Maryland’s ranking on business taxes: anywhere from 6 to 41

We are obsessed with where Maryland ranks. It’s human nature. That's why we pay attention to stories about how the Free State ranks in terms of education or business climate. However, most of the published rankings of tax levels or “business climate” don’t tell us what we think they do or what we want to know--they lack any relation to actual economic performance or to Maryland's ability to invest in a high quality of life for ourselves and our children.

Peter Fisher’s new report, “Grading Places: What do Business Climate ranking Really Tell Us?” critically examines six different measures of tax or business policies, and find them to be "deeply flawed and of no value in informing state policy."

Four of the measures are widely reported indexes that are supposed to summarize something about states’ friendliness to businesses. Fisher’s analysis discredits these indexes in three ways:

• First, he finds that many of the indicators used as components of the indexes don’t make sense.
• Second, he finds that the way the final score is computed often gives greater rate to more trivial components, so that the final rankings could be meaningless even if the individual components did have some value.
• Third, and most importantly from a practical viewpoint, Fisher shows that the results of these rankings actually have no statistically significant relationship to growth in Gross State Products, employment, wages, or poverty rates.

The other two measures are “representative firm” models. These studies use the approach of specifying a uniform, hypothetical business, and then estimating the tax bill that firm would have if it were located in any of the 50 states. Fisher finds this approach sounder. However he finds that in these studies the simplifying assumptions used make the results irrelevant for most real businesses.  

Index	Maryland’s Rank	Top State
Business Climate Indexes
US Business Policy Index (Small Business and Entrepreneurship Council)	36th	South Dakota
State Competitiveness Report (Beacon Hill Institute)	23rd	Massachusetts
State Business Tax Climate Index (Tax Foundation)	41st	Wyoming
ALEC-Laffer Economic Competitiveness Index (American Legislative Exchange Council)	32nd	Utah
Representative Firm Models
Competitiveness of State and Local Business Taxes on New Investment (Council on State Taxation/Ernst and Young)	12th (effective tax rate on capital) 25th (ETR on jobs)	Maine
Location Matters (Tax Foundation/KPMG)	46th (new firms) 8th (mature firms)	Nebraska (new firms) Wyoming (mature firms)
Reference for Comparison Purposes
Estimated effective tax rates (Council on State Taxation/Ernst and Young)	6th	Oregon

The chart shows that the ranking for Maryland varies wildly from one report to the next. And that would be true for pretty much any state. The top-ranked states in the different reports are  - literally - all over the map. And, with all due respect to the many wonderful qualities of Nebraska and South Dakota, they may not be the states where you would prefer to live and do business.

Here in Maryland, conservatives and business advocates particularly like to indict our state’s policies using the Tax Foundation’s State Business Tax Climate Index. This index combines 118 different features of state tax policy. They include the top corporate- and individual-income tax rates and also the number of tax brackets. States are rewarded for applying the sales tax to gasoline and groceries, and downgraded for applying it to business purchases. States get points for conforming with federal depreciation schedules, but lose points for having tax credits for research and development or job creation.

The main components of the Tax Foundation index are assigned weights based on the degree of variability in the component scores. This has the effect of maximizing the differences among states’ final scores. However, it also creates a nonsensical result. If the authors of the index had used the percentage of taxes associated with each category as the weight, 31 states would move up or down at least 10 places in the rankings. Maryland would be 34th instead of 41st. That doesn't mean that 34th is Maryland's correct ranking - it shows that the TF's system for calculating the ranks changes markedly when you make small changes in the methodology.

Finally, the mish-mosh of indicators has no relation to what businesses actually pay in taxes. While Maryland ranks 41st in the Tax Foundation index, we rank 6th lowest in business taxes as a share of Gross State Product.

Maryland gets low marks from TF mainly because of our progressive income tax. Maryland businesses benefit from lower-than-average property and sales taxes (much larger slices of a typical business' tax bill), but the TF's methodology gives lower weights to these factors. 

Fisher concludes that the Tax Foundation’s ratings consistently favor regressive tax structures that fall disproportionately on the poor.

About the state ranking studies in general, Fisher writes: “They display no predictive value about economic growth. They come to highly inconsistent findings among themselves…. The result is not a useful summary measure of business climate as claimed. It is at best meaningless, and at worst a state ranking manipulated to make the case for policy positions advocated by the organization sponsoring the index.”

As hard as it is, we in Maryland should ignore these slanted pseudo-scientific pieces of corporate propaganda. To build our economy for the future, we need tax policies that are adequate to fund public investments in education, infrastructure, and a high quality of life; and that are fair to working families and businesses of all sizes.

Film tax credits are ineffective

Image: Wpclipart.com

Legislators are considering a bill that would more than triple the state's film production tax credit cap to $25 million