as access to raw materials or infrastructure or a skilled labor pool–but a simple, sensible tax system can positively impact business operations with regard to these resources. Furthermore, unlike changes to a state’s health-care, transportation, or education systems, 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 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 a foreign location.[1] Certainly, job creation is rapid overseas, as previously underdeveloped nations enter the world economy, though in the aftermath of federal tax reform, U.S. businesses no longer face the third-highest corporate tax rate in the world, but rather one in line with averages for industrialized nations.[2] 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, Michigan, to Dayton, Ohio, than from Detroit to New Delhi, India. This means that state lawmakers must be aware of how their states’ business climates match up against their immediate neighbors and to other regional competitor states.

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 (D) proposed a hefty gross receipts tax.[3] Only when the legislature resoundingly defeated the bill did the investment resume. In 2005, California-based Intel decided to build a multibillion-dollar chip-making facility in Arizona due to its favorable corporate income tax system.[4] In 2010, Northrup Grumman chose to move its headquarters to Virginia over Maryland, citing the better business tax climate.[5] In 2015, General Electric and Aetna threatened to decamp from Connecticut if the governor signed a budget that would increase corporate tax burdens, and General Electric actually did so.[6] 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. 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 mindful of their states’ business tax climates, but they are sometimes 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.[7] A 2007 USA TODAY article chronicled similar problems other states have had with companies that receive generous tax incentives.[8]

Lawmakers make 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 an undesirable business tax climate. A far more effective approach is the systematic improvement of the state’s business tax climate for the long term to improve the state’s competitiveness. When assessing which changes to make, lawmakers need to remember 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), shareholders (through lower dividends or share value), or some combination of the above. 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 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.

To some extent, tax-induced economic distortions are a fact of life, but policymakers should strive 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 minimize tax-induced economic distortions.

Ranking the competitiveness of 50 very different tax systems presents many challenges, especially when a state dispenses with a major tax entirely. Should Indiana’s tax system, which includes three relatively neutral taxes on 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 statewide tax on individual income or sales?

The Index deals with such questions by comparing the states on more than 120 variables in the five major areas of taxation (corporate taxes, individual income taxes, sales taxes, unemployment insurance taxes, and property taxes) and then adding the results to yield a final, overall ranking. This approach rewards states on particularly strong aspects of their tax systems (or penalizes them on particularly weak aspects), while 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 Indiana score well.

Literature Review

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 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 who all value public services similarly.

However, businesses sort out the costs and benefits of taxes differently from individuals. For businesses, which can be more mobile and must earn profits to justify their existence, taxes reduce profitability. Theoretically, businesses could be expected to be more responsive than individuals to the lure of low-tax jurisdictions. Research suggests that corporations engage in “yardstick competition,” comparing the costs of government services across jurisdictions. Shleifer (1985) first proposed comparing regulated franchises in order to determine efficiency. Salmon (1987) extended Shleifer’s work to look at subnational 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 federal 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 nonmanufacturing 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 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 concluded that the conventional view that state and local taxes have little effect on business is false.

Papke and Papke (1986) found that tax differentials among 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 tax elasticities of -0.1 to -0.5 that imply 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 had expanded sufficiently for Bartik (1991) to identify 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) found that taxes are a statistically significant factor in private-sector job growth. Specifically, they found that personal property taxes and sales taxes have economically large negative effects on the annual growth of private employment.

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 the 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.

Although the literature has largely congealed around a general consensus that taxes are a substantial factor in the decision-making process for businesses, disputes remain, and some scholars are unconvinced.

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. However, his conclusion is premised on there being few significant differences in state tax systems. He concedes that high-tax states will lose economic activity to average or low-tax states “as long as the elasticity is negative and significantly different from zero.” Indeed, he approvingly cites a State Policy Reports article that finds that 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.[9]

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.

However, there is ample evidence that states 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 income tax rate increased from 3 percent to 5 percent, and the corporate income tax rate rose from 7.3 percent to 9.5 percent.[10] 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 deals with both firms, totaling $235 million over the next decade, to keep them from leaving the state.[11]

A new literature review, Kleven et al. (2019), summarizes recent evidence for tax-driven migration. Meanwhile, Giroud and Rauh (2019) use microdata on multistate firms to estimate the impact of state taxes on business activity, and find that C corporation employment and establishments have short-run corporate tax elasticities of -0.4 to -0.5, while pass-through entities show elasticities of -0.2 to -0.4, meaning that, for each percentage-point increase in the rate, employment decreases by 0.4 to 0.5 percent for C corporations subject to the corporate income tax, and by 0.2 to 0.4 percent within pass-through businesses subject to the individual income tax.

Measuring the Impact of Tax Differentials

Some recent contributions to the literature on state taxation criticize business and tax climate studies in general.[12] 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? now published by Good Jobs First, criticizes four indices: The U.S. Business Policy Index published by the Small Business and Entrepreneurship Council, Beacon Hill’s Competitiveness Report, the American Legislative Exchange Council’s Rich States, Poor States, and this study. The first edition also critiqued the Cato Institute’s Fiscal Policy Report Card and the Economic Freedom Index by the Pacific Research Institute. In the report’s first edition, published before Fisher summarized his objections: “The underlying problem with the … 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). In the second edition, he identified three overarching questions: (1) whether the indices included relevant variables, and only relevant variables; (2) whether these variables measured what they purport to measure; and (3) how the index combines these measures into a single index number (Fisher 2013). Fisher’s primary argument is that if the indexes did what they purported to do, then all five would rank the states similarly.

Fisher’s conclusion holds little weight because the five indices 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 (the 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 (the 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 rather the narrower business tax climate, and its variables reflect this focus. 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 1970s view that the effects of taxes are “small or non-existent,” our study reflects strong 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 indices are able to predict growth. Specifically, they concluded, “The State Business Tax Climate Index explains growth consistently.” This finding was confirmed by Anderson (2006) in a study for the Michigan House of Representatives, and more recently by Kolko, Neumark, and Mejia (2013), who, in an analysis of the ability of 10 business climate indices to predict economic growth, concluded that the State Business Tax Climate Index yields “positive, sizable, and statistically significant estimates for every specification” they measured, and specifically cited the Index as one of two business climate indices (out of 10) with particularly strong and robust evidence of predictive power.

Bittlingmayer et al. also found that relative tax competitiveness matters, especially at the borders, and therefore, indices that place a high premium on tax policies do a better job of explaining growth. They also 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 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 State Business Tax Climate Index is a hierarchical structure built from five components:

• Individual Income Tax
• Sales Tax
• Corporate Income 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 0 (worst) to 10 (best). Each component is devoted to a major area of state taxation and includes numerous variables. Overall, there are 125 variables measured in this report.

The five components are not weighted equally, as they are in some indices. 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:

• 30.6% — Individual Income Tax
• 23.5% — Sales Tax
• 21.1% — Corporate Tax
• 15.0% — Property Tax
• 9.8% — 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 another state 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 subindices devoted to measuring the impact of the tax rates and the tax bases. Each subindex 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 subindex 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 subindex is problematic because the extreme valuation of a dummy can overly influence the results of the subindex. To counter this effect, the Index generally weights scalar variables at 80 percent and dummy variables at 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 among the states’ tax systems, especially for pragmatic business owners who want to know which states have the best tax system in each region.

Comparing States without a Tax. One problem associated with a relative scale 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.

Three notable exceptions to this rule exist. The first is in Washington, Tennessee, and Texas, which do not have taxes on wage income but do apply their gross receipts taxes to S corporations. (Washington and Texas also apply these to limited liability corporations.) Because these entities are generally taxed through the individual code, do not score perfectly in the individual income tax component. The second exception is found in Nevada, where a payroll tax (for purposes other than unemployment insurance) is also included in the individual income tax component. The final exception is in zero sales tax states–Alaska, Montana, New Hampshire, Oregon, and Delaware–which do not have general sales taxes but still do not score a perfect 10 in that component section because of excise taxes on gasoline, beer, spirits, and cigarettes, which are included in that section. Alaska, moreover, forgoes a state sales tax, but does permit local option sales taxes.

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 indices. For example, the unadjusted average score of the corporate income tax component is

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 each state’s score by a constant value.

Once the scores are normalized, it is possible to compare states across indices. For example, because of normalization, it is possible to say that Connecticut’s score of 5.10 on corporate income taxes is better than its score of 4.80 on the sales 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 2023 Index and represents the tax climate of each state as of July 1, 2022, the first day of fiscal year 2023 for most states.

District of Columbia

The District of Columbia (D.C.) is only included as an exhibit and its scores and “phantom ranks” offered do not affect the scores or ranks of other states.

Past Rankings and Scores

This report includes 2014-2021 Index rankings that can be used for comparison with the 2022 rankings and scores. These can differ from previously published Index rankings and scores due to the enactment of retroactive statutes, backcasting of the above methodological changes, and corrections to variables brought to our attention since the last report was published. The scores and rankings in this report are definitive.

Corporate Tax

This component measures the impact of each state’s principal tax on business activities and accounts for 21.1 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 (gross receipts minus expenses). Some states, however, problematically 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 Merchants’ License Tax, as does Tennessee with its Business Tax, Virginia with its locally-levied Business/Professional/Occupational License (BPOL) tax, and West Virginia with its local Business & Occupation (B&O) tax. Texas also added the Margin Tax, a complicated gross receipts tax, in 2007, Nevada adopted the gross receipts-based multi-rate Commerce Tax in 2015, and Oregon implemented a new modified gross receipts tax in 2020. However, in 2011, Michigan passed a significant corporate tax reform that eliminated the state’s modified gross receipts tax and replaced it with a 6 percent corporate income tax, effective January 1, 2012.[13] The previous tax had been in place since 2007, and Michigan’s repeal followed others in Kentucky (2006) and New Jersey (2006). Several states contemplated gross receipts taxes in 2017, but none were adopted.

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 subindex is calculated 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 thus receive a perfect score.

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 calculate the parallel subindex 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, among others. States that score well on the corporate tax base subindex generally will have few business tax credits, generous carryback and carryforward provisions, deductions for net operating losses, conformity to the Internal Revenue Code, and provisions that alleviate double taxation.

Table 3. Corporate Tax Component of the State Business Tax Climate Index (2014–2023)

	Prior Year Ranks								2022		2023		2022-2023 Change
State	2014	2015	2016	2017	2018	2019	2020	2021	Rank	Score	Rank	Score	Rank	Score
Alabama	23	24	22	14	21	22	23	23	17	5.53	18	5.52	-1	-0.01
Alaska	25	26	26	25	26	25	25	25	27	5.10	28	5.09	-1	-0.01
Arizona	22	22	20	19	14	16	21	22	23	5.31	23	5.29	0	-0.02
Arkansas	36	36	38	38	38	39	33	33	29	4.90	29	4.96	0	0.06
California	29	31	33	32	31	37	27	27	46	4.06	46	4.05	0	-0.01
Colorado	19	13	15	18	18	6	7	9	6	6.03	7	6.00	-1	-0.03
Connecticut	27	29	31	31	30	33	26	26	26	5.10	27	5.09	-1	-0.01
Delaware	50	50	50	50	50	50	50	50	50	2.41	50	2.41	0	0.00
Florida	13	14	16	19	19	11	9	6	7	5.99	10	5.77	-3	-0.22
Georgia	9	10	10	11	10	8	6	7	8	5.92	8	5.90	0	-0.02
Hawaii	5	5	4	6	11	12	17	19	19	5.48	19	5.46	0	-0.02
Idaho	17	21	21	23	23	27	28	28	28	5.02	26	5.10	2	0.08
Illinois	43	44	32	24	35	36	35	35	38	4.48	38	4.47	0	-0.01
Indiana	28	27	23	22	22	19	11	12	11	5.75	11	5.74	0	-0.01
Iowa	48	48	48	48	48	46	48	46	33	4.86	34	4.85	-1	-0.01
Kansas	35	35	37	37	37	31	34	30	21	5.39	21	5.38	0	-0.01
Kentucky	24	25	25	26	24	15	13	15	15	5.62	15	5.60	0	-0.02
Louisiana	16	20	35	39	39	34	36	34	34	4.76	32	4.87	2	0.11
Maine	41	42	41	40	40	32	37	36	35	4.59	35	4.58	0	-0.01
Maryland	14	15	17	21	20	26	31	32	32	4.87	33	4.86	-1	-0.01
Massachusetts	32	34	36	35	34	38	38	37	36	4.56	36	4.55	0	-0.01
Michigan	8	8	8	9	8	13	18	20	20	5.44	20	5.42	0	-0.02
Minnesota	40	40	42	42	41	43	45	43	43	4.15	43	4.13	0	-0.02
Mississippi	10	11	12	12	12	14	10	13	13	5.66	13	5.64	0	-0.02
Missouri	4	4	3	5	5	4	3	3	3	6.79	3	6.77	0	-0.02
Montana	15	16	18	13	13	9	20	21	22	5.35	22	5.34	0	-0.01
Nebraska	34	28	27	27	27	28	30	31	31	4.88	30	4.92	1	0.04
Nevada	1	1	24	33	32	21	24	24	25	5.19	25	5.18	0	-0.01
New Hampshire	47	47	47	47	43	45	42	44	44	4.10	44	4.10	0	0.00
New Jersey	37	37	39	41	44	49	49	48	48	3.51	48	3.50	0	-0.01
New Mexico	33	33	30	29	25	23	22	11	12	5.74	12	5.72	0	-0.02
New York	21	19	11	8	7	18	14	16	24	5.21	24	5.19	0	-0.02
North Carolina	26	23	7	4	3	3	4	4	4	6.17	5	6.15	-1	-0.02
North Dakota	20	18	14	16	16	17	19	8	9	5.91	9	5.90	0	-0.01
Ohio	45	43	46	46	47	42	41	40	39	4.44	39	4.43	0	-0.01
Oklahoma	11	9	9	10	9	20	8	10	10	5.82	4	6.20	6	0.38
Oregon	30	32	34	34	33	29	32	49	49	2.80	49	2.79	0	-0.01
Pennsylvania	42	41	43	43	42	44	44	42	42	4.16	42	4.15	0	-0.01
Rhode Island	38	38	29	30	29	35	40	39	40	4.41	40	4.39	0	-0.02
South Carolina	12	12	13	15	15	5	5	5	5	6.07	6	6.05	-1	-0.02
South Dakota	1	1	1	1	1	1	1	1	1	10.00	1	10.00	0	0.00
Tennessee	44	45	44	44	45	48	47	45	45	4.08	45	4.07	0	-0.01
Texas	49	49	49	49	49	47	46	47	47	4.00	47	3.98	0	-0.02
Utah	6	6	5	3	4	7	12	14	14	5.63	14	5.63	0	0.00
Vermont	39	39	40	36	36	40	43	41	41	4.33	41	4.31	0	-0.02
Virginia	7	7	6	7	6	10	15	17	16	5.56	17	5.54	-1	-0.02
Washington	46	46	45	45	46	41	39	38	37	4.49	37	4.47	0	-0.02
West Virginia	18	17	19	17	17	24	16	18	18	5.48	16	5.60	2	0.12
Wisconsin	31	30	28	28	28	30	29	29	30	4.89	31	4.88	-1	-0.01
Wyoming	1	1	1	1	1	1	1	1	1	10.00	1	10.00	0	0.00
District of Columbia	37	37	37	26	26	24	27	27	28	5.05	29	5.04	-1	-0.01
Note: A rank of 1 is best, 50 is worst. All scores are for fiscal years. DC’s score and rank do not affect other states. Source: Tax Foundation.

Corporate Tax Rate

The corporate tax rate subindex is designed to gauge how a state’s corporate income tax top marginal 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 of 21 percent, substantially reduced by the Tax Cuts and Jobs Act of 2017 from a graduated-rate tax with a top rate of 35 percent, the highest rate among industrialized nations. Two states levy neither a corporate income tax nor a gross receipts tax: South Dakota and Wyoming. These states automatically score a perfect 10 on this subindex. Therefore, this section ranks the remaining 48 states relative to each other.

Top Tax Rate. New Jersey’s 11.5 percent rate (including a temporary and retroactive surcharge from 2020 to 2023) 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 Iowa and Minnesota (both at 9.8 percent), Alaska (9.4 percent), Maine (8.93 percent), and California (8.84 percent). By contrast, North Carolina’s rate of 2.5 percent is the lowest nationally, followed by Missouri’s and Oklahoma’s (both at 4 percent), North Dakota’s at 4.31 percent, and Florida’s at 4.458 percent. Other states with comparatively low top corporate tax rates are Colorado (4.55 percent), Arizona and Indiana (both at 4.9 percent), Utah (4.95 percent), and Kentucky, Mississippi, and South Carolina, 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. Twenty-nine states and the District of Columbia have single-rate systems, and they score best. Single-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

graduated 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.[14]

A single-rate 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 (five brackets) and Maine and New Jersey (four brackets).

Corporate Tax Base

This subindex measures the economic impact of each state’s definition of what should be subject to corporate taxation.

The three criteria used to measure the competitiveness of each state’s corporate 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 subindex.

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. Simply put, the NOL deduction helps level the playing field among cyclical and noncyclical industries. Under the Tax Cuts and Jobs Act, the federal government allows losses to be carried forward indefinitely, though they may only reduce taxable income by 80 percent in any given year. Because gross receipts taxes inherently preclude the possibility of carrying net operating losses backward or forward, the Index treats states with statewide gross receipts taxes as having the equivalent of no NOL carryback or carryforward provisions.

California has temporarily suspended its net operating loss provisions as a revenue-raising measure during the pandemic despite the state posting record surpluses. It is the only state without an active NOL provision and is assigned the worst score across all NOL variables.

Number of Years Allowed for Carryback and Carryforward. This variable measures the number of years allowed on a carryback or carryforward 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 FY 2022 with better treatment of the carryforward (up to a maximum of 20 years) than the carryback (up to a maximum of three years). States score well on the Index if they conform to the new federal provisions or provide their own robust system of carryforwards and carrybacks.

Caps on the Amount of Carryback and Carryforward. When companies have a larger 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 ranked lower in the Index. Two states, Idaho and Montana, limit the number of carrybacks, though they do better than many of their peers in offering any carryback provisions at all. Of states that allow a carryforward of losses, only Illinois, New Hampshire, and Pennsylvania limit carryforwards. Illinois’ cap is a recent addition, intended to only apply to tax years 2021 through 2024. As a result, these states score poorly on 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 industry or individual business, a stark departure from the principle of tax neutrality. Firms with few steps in their production chain are relatively lightly taxed under a gross receipts tax, and vertically-integrated, high-margin firms prosper, while firms with longer production chains are exposed to a substantially higher tax burden. 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, Nevada, Ohio, Oregon, Tennessee, 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 employee compensation but not both. The Virginia BPOL tax, the West Virginia B&O, and the Pennsylvania business privilege tax are not included in this survey, because they are assessed at the local level and not levied uniformly across the state.

Federal Income Used as State Tax Base. States that use federal definitions of income reduce the tax compliance burden on their taxpayers. Two states (Arkansas and Mississippi) do not conform to federal definitions of corporate income 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 Accelerated Cost Recovery System (ACRS) and Modified Accelerated Cost Recovery System (MACRS) depreciation schedules. 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. Thirteen states are penalized because they do not fully conform to the federal system: Alaska, California, Delaware, Iowa, Louisiana, Maryland, Minnesota, Mississippi, New Hampshire, North Carolina, Oklahoma, Oregon, and Tennessee.

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.

Five states have an AMT on corporations and thus score poorly: California, Iowa, Kentucky, Minnesota, and New Hampshire.

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. Twenty-three states allow deductions for foreign taxes paid and score well. The remaining 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 corporate income taxes, 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 15 states with graduated corporate income taxes fail to index their tax brackets: Alaska, Arkansas, Hawaii, Iowa, Kansas, Louisiana, Maine, Mississippi, Nebraska, New Jersey, New Mexico, New York, North Dakota, Oregon, and Vermont.

Throwback. To reduce the double taxation of corporate income, states use apportionment formulas that seek 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 and throwout rules for sales of tangible property 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. , while 22 states and the District of Columbia do.

Section 168(k) Expensing. Because corporate income taxes are intended to fall on net income, they should include deductions for business expenses—including investment in machinery and equipment. Historically, however, businesses have been required to depreciate the value of these purchases over time. In recent years, the federal government offered “bonus depreciation” to accelerate the deduction for these investments, and under the Tax Cuts and Jobs Act, investments in machinery and equipment are fully deductible in the first year, a policy known as “full expensing.” Nineteen states follow the federal government in offering full expensing, while two offer “bonus depreciation” short of full expensing.

Net Interest Limitation. Federal law now restricts the deduction of business interest, limiting the deduction to 30 percent of modified income, with the ability to carry the remainder forward to future tax years. This change was intended to eliminate the bias in favor of debt financing (over equity financing) in the federal code, but particularly when states adopt this limitation without incorporating its counterbalancing provision, full expensing, the result is higher investment costs.

Inclusion of GILTI. Historically, states have largely avoided taxing international income. Following federal tax reform, however, some states have latched onto the federal provision for the taxation of Global Low-Taxed Intangible Income (GILTI), intended as a guardrail for the new federal territorial system of taxation, as a means to broaden their tax bases to include foreign business activity. States that tax GILTI are penalized in the Index, while states receive partial credit for moderate taxation of GILTI (for instance, by adopting the Section 250 deduction) and are rewarded for decoupling or almost fully decoupling from GILTI (by, for instance, treating it as largely-deductible foreign dividend income in addition to providing the Section 250 deduction).

Tax Credits

Many states provide tax credits that lower the effective tax rates for certain industries and 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, with states that offer them scoring 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 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, job tax credits can misfire in a number of ways. They induce businesses whose economic position would be best served by spending more on new equipment or marketing to hire new employees instead. They also 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. Research and development 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. Thus, states that offer such credits score poorly on the Index.

Individual Income Tax

The individual income tax component, which accounts for 30.6 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.

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.” 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 businesses 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 reduce both the quantity and quality of the labor pool. This is consistent with the findings of 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, continually reducing 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, then a rational person would stop working and take the hour to pursue leisure. Additionally, workers earning higher wages–$30 per hour, for example–who 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 pretax 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.[16]

The individual income tax rate subindex 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 subindex takes into account measures enacted to prevent double taxation, whether the code is indexed for inflation, and how the tax code treats married couples compared to singles. States that score well protect married couples from being taxed more severely than if they had filed as two single individuals. They also protect taxpayers from double taxation by recognizing LLCs and S corporations 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 impose an individual income tax 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 or non-UI payroll tax are, not surprisingly, the highest scoring states on this component: Alaska, Florida, South Dakota, Tennessee, Texas, Washington, and Wyoming. Nevada, which taxes wage income (but not unearned income) at a low rate under a non-UI payroll tax, also does extremely well in this component of the Index. New Hampshire also scores well, because while the state levies a tax on individual income in the form of interest and dividends, it does not tax wages and salaries.[17] Colorado, Illinois, Indiana, Kentucky, Massachusetts, Michigan, North Carolina, Pennsylvania, and Utah score highly because they have a single, low tax rate.

Scoring near the bottom of this component are states that 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 corporations.

Table 4. Individual Income Tax Component of the State Business Tax Climate Index (2014–2023)

	Prior Year Ranks								2022		2023		2022-2023 Change
State	2014	2015	2016	2017	2018	2019	2020	2021	Rank	Score	Rank	Score	Rank	Score
Alabama	23	25	25	25	25	31	31	29	28	4.90	30	4.89	-2	-0.01
Alaska	1	1	1	1	1	1	1	1	1	10.00	1	10.00	0	0.00
Arizona	22	24	18	19	19	19	17	18	18	5.35	16	5.84	2	0.49
Arkansas	34	36	37	40	40	40	40	42	38	4.32	37	4.48	1	0.16
California	50	50	50	50	50	49	49	50	49	2.06	49	2.06	0	0.00
Colorado	15	14	14	14	14	13	13	13	14	5.90	14	5.89	0	-0.01
Connecticut	42	42	46	47	47	43	45	47	47	3.41	47	3.41	0	0.00
Delaware	43	43	42	44	44	44	44	44	44	3.81	44	3.81	0	0.00
Florida	1	1	1	1	1	1	1	1	1	10.00	1	10.00	0	0.00
Georgia	33	35	35	35	35	37	36	36	35	4.72	35	4.72	0	0.00
Hawaii	47	47	47	38	38	47	47	46	46	3.46	46	3.46	0	0.00
Idaho	20	21	23	24	24	23	25	24	20	5.20	19	5.32	1	0.12
Illinois	10	15	11	11	13	14	14	12	13	5.91	13	5.90	0	-0.01
Indiana	14	13	15	15	15	15	15	14	15	5.85	15	5.84	0	-0.01
Iowa	41	41	41	42	42	42	41	40	40	4.27	40	4.26	0	-0.01
Kansas	16	17	17	17	18	21	22	21	22	5.10	22	5.10	0	0.00
Kentucky	36	38	38	37	37	17	18	17	17	5.54	18	5.54	-1	0.00
Louisiana	32	33	32	32	31	35	35	35	34	4.73	25	5.02	9	0.29
Maine	26	28	34	31	32	25	20	22	23	5.09	23	5.08	0	-0.01
Maryland	44	44	43	46	46	45	43	45	45	3.66	45	3.66	0	0.00
Massachusetts	12	11	12	12	11	11	11	16	11	6.00	11	6.10	0	0.10
Michigan	13	12	13	13	12	12	12	11	12	5.98	12	5.97	0	-0.01
Minnesota	45	45	44	45	45	46	46	43	43	3.90	43	3.89	0	-0.01
Mississippi	21	22	24	23	23	28	28	27	26	4.96	26	4.99	0	0.03
Missouri	31	32	31	33	33	27	23	20	21	5.14	21	5.15	0	0.01
Montana	18	19	20	20	20	22	24	23	24	5.05	24	5.07	0	0.02
Nebraska	38	34	33	34	34	30	30	30	29	4.87	32	4.87	-3	0.00
Nevada	1	1	1	1	1	5	5	5	5	8.51	5	8.50	0	-0.01
New Hampshire	9	9	9	9	9	9	9	9	9	6.36	9	6.35	0	-0.01
New Jersey	48	48	48	48	48	50	50	49	48	2.09	48	2.09	0	0.00
New Mexico	19	20	22	22	22	26	27	26	36	4.54	36	4.54	0	0.00
New York	49	49	49	49	49	48	48	48	50	1.88	50	1.88	0	0.00
North Carolina	37	16	16	16	16	16	16	15	16	5.76	17	5.76	-1	0.00
North Dakota	27	23	21	21	21	18	19	25	25	4.98	27	4.97	-2	-0.01
Ohio	46	46	45	43	43	41	42	41	41	4.23	41	4.23	0	0.00
Oklahoma	29	30	29	28	28	32	32	31	30	4.85	31	4.88	-1	0.03
Oregon	35	37	36	36	36	38	39	38	42	4.00	42	4.00	0	0.00
Pennsylvania	17	18	19	18	17	20	21	19	19	5.22	20	5.18	-1	-0.04
Rhode Island	25	27	27	27	27	24	26	32	31	4.83	33	4.82	-2	-0.01
South Carolina	30	31	30	30	30	34	34	34	33	4.79	28	4.89	5	0.10
South Dakota	1	1	1	1	1	1	1	1	1	10.00	1	10.00	0	0.00
Tennessee	8	8	8	8	8	8	8	8	6	8.29	6	8.28	0	-0.01
Texas	6	6	6	6	6	6	6	6	7	8.00	7	7.99	0	-0.01
Utah	11	10	10	10	10	10	10	10	10	6.10	10	6.11	0	0.01
Vermont	40	40	40	41	41	36	38	39	39	4.32	39	4.30	0	-0.02
Virginia	28	29	28	29	29	33	33	33	32	4.79	34	4.79	-2	0.00
Washington	6	6	6	6	6	6	6	6	7	8.00	8	6.87	-1	-1.13
West Virginia	24	26	26	26	26	29	29	28	27	4.90	29	4.89	-2	-0.01
Wisconsin	39	39	39	39	39	39	37	37	37	4.38	38	4.35	-1	-0.03
Wyoming	1	1	1	1	1	1	1	1	1	10.00	1	10.00	0	0.00
District of Columbia	47	47	46	49	49	47	47	48	48	2.87	48	2.62	0	-0.25
Note:  A rank of 1 is best, 50 is worst. All scores are for fiscal years. DC’s score and rank do not affect other states. Source: Tax Foundation.

Individual Income Tax Rate

The rate subindex compares the states that tax individual income after setting aside the five states that do not and therefore receive perfect scores: Alaska, Florida, South Dakota, and Wyoming. Tennessee, Texas, and Washington do not have an individual income tax, but they do tax S corporation income—and Texas and Washington tax LLC income—through their gross receipts taxes and thus do not score perfectly in this component. Nevada has a low-rate payroll tax on wage income. New Hampshire, meanwhile, does not tax wage and salary income but does tax interest and dividend income.

Top Marginal Tax Rate. California has the highest top income tax rate of 13.3 percent. Other states with high top rates include Hawaii (11.0 percent), New York (10.9 percent), New Jersey (10.75 percent), Oregon (9.9 percent), Minnesota (9.85 percent), Vermont (8.75 percent), and Iowa (8.53 percent).

States with the lowest top statutory rates are North Dakota (2.9 percent), Arizona (2.98 percent), Pennsylvania (3.07 percent), Indiana (3.23 percent), Ohio (3.99 percent), Michigan and Louisiana (both at 4.25 percent), Colorado (4.55 percent), and Utah (4.85 percent). Alabama, Kentucky, Mississippi, and New Hampshire all impose a top statutory rate of 5 percent.[18] Illinois and Kansas, which previously boasted rates below 5 percent, both adopted rate increases in recent years. (Although Illinois’ statutory rate is 4.95 percent, it also imposes an additional 1.5 percent tax on pass-through businesses, discussed elsewhere, bringing the rate for these entities to 6.45 percent.)

In addition to statewide income tax rates, some states allow local-level income taxes.[19] We represent these as the mean between the rate in the capital city and most populous city. In some cases, states authorizing local-level income taxes still keep the level of income taxation modest overall. For instance, Alabama, Indiana, Michigan, and Pennsylvania allow local income add-ons, but are still among the states with the lowest overall rates.

Top Tax Bracket Threshold. This variable assesses the degree to which pass-through 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 are Colorado, Illinois, Indiana, Kentucky, Massachusetts, Michigan, New Hampshire, North Carolina, Pennsylvania, and Utah. States with high kick-in levels score the worst. These include New York ($25 million), New Jersey ($1 million of taxable income), California ($1 million), Connecticut ($500,000), and North Dakota ($445,000 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 $3,500 and a personal exemption of $2,250, for a combined value of $5,750. Statutorily, Kansas has a top rate on all taxable income over $30,000 and two lower brackets, one beginning at the first dollar of income and another at $15,000, so it has an average bracket width of $10,000. Because of its deduction and exemption, however, Kansas’s top rate actually kicks in at $35,750 of income, and it has three tax brackets below that with an average width of $11,917. The size of allowed standard deductions and exemptions varies considerably.[20]

Pennsylvania scores the best in this variable by having only one tax bracket (that is, a flat tax with no standard deduction). States with only two brackets (that is, flat taxes with a standard deduction) are Colorado, Illinois, Indiana, Kentucky, Massachusetts, Michigan, New Hampshire, North Carolina, and Utah. On the other end of the spectrum, Hawaii scores worst with 12 brackets, followed by California with 10 brackets, and Iowa and Missouri with 9 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 impose ever-increasing rates throughout the income spectrum, causing individuals and noncorporate businesses to alter their income-earning and tax-planning behavior. This subindex 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.

Income Recapture. Connecticut and New York apply the rate of the top income tax bracket to previous taxable income after the taxpayer crosses the top bracket threshold, while Arkansas imposes different tax tables depending on the filer’s level of income. New York’s recapture provision is the most damaging and results in an approximately $22,000 penalty for reaching the top bracket. Income recapture provisions are poor policy, because they result in dramatically high marginal tax rates at the point of their kick-in, and they are nontransparent in that they raise tax burdens substantially without being reflected in the statutory rate.

Individual Income Tax Base

States have different definitions of taxable income, and some create greater impediments to economic activity than others. The base subindex gives a 40 percent weight to the double taxation of taxable income and a 60 percent weight to an accumulation of other base issues, including indexation and marriage penalties.

The states with no individual income tax of any kind achieve perfect neutrality. Tennessee and Texas, however, are docked slightly because they do not recognize LLCs or S corporations, and Nevada’s payroll tax keeps the state from achieving a perfect store. New Hampshire only taxes interest and dividend income, while Washington only taxes capital gains income. Of the other 43 states, Arizona, Idaho, Illinois, Maine, Michigan, Missouri, Montana, and Utah have the best scores, avoiding many problems with the definition of taxable income that plague other states. Meanwhile, states where the tax base is found to cause an unnecessary drag on economic activity include New Jersey, Delaware, New York, California, Connecticut, and Ohio.

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 are dominated (85 percent) by married couples. This same 20 percent also have 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 pass-through businesses. Twenty-three states and the District of Columbia have marriage penalties built into their income tax brackets.

Some states attempt to get around the marriage penalty problem by allowing married couples to file as if they were singles or by offering an offsetting tax credit. While helpful in offsetting the dollar cost of the marriage penalty, these solutions come at the expense of added tax complexity. Still, states that allow married couples to file as singles do not receive a marriage penalty score reduction.

Double Taxation of Capital Income. Since most 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.[21] 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 that tax wage income score poorly by this criterion. New Hampshire, which taxes individuals on interest and dividends, scores somewhat better because it does not tax capital gains. Washington scores even better on this metric because it taxes certain capital gains income but does not have a corporate income tax, nor does it tax wage and salary income. Nevada’s payroll tax does not apply to capital income, and thus scores perfectly on this measure, along with states that forgo all income taxation.

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.

Alternative Minimum Tax (AMT)

At the federal level, 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. AMTs are 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. Five states score poorly for imposing an AMT on individuals: California, Colorado, Connecticut, Iowa, and Minnesota.

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 was the creation of the limited liability corporation (LLC) and the S corporation. LLCs and S corporations provide businesses some of the benefits of incorporation, such as limited liability, without the overhead of becoming a traditional 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 to at least some degree, and all but Louisiana recognize S corporations in some fashion, but those that require additional state election or make the entity file through the state’s gross receipts tax (as in Delaware, Ohio, Texas, and Washington) score poorly in this variable.

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. 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-five states index all three or do not impose an individual income tax; 15 states and the District of Columbia index one or two of the three; and 10 states do not index at all.

Sales Taxes

Sales tax makes up 23.7 percent of each state’s Index score. The type of sales tax familiar to taxpayers is a tax levied on the purchase price of a good at the point of sale. Due to the inclusion of some business inputs in most states’ sales tax bases, the rate and structure of the sales tax is an important consideration for many businesses. The sales tax can also hurt the business tax climate because as the sales tax rate climbs, customers make fewer purchases or seek low-tax alternatives. As a result, business is lost to lower-tax locations, causing lost profits, lost jobs, and lost tax revenue.[22] The effect of differential sales tax rates among 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.[23]

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.[24] Hawaii, New Mexico, South Dakota, and Washington 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.

Excise taxes are sales taxes levied on specific goods. Goods subject to excise taxation are typically (but not always) perceived to be luxuries or vices, the latter of which are less sensitive to 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,[25] Delaware, Montana, New Hampshire, and Oregon–achieve the best sales tax component scores. Among states with a sales tax, those with low general rates and broad bases, and which avoid tax pyramiding, do best. Wyoming, Wisconsin, Maine, Nebraska, Idaho, Michigan, and Virginia all do well, with well-structured sales taxes and modest excise tax rates.

At the other end of the spectrum, Alabama, Washington, Louisiana, California, and Tennessee fare the worst, imposing high rates and taxing a range of business inputs, such as utilities, services, manufacturing, and leases—and maintaining relatively high excise taxes. Louisiana and Tennessee have the highest combined state and local rates of 9.55 percent. In general, these states levy high sales tax rates that apply to a wide range of business input items.

Table 5. Sales Tax Component of the State Business Tax Climate Index (2014–2023)

	Prior Year Ranks								2022		2023		2022-2023 Change
State	2014	2015	2016	2017	2018	2019	2020	2021	Rank	Score	Rank	Score	Rank	Score
Alabama	50	50	50	49	49	50	50	50	50	2.56	50	2.54	0	-0.02
Alaska	5	5	5	5	5	5	5	5	5	8.07	5	8.04	0	-0.03
Arizona	43	43	43	43	43	40	40	40	40	4.06	41	4.06	-1	0.00
Arkansas	44	45	46	44	44	43	45	45	45	3.73	45	3.74	0	0.01
California	46	46	45	45	46	47	47	47	47	3.37	47	3.36	0	-0.01
Colorado	37	37	37	37	37	37	37	36	38	4.26	40	4.22	-2	-0.04
Connecticut	34	34	32	32	29	29	26	25	23	4.80	23	4.80	0	0.00
Delaware	2	2	1	1	1	2	2	2	2	9.01	2	8.98	0	-0.03
Florida	23	23	23	29	30	22	23	23	21	4.94	21	4.93	0	-0.01
Georgia	27	27	34	31	32	30	30	29	29	4.61	31	4.58	-2	-0.03
Hawaii	31	31	27	26	26	32	29	28	28	4.63	27	4.63	1	0.00
Idaho	14	12	15	15	15	12	12	10	10	5.40	10	5.39	0	-0.01
Illinois	35	35	33	27	27	35	34	39	39	4.22	38	4.28	1	0.06
Indiana	21	22	18	9	9	13	20	20	19	5.01	19	5.01	0	0.00
Iowa	18	18	20	20	19	18	15	15	15	5.17	15	5.17	0	0.00
Kansas	24	25	29	28	28	27	38	37	26	4.72	25	4.70	1	-0.02
Kentucky	11	19	14	13	14	19	14	14	14	5.21	14	5.20	0	-0.01
Louisiana	48	47	48	50	50	48	48	48	48	3.04	48	3.03	0	-0.01
Maine	7	8	8	8	8	9	8	8	8	5.64	8	5.83	0	0.19
Maryland	12	16	17	18	18	17	19	18	27	4.64	30	4.58	-3	-0.06
Massachusetts	19	21	19	19	11	11	13	13	13	5.23	13	5.22	0	-0.01
Michigan	10	10	9	10	12	14	11	11	11	5.38	11	5.38	0	0.00
Minnesota	30	33	26	25	25	26	28	27	31	4.60	29	4.59	2	-0.01
Mississippi	38	39	39	39	39	36	33	32	33	4.49	33	4.47	0	-0.02
Missouri	22	24	25	23	24	25	24	24	25	4.78	26	4.70	-1	-0.08
Montana	3	3	3	3	3	3	3	3	3	8.94	3	8.92	0	-0.02
Nebraska	15	13	12	12	21	8	9	9	9	5.50	9	5.52	0	0.02
Nevada	41	41	41	41	42	45	44	44	44	3.81	44	3.81	0	0.00
New Hampshire	1	1	2	2	2	1	1	1	1	9.05	1	9.02	0	-0.03
New Jersey	40	40	40	40	41	42	42	42	43	3.96	42	3.97	1	0.01
New Mexico	42	42	42	42	40	41	41	41	41	4.05	35	4.39	6	0.34
New York	45	44	44	46	45	44	43	43	42	3.96	43	3.90	-1	-0.06
North Carolina	26	17	21	21	20	24	21	21	20	4.97	20	4.95	0	-0.02
North Dakota	33	32	35	35	35	31	27	30	30	4.60	28	4.59	2	-0.01
Ohio	29	29	30	33	31	28	32	34	35	4.39	36	4.38	-1	-0.01
Oklahoma	36	36	36	36	36	39	39	38	37	4.27	39	4.24	-2	-0.03
Oregon	4	4	4	4	4	4	4	4	4	8.83	4	8.82	0	-0.01
Pennsylvania	20	20	22	22	22	21	17	17	17	5.13	16	5.15	1	0.02
Rhode Island	28	28	24	24	23	23	25	26	24	4.79	24	4.79	0	0.00
South Carolina	32	30	31	30	33	34	31	31	32	4.51	32	4.49	0	-0.02
South Dakota	25	26	28	34	34	33	35	33	34	4.43	34	4.42	0	-0.01
Tennessee	47	48	47	47	47	46	46	46	46	3.53	46	3.53	0	0.00
Texas	39	38	38	38	38	38	36	35	36	4.37	37	4.36	-1	-0.01
Utah	17	14	13	17	17	15	22	22	22	4.93	22	4.93	0	0.00
Vermont	16	15	16	16	16	20	16	16	16	5.13	17	5.10	-1	-0.03
Virginia	9	9	10	11	10	10	10	12	12	5.25	12	5.24	0	-0.01
Washington	49	49	49	48	48	49	49	49	49	2.95	49	2.97	0	0.02
West Virginia	13	11	11	14	13	16	18	19	18	5.04	18	5.02	0	-0.02
Wisconsin	8	7	7	7	7	7	7	7	7	6.02	7	6.01	0	-0.01
Wyoming	6	6	6	6	6	6	6	6	6	6.03	6	6.03	0	0.00
District of Columbia	34	34	34	35	35	32	36	34	37	4.33	39	4.28	-2	-0.05
Note:  A rank of 1 is best, 50 is worst. All scores are for fiscal years. DC’s score and rank do not affect other states. Source: Tax Foundation.

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 or certain online  purchases, leaving less business activity in the state. This subindex 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 1.76 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 (and the District of Columbia) with a statewide sales tax, Colorado’s 2.9 percent rate is the lowest. Five states have a 4 percent state-level sales tax: Alabama, Georgia, Hawaii, New York, and Wyoming. At the other end is California with a 7.25 percent state sales tax, including a mandatory statewide local add-on tax. Tied for second-highest are Indiana, Mississippi, Rhode Island, and Tennessee (all at 7 percent). Other states with high statewide rates include Minnesota (6.88 percent) and Nevada (6.85 percent).

Local Option Sales Tax Rates. Thirty-eight 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.[26] Local jurisdictions in Colorado, for example, add an average of 4.87 percent in local sales taxes to the state’s 2.9 percent state-level rate, bringing the total average sales tax rate to 7.77 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 (5.24 and 5.10 percent, respectively), and in both states the average local option sales tax is higher than the state sales tax rate. Other states with high local option sales taxes include Colorado (4.87 percent), New York (4.52 percent), and Oklahoma (4.49 percent).

States with the highest combined state and average local sales tax rates are Louisiana and Tennessee (both at 9.55 percent), Arkansas (9.47 percent), Washington (9.29 percent), and Alabama (9.24 percent). At the low end are Alaska (1.76 percent), Hawaii (4.44 percent), Wyoming (5.36 percent), Wisconsin (5.43 percent), and Maine (5.5 percent).

Remote Seller Protections. With the Supreme Court’s elimination of the physical presence requirement for imposing sales tax collection obligations, all states with sales taxes are now requiring remote sellers to collect and remit sales tax. While most states have adopted safe harbors for small sellers and have a single point of administration for all state and local sales taxes, a few diverge from these practices, imposing substantial compliance costs on out-of-state retailers. Alabama, Alaska (which only has local sales taxes), Colorado, and Louisiana lack uniform administration, while Kansas does not offer a safe harbor for small sellers.

Sales Tax Base

The sales tax base subindex is computed according to five features of each state’s sales tax:

• whether the base includes a variety of business-to-business transactions such as machinery, raw materials, office equipment, farm equipment, and business leases;
• whether the base includes goods and services typically purchased by consumers, such as groceries, clothing, and gasoline;
• whether the base includes services, such as legal, financial, accounting, medical, fitness, landscaping, and repair;
• whether the state leans on sales tax holidays, which temporarily exempt select goods from the sales tax; and
• the excise tax rate on products such as gasoline, diesel fuel, tobacco, spirits, and beer.

The top five states on this subindex—New Hampshire, Delaware, Montana, Oregon, and Alaska—are the five states without a general state sales tax. However, none receives a perfect score because each levies gasoline, diesel, tobacco, and beer excise taxes. States like Wyoming, Kansas, Nebraska, Colorado, Idaho, and Missouri achieve high scores on their tax base by avoiding the problems of tax pyramiding and adhering to low excise tax rates, though of these, Colorado receives poor marks for a lack of local base conformity.

States with the worst scores on the base subindex are Hawaii, Alabama, Washington, California, South Dakota, New Jersey, New Mexico, and Maryland. Their tax systems hamper economic growth by including too many business inputs, excluding too many consumer goods and services, and imposing 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 price that already contains taxes. This tax pyramiding invariably results in some industries being taxed more heavily than others, which violates the principle of neutrality and 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 providers. 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.[27] 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 pizzeria down the street cannot. The owners of the pizzeria 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, and public finance scholars overwhelmingly oppose applying the sales tax to business inputs due to the resulting pyramiding and lack of transparency.

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. 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. Hawaii, New Mexico, South Dakota, and Washington are examples of states that tax many business inputs.

Sales Tax Breadth. An economically neutral sales tax base includes all final retail sales of goods and services purchased by the end-users. In practice, however, states tend to include most goods, but relatively few services, in their sales tax bases, a growing issue in an increasingly service-oriented economy. Professor John Mikesell of Indiana University estimates that, nationwide, sales taxes extend to about 36 percent of all final consumer transactions.[28] 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. A well-structured sales tax, however, does not fall upon business inputs. Therefore, states that tax services that are business inputs score poorly on the Index, while states are rewarded for expanding their base to include more final retail sales of goods and services.

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 seven states do so. While all states levy an excise tax on gasoline, these funds are often dedicated for transportation purposes, making them a form of user tax distinct from the general sales tax. The five states that fully include gasoline in their sales tax base (Florida, Hawaii, Illinois, Indiana, and Michigan) get a better score. Several other states receive partial credit for applying an ad valorem tax to gasoline sales, but at a different rate than the general sales tax. New York currently applies local sales taxes only.

Sales Tax on Groceries. A well-structured sales tax includes all end-user goods in the tax base, to keep the base broad, rates low, and prevent distortions in the marketplace. Many states exempt groceries to reduce the incidence of the sales tax on low-income residents. Such an exemption, however, also benefits grocers and higher-income residents, and creates additional compliance costs due to the necessity of maintaining complex, ever-changing lists of exempt and nonexempt products. Public assistance programs such as the Women, Infants, and Children (WIC) program or the Supplement Nutrition Assistance Program (SNAP) provide more targeted assistance than excluding groceries from the sales tax base. Thirteen 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 such as 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. Though gas taxes–along with tolls–are one of the best ways to raise revenue for transportation projects (roughly approximating a user fee for infrastructure use), gasoline represents a large input for most businesses, so states that levy higher rates have a less competitive business tax climate. State excise taxes on gasoline range from 70.95 cents in California (although this tax is suspended from June through December 2022) to 15.13 cents per gallon in Alaska. The Index relies upon calculated rates from the American Petroleum Institute, capturing states’ base excise taxes in addition to other gallonage-based fees and ad valorem taxes placed upon gasoline. General sales tax rates that apply to gasoline are included in this calculated rate, but states which include, or partially include, gasoline in the sales tax base are rewarded in the sales tax breadth measure.

Tobacco, spirits, and beer excise taxes can 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.[29]

States with the highest tobacco taxes per pack of 20 cigarettes are New York and Connecticut (at $4.35 each), Rhode Island ($4.25), Minnesota ($3.70), and Massachusetts ($3.51), while states with the lowest tobacco taxes are Missouri (17 cents), Georgia (37 cents), North Dakota (44 cents), North Carolina (45 cents), and South Carolina and Idaho (57 cents).

States with the highest beer taxes on a per gallon basis are Tennessee ($1.29), 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 and Wisconsin (6 cents), and Colorado, Oregon, and Pennsylvania (each at 8 cents). States with the highest spirits taxes per gallon are Washington ($37.81), Oregon ($21.95), and Virginia ($19.89).

Property Tax

The property tax component, which includes taxes on real and personal property, net worth, and the transfer of assets, accounts for 14.4 percent of each state’s Index score.

When properly structured, property taxes exceed most other taxes in comporting with the benefit principle and can be fairly economically efficient. In the realm of public finance, they are often also prized for their comparative transparency among taxes, though that transparency may contribute to the public’s generally low view of property taxes. The Tax Foundation’s Survey of Tax Attitudes found that local property taxes are perceived as the second most unfair state or local tax.[30]

Property taxes matter to businesses, and the tax rate on commercial property is often higher than the tax on comparable residential property. Additionally, many localities and states 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 over $839 billion in state and local taxes in fiscal year 2020, of which $330 billion (39.2 percent) was for property taxes. The property taxes included tax on real, personal, and utility property owned by businesses (Phillips et al. 2021). Since property taxes can be a large burden on 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 uniquely 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.

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 the establishment of small businesses. 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 which keep statewide property taxes low better position themselves to attract business investment. Localities competing for business can put themselves at a greater competitive advantage by keeping personal property taxes low.

Taxes on capital stock, tangible and 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, Indiana, Idaho, Delaware, Nevada, and Ohio. 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 component are Connecticut, New York, Vermont, Maine, Massachusetts, New Jersey, and Illinois. These states generally have high property tax rates and levy several wealth-based taxes.

The property tax portion of the Index is composed of two equally weighted subindices devoted to measuring the economic impact of both rates and bases. The rate subindex consists of property tax collections (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.[31]

Table 6. Property Tax Component of the State Business Tax Climate Index (2014–2023)

	Prior Year Ranks								2022		2023		2022-2023 Change
State	2014	2015	2016	2017	2018	2019	2020	2021	Rank	Score	Rank	Score	Rank	Score
Alabama	13	13	21	17	16	19	19	21	20	5.31	18	5.33	2	0.02
Alaska	29	30	19	25	40	23	25	25	26	5.18	26	5.17	0	-0.01
Arizona	11	11	12	11	11	11	11	10	11	5.68	11	5.76	0	0.08
Arkansas	23	24	27	24	24	27	27	28	29	5.12	27	5.17	2	0.05
California	16	16	13	14	14	13	15	14	14	5.44	19	5.33	-5	-0.11
Colorado	39	39	34	33	32	33	33	33	34	4.70	36	4.51	-2	-0.19
Connecticut	50	50	50	50	50	50	50	50	50	2.32	50	2.27	0	-0.05
Delaware	5	5	5	7	7	4	4	4	4	6.31	4	6.28	0	-0.03
Florida	22	23	17	13	12	12	12	12	12	5.58	12	5.55	0	-0.03
Georgia	28	28	25	26	27	30	31	27	27	5.15	28	5.11	-1	-0.04
Hawaii	20	20	16	18	19	22	28	30	31	5.00	32	4.86	-1	-0.14
Idaho	2	2	2	2	2	3	3	3	3	6.47	3	6.45	0	-0.02
Illinois	45	45	47	46	47	45	44	45	45	3.87	44	3.96	1	0.09
Indiana	3	3	3	3	3	2	2	2	1	6.51	2	6.46	-1	-0.05
Iowa	37	37	38	39	37	38	38	38	39	4.35	40	4.30	-1	-0.05
Kansas	26	26	29	30	30	31	18	19	19	5.35	17	5.35	2	0.00
Kentucky	17	17	23	22	20	24	23	24	24	5.20	24	5.23	0	0.03
Louisiana	19	19	18	27	22	28	29	26	25	5.19	23	5.26	2	0.07
Maine	38	38	39	40	39	40	40	40	41	4.24	47	3.72	-6	-0.52
Maryland	41	41	41	41	42	41	41	43	43	4.12	42	4.15	1	0.03
Massachusetts	44	44	45	45	45	46	45	46	46	3.73	46	3.81	0	0.08
Michigan	27	27	28	28	26	26	26	22	23	5.22	25	5.22	-2	0.00
Minnesota	30	31	32	32	31	32	32	32	32	4.93	31	4.91	1	-0.02
Mississippi	34	34	37	37	36	37	37	37	38	4.43	37	4.45	1	0.02
Missouri	12	12	14	10	9	9	9	8	7	5.99	7	6.03	0	0.04
Montana	15	15	22	19	28	20	21	20	22	5.23	21	5.31	1	0.08
Nebraska	36	36	35	38	38	39	39	41	40	4.28	39	4.34	1	0.06
Nevada	7	7	7	6	6	5	6	5	5	6.17	5	6.19	0	0.02
New Hampshire	43	43	44	44	44	47	46	47	47	3.70	43	4.01	4	0.31
New Jersey	48	48	48	47	49	44	47	44	44	3.87	45	3.87	-1	0.00
New Mexico	1	1	1	1	1	1	1	1	2	6.50	1	6.51	1	0.01
New York	47	47	46	48	46	48	48	49	49	2.89	49	2.83	0	-0.06
North Carolina	10	10	26	29	29	14	13	13	13	5.52	13	5.53	0	0.01
North Dakota	4	4	4	4	4	6	7	11	10	5.70	9	5.91	1	0.21
Ohio	8	8	6	5	5	7	5	6	6	6.12	6	6.13	0	0.01
Oklahoma	21	22	24	21	21	29	30	31	30	5.06	30	5.02	0	-0.04
Oregon	18	18	11	16	17	16	20	16	17	5.37	20	5.31	-3	-0.06
Pennsylvania	32	32	30	15	15	17	16	15	15	5.43	16	5.46	-1	0.03
Rhode Island	46	46	43	43	43	42	42	42	42	4.19	41	4.28	1	0.09
South Carolina	35	35	36	36	35	36	35	35	36	4.60	35	4.60	1	0.00
South Dakota	9	9	10	12	13	15	14	23	18	5.36	14	5.53	4	0.17
Tennessee	40	40	40	35	34	35	34	34	33	4.73	33	4.76	0	0.03
Texas	33	33	33	34	33	34	36	36	37	4.47	38	4.35	-1	-0.12
Utah	6	6	8	8	8	8	8	7	8	5.98	8	5.94	0	-0.04
Vermont	49	49	49	49	48	49	49	48	48	3.24	48	3.23	0	-0.01
Virginia	24	25	20	23	23	25	24	29	28	5.14	29	5.11	-1	-0.03
Washington	14	14	15	20	18	18	17	18	21	5.27	22	5.30	-1	0.03
West Virginia	25	21	9	9	10	10	10	9	9	5.77	10	5.80	-1	0.03
Wisconsin	31	29	31	31	25	21	22	17	16	5.40	15	5.47	1	0.07
Wyoming	42	42	42	42	41	43	43	39	35	4.61	34	4.60	1	-0.01
District of Columbia	46	50	40	47	48	48	48	49	49	2.95	49	2.84	0	-0.11
Note:  A rank of 1 is best, 50 is worst. All scores are for fiscal years. DC’s score and rank do not affect other states. Source: Tax Foundation.

Property Tax Rate

The property tax rate subindex consists of property tax collections per capita (40 percent of the subindex score), property tax collections as a percent of personal income (40 percent of the subindex score), and capital stock taxes (20 percent of the subindex score). The heavy weighting of tax collections is due to 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 preferable–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, because 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 ($3,513), New Hampshire ($3,246), Connecticut ($3,215), New York ($3,180), and Vermont ($2,938). The states that collect the least per capita are Alabama ($620), Arkansas ($788), Oklahoma ($826), Tennessee ($834), and Kentucky ($873).

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 Maine (5.21 percent), Vermont (4.82 percent), New Jersey (4.80 percent), New Hampshire (4.79 percent), New York (4.36 percent), and Connecticut (4.20 percent). States that score well with low effective tax rates are Alabama (1.37 percent), Tennessee (1.61 percent), Arkansas (1.69 percent), Oklahoma (1.75 percent), Louisiana (1.80 percent), and Delaware (1.86 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 their limited cash flow to pay their capital stock tax. In assessing capital stock taxes, the subindex accounts for three variables: the capital stock tax rate; the maximum payment; and whether any capital stock tax is imposed in addition to a corporate income tax, or whether the business is liable for the higher of the two. The capital stock tax subindex is 20 percent of the total rate subindex.

This variable measures the rate of taxation as levied by the 16 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. Kansas completed the phaseout of its tax in 2011. West Virginia and Rhode Island fully phased out their capital stock taxes as of January 1, 2015, and Pennsylvania phased out its capital stock tax in 2016. New York finished a phaseout of the state’s capital stock tax as of January 1, 2021, but the legislature decided to temporarily reinstate the tax due to coronavirus-related budget concerns. Similarly, Illinois had plans to begin a phaseout in 2020, completing the process in 2024. After two years, Illinois reversed its phaseout plan and opted instead to freeze the franchise tax exemption at $1,000. Connecticut plans to phase out its tax by January 1, 2024. States with the highest capital stock tax rates include Arkansas (0.30 percent), Louisiana (0.275 percent), Massachusetts (0.26 percent), Connecticut (0.21 percent), Tennessee (0.25 percent), and New York (0.1875 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 are Alabama, Connecticut, Delaware, Georgia, Illinois, Nebraska, New York, and Oklahoma, and among states with a capital stock tax, 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 their capital stock tax or their corporate tax. These states (Connecticut, Massachusetts, and New York) are given credit for this provision. States that do not have a capital stock tax get the best scores in this subindex while the states that force companies to pay both score the worst.

Property Tax Base

This subindex is composed of dummy variables listing the different types of property taxes each state levies. Seven taxes are included and each is equally weighted. Delaware, Idaho, Indiana, Ohio, Alaska, New Mexico, North Dakota, Nevada, New Hampshire, New Jersey, North Carolina, and Pennsylvania score the best because they each only levy one of the seven taxes. Connecticut, Maryland, and Kentucky receive the worst scores because they impose many of these taxes.

Business Tangible Property Tax. This variable rewards states which remove, or substantially remove, business tangible personal property from their tax base. Taxes on tangible personal property, meaning property that can be touched or moved (as opposed to real estate), are a source of tax complexity and nonneutrality, incentivizing firms to change their investment decisions and relocate to avoid the tax. Eight states (Delaware, Hawaii, Illinois, Iowa, New Jersey, New York, Ohio, and Pennsylvania) exempt all tangible personal property from taxation, while another four states (Minnesota, New Hampshire, North Dakota, and South Dakota) exempt most such property from taxation except for select industries that are centrally assessed.

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. Eight states levy this tax in various degrees: Alabama, Iowa, Kentucky, Louisiana, Mississippi, South Dakota, Tennessee, and Texas.[32]

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.

Split Roll Taxation. In some states, different classes of property—like residential, commercial, industrial, and agricultural property—face distinct tax burdens, either because they are taxed at different rates or are exposed to different assessment ratios. When such distinctions exist, the state is said to have a split (rather than unified) property tax roll. The Index assesses whether states utilize split roll taxation, which tends to discriminate against business property, and what ratio exists between commercial and residential property taxation.

Property Tax Limitation Regimes. Most states limit the degree to which localities can raise property taxes, but these property tax limitation regimes vary dramatically. Broadly speaking, there are three types of property tax limitations. Assessment limits restrict the rate at which a given property’s assessed value can increase each year. (It often, but not always, resets upon sale or change of use, and sometimes resets when substantial improvements are made.) Rate limits, as the name implies, either cap the allowable rate or restrict the amount by which the rate can be raised in a given year. Finally, levy limits impose a restriction on the growth of total collections (excluding those from new construction), implementing or necessitating rate reductions if revenues exceed the allowable growth rate. Most limitation regimes permit voter overrides. The Index penalizes states for imposing assessment limitations, which distort property taxation, leading to similar properties facing highly disparate effective rates of taxation and influencing decisions about property utilization. It also rewards states for adopting either a rate or levy limit, or both.

Asset Transfer Taxes (Estate, Inheritance, and Gift Taxes). Four 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.[33] The four taxes are real estate transfer taxes, estate taxes, inheritance 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 piggybacked 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 reintroducing 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 reenacted 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. The tax reform law of 2017 raised the federal exemption still further. Thirty-eight 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, including two which repealed their estate tax this year. Twelve states and the District of Columbia 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. Six states have inheritance taxes and are punished in the Index, because the inheritance tax causes economic distortions. Maryland has both an estate tax and an inheritance tax, the only state to impose both after New Jersey completed the repeal of its estate tax.

Connecticut is the only state with a gift tax, and it scores poorly. Gift taxes are designed to stop individuals’ attempts to avoid the estate tax by giving their estates away before they die. Gift taxes have a negative impact on a state’s business tax climate because they also heavily impact individuals who have sole proprietorships, S corporations, and LLCs.

Unemployment Insurance Taxes

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. Compared to 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.[34]

One of the worst aspects of the UI tax system is that financially troubled businesses, for which 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 component of the Index consists of two equally weighted subindices, one that measures each state’s rate structure and one that focuses on the tax base. Unemployment insurance taxes comprise 9.8 percent of a state’s final Index score.

Overall, the states with the least damaging UI taxes are Oklahoma, Florida, Delaware, Louisiana, Mississippi, and Michigan. 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.

Conversely, the states with the worst UI taxes are Massachusetts, Rhode Island, Kentucky, Idaho, and Maryland. These states tend to have rate structures with high minimum and maximum rates and wage bases above the federal level. They also tend to feature more complicated experience formulas and charging methods, and have added benefits and surtaxes to their systems.

Table 7. Unemployment Insurance Tax Component of the State Business Tax Climate Index (2014–2023)

	Prior Year Ranks								2022		2023		2022-2023 Change
State	2014	2015	2016	2017	2018	2019	2020	2021	Rank	Score	Rank	Score	Rank	Score
Alabama	23	25	26	14	11	12	18	15	18	5.16	19	5.15	-1	-0.01
Alaska	26	24	22	29	24	34	45	44	44	4.31	44	4.33	0	0.02
Arizona	2	4	5	11	15	13	6	8	14	5.50	14	5.47	0	-0.03
Arkansas	28	40	43	30	31	33	23	23	20	5.13	20	5.14	0	0.01
California	14	14	13	16	13	17	22	21	24	5.07	24	5.03	0	-0.04
Colorado	38	35	34	42	34	39	42	40	40	4.52	42	4.45	-2	-0.07
Connecticut	21	20	20	21	19	23	21	22	23	5.09	23	5.07	0	-0.02
Delaware	1	3	3	3	3	3	3	3	2	5.96	2	5.99	0	0.03
Florida	4	2	2	2	2	2	2	2	4	5.87	3	5.92	1	0.05
Georgia	39	39	39	35	37	37	38	38	37	4.69	35	4.70	2	0.01
Hawaii	32	28	24	24	26	26	28	25	31	4.88	30	4.90	1	0.02
Idaho	47	46	45	46	45	47	47	47	46	4.05	47	4.04	-1	-0.01
Illinois	41	37	37	38	41	41	39	42	42	4.50	43	4.41	-1	-0.09
Indiana	10	9	15	10	10	11	25	27	26	4.93	27	4.93	-1	0.00
Iowa	33	33	35	34	33	32	34	36	34	4.80	33	4.81	1	0.01
Kansas	7	8	11	12	12	15	14	14	16	5.41	15	5.42	1	0.01
Kentucky	46	45	46	48	47	46	48	48	48	3.87	48	4.01	0	0.14
Louisiana	5	5	4	9	4	4	4	4	6	5.73	6	5.73	0	0.00
Maine	37	42	41	44	43	24	31	32	35	4.79	38	4.60	-3	-0.19
Maryland	31	21	28	26	23	28	32	33	47	4.03	41	4.46	6	0.43
Massachusetts	48	48	47	49	49	50	50	50	50	3.41	50	3.32	0	-0.09
Michigan	44	47	48	47	48	48	17	18	7	5.66	8	5.66	-1	0.00
Minnesota	34	29	29	28	36	25	33	31	28	4.90	34	4.80	-6	-0.10
Mississippi	8	7	8	5	5	5	5	5	5	5.79	5	5.80	0	0.01
Missouri	13	13	12	7	7	8	9	7	3	5.91	4	5.92	-1	0.01
Montana	20	18	18	19	20	21	20	20	19	5.15	18	5.16	1	0.01
Nebraska	12	12	10	8	9	9	11	11	11	5.56	11	5.56	0	0.00
Nevada	43	43	42	43	44	44	46	46	45	4.19	46	4.19	-1	0.00
New Hampshire	45	44	44	41	42	43	44	43	43	4.32	45	4.32	-2	0.00
New Jersey	30	32	32	25	35	31	30	30	33	4.86	32	4.85	1	-0.01
New Mexico	11	10	7	17	16	10	8	9	8	5.64	9	5.65	-1	0.01
New York	24	31	33	32	29	30	37	37	36	4.76	40	4.50	-4	-0.26
North Carolina	9	11	9	6	6	7	10	10	10	5.58	10	5.59	0	0.01
North Dakota	16	16	16	15	14	14	13	13	9	5.63	7	5.68	2	0.05
Ohio	6	6	6	4	8	6	7	6	13	5.54	13	5.52	0	-0.02
Oklahoma	3	1	1	1	1	1	1	1	1	6.05	1	6.07	0	0.02
Oregon	29	30	27	33	30	36	35	35	39	4.62	36	4.69	3	0.07
Pennsylvania	50	50	50	45	50	45	41	39	22	5.09	22	5.08	0	-0.01
Rhode Island	49	49	49	50	46	49	49	49	49	3.76	49	3.77	0	0.01
South Carolina	35	36	31	37	28	27	26	24	29	4.90	29	4.91	0	0.01
South Dakota	40	41	40	40	38	38	43	41	38	4.67	37	4.68	1	0.01
Tennessee	25	26	25	23	22	22	24	26	21	5.09	21	5.10	0	0.01
Texas	15	15	14	13	25	18	12	12	12	5.55	12	5.55	0	0.00
Utah	19	22	19	22	21	16	15	17	17	5.39	16	5.40	1	0.01
Vermont	17	17	17	20	18	20	16	16	15	5.48	17	5.36	-2	-0.12
Virginia	42	38	38	39	40	42	40	45	41	4.52	39	4.52	2	0.00
Washington	18	19	21	18	17	19	19	19	25	5.02	25	5.02	0	0.00
West Virginia	22	23	23	27	27	29	29	28	27	4.93	26	4.95	1	0.02
Wisconsin	27	27	36	36	39	40	36	34	30	4.88	31	4.90	-1	0.02
Wyoming	36	34	30	31	32	35	27	29	32	4.86	28	4.92	4	0.06
District of Columbia	25	27	27	27	29	32	34	36	39	4.66	38	4.64	1	-0.02
Note:  A rank of 1 is best, 50 is worst. All scores are for fiscal years. DC’s score and rank do not affect other states. Source: Tax Foundation.

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 rate subindex are Florida, Nebraska, Louisiana, Missouri, South Carolina, Mississippi, and Georgia. 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 New York, Massachusetts, Washington, Rhode Island, Alaska, and Oregon.

The subindex 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, South Dakota, and Wisconsin) to 2.10 percent (in New York).

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, Florida, Hawaii, Idaho, Nebraska, Nevada, and Oregon) to 20.93 percent (in Arizona).

Taxable Wage Base. California, Florida, and Tennessee receive the best scores in this variable with a taxable wage base of $7,000—in line with the federal taxable wage base. The state with the highest taxable bases and, thus, the worst score on this variable, is Washington ($62,500).

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 implement when unemployment is low and the UI fund is flush. The minimum rate on the most favorable schedule ranges from zero in 22 states to 1.0 percent in Alaska.

Most Favorable Schedule: Maximum Tax Rate. The lowest maximum rate of 5.4 percent is imposed by 22 states and the District of Columbia. The state with the highest maximum tax rate and, thus, the worst maximum tax score, is Wisconsin (10.7 percent).

Least Favorable Schedule: Minimum Tax Rate. Thirteen states receive the best score on this variable with a minimum tax rate of zero percent. The state with the highest minimum tax rate and, thus, the worst minimum tax score, is Hawaii (2.4 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 state with the highest maximum tax rate and, thus, the worst maximum tax score, is Massachusetts (18.55 percent).

Unemployment Insurance Tax Base

The UI base subindex 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 subindex are Oklahoma, Delaware, Vermont, New Mexico, and North Dakota. 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 Virginia, Nevada, Idaho, Maine, and Georgia. 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 subindex are experience rating formulas (40 percent of the subindex score), charging methods (40 percent of the subindex score), and a host of smaller factors aggregated into one variable (20 percent of the subindex score).

Experience Rating Formula. A business’s experience rating formula determines the rate the firm must pay—whether it will lean toward 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–contribution, benefit, and payroll–are based solely on the business’s experience and are therefore nonneutral by design.[35] 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 subindex 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: Nine 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-four states and the District of Columbia 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 states that charge in proportion to base-period wages receive the best score. The states that charge the most recent or principal employer receive the worst score. The states 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 subindex 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 Connecticut, Delaware, Louisiana, Missouri, Ohio, and Vermont. On the other hand, the states that receive the worst scores are Virginia, Nevada, Georgia, Idaho, Kentucky, Maine, Illinois, New Hampshire, Rhode Island, and South Carolina. Most states 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-seven 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. Nine states have these taxes on the books, though they fall under different names, such as 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-eight states and the District of Columbia have these taxes on the books, though they fall under several names, such as advance interest tax and bond assessment tax (Colorado) and temporary emergency assessment tax (Delaware).

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 paying the costs of the reserve tax’s collection. Four states have these taxes on the books: Idaho and Iowa (reserve tax), Nebraska (state UI tax), and North Carolina (reserve fund tax).

Surtaxes for UI Administration or Non-UI Purposes. Twenty-nine states and the District of Columbia 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 the state training and employment program (Arkansas), 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, Hawaii, New Jersey, 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 these programs; the money comes right out of the states’ unemployment funds. Because the balance of the funds triggers various taxes, the TDIs are included as a negative factor in the calculation of this subindex.

Voluntary Contributions. Twenty-six 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 nonneutralities 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 nonneutral in almost all cases since the rate is higher than the lowest rate schedule. The longer this rate is in effect, the worse the nonneutrality. 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.

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[1] See U.S. Department of Labor, “Extended Mass Layoffs, First Quarter 2013​,” Table 10, May 13, 2013.

[2] Daniel Bunn, “Corporate Income Tax Rates Around the World, 2018,” Tax Foundation, Nov. 27, 2018,

[3] Editorial, “Scale it back, Governor,” Chicago Tribune, March 23, 2007.

[4] Ryan Randazzo, Edythe Jenson, and Mary Jo Pitzl, “Cathy Carter Blog: Chandler getting new $5 billion Intel facility,” AZCentral.com, Mar. 6, 2013.

[5] Dana Hedgpeth and Rosalind Helderman, “Northrop Grumman decides to move headquarters to Northern Virginia,” The Washington Post, April 27, 2010.

[6] Susan Haigh, “Connecticut House Speaker: Tax ‘mistakes’ made in budget,” Associated Press, Nov. 5, 2015.

[7] Austin Mondine, “Dell cuts North-Carolina plant despite $280m sweetener,” TheRegister.co.uk, Oct. 8, 2009.

[8] Dennis Cauchon, “Business Incentives Lose Luster for States,” USA TODAY, Aug. 22, 2007.

[9] State Policy Reports, Vol. 12, No. 11, Issue 1, p. 9, June 1994.

[10] Both rate increases had a temporary component and were allowed to partially expire before legislators overrode a gubernatorial veto to increase rates above where they would have been should they have been allowed to sunset.

[11] Benjamin Yount, “Tax increase, impact, dominate Illinois Capitol in 2011,” Illinois Statehouse News, Dec. 27, 2011.

[12] A trend in tax literature throughout the 1990s was the increasing use of indices 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 The Wall Street Journal’s 2004 Index of Economic Freedom. Plaut and Pluta (1983) examined the use of business climate indices as explanatory variables for business location movements. They found that such general indices do have a significant explanatory power, helping to explain, for example, why businesses have moved from the Northeast and Midwest toward the South and Southwest. In turn, they also found that high taxes have a negative effect on employment growth.

[13] See Mark Robyn, “Michigan Implements Positive Corporate Tax Reform,” Tax Foundation, Feb. 10, 2012.

[14] Jeffrey L. Kwall, “The Repeal of Graduated Corporate Tax Rates,” Tax Notes, June 27, 2011, 1395.

[15] For example, see Alan Peters and Peter Fisher, “The Failures of Economic Development Incentives,” Journal of the American Planning Association 70(1), Winter 2004, 27; and William F. Fox and Matthew N. Murray, “Do Economic Effects Justify the Use of Fiscal Incentives?” Southern Economic Journal 71(1), July 2004, 78.

[16] See Edward C. Prescott, “Why Do Americans Work So Much More than Europeans?” Federal Reserve Bank of Minneapolis Quarterly Review, July 2004. See also J. Scott Moody and Scott A. Hodge, “Wealthy Americans and Business Activity,” Tax Foundation, Aug. 1, 2004.

[17] Tennessee has begun the process of phasing out its tax on interest and dividend income.

[18] New Hampshire taxes only interest and dividends. To account for this, the Index converts the statutory tax rate 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.

[19] See Jared Walczak, “Local Income Taxes in 2019,” Tax Foundation, July 30, 2019.

[20] 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 component score, tax credits are converted into equivalent income exemptions or deductions.

[21] 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.

[22] 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.

[23] 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 explained 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.

[24] 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.

[25] Alaska does authorize local governments to levy their own sales taxes, however, which is reflected in the state’s sales tax component score.

[26] The average local option sales tax rate is calculated as an average of local statutory rates, weighted by population. See Jared Walczak and Scott Drenkard, “State and Local Sales Tax Rates, Midyear 2016,” Tax Foundation, July 5, 2016.

[27] See Timothy J. Besley and Harvey S. Rosen, “Sales Taxes and Prices: An Empirical Analysis,” NBER Working Paper No. 6667, July 1998.

[28] Jared Walczak, “State Sales Tax Breadth and Reliance, Fiscal Year 2021,” Tax Foundation, May 4, 2022,

[29] See Scott Drenkard and Joseph Bishop-Henchman, “Cigarette Taxes and Cigarette Smuggling by State, 2014” Tax Foundation, Jan. 17, 2017.

[30] See 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, Apr. 8, 2009.

[31] Though not included directly in this Index for data availability reasons, tangible personal property taxes can also affect business decisions. For a comprehensive review of these taxes and reform recommendations, see Joyce Errecart, Ed Gerrish, and Scott Drenkard, “States Moving Away from Taxes on Tangible Personal Property,” Tax Foundation, Oct. 4, 2012.

[32] Some states, like Kentucky, are often considered not to impose an intangible property tax but continue to levy a low millage on financial deposits.

[33] For a summary of the effects of the estate tax on business, see Congressional Budget Office, “Effects of the Federal Estate Tax on Farms and Small Businesses,” July 2005. For a summary on the estate tax in general, see David Block and Scott Drenkard, “The Estate Tax: Even Worse Than Republicans Say,” Tax Foundation, Sept. 4, 2012.

[34] See generally Joseph Bishop-Henchman, “Unemployment Insurance Taxes: Options for Program Design and Insolvent Trust Funds,” Tax Foundation, Oct. 17, 2011.

[35] 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 UI tax rates.

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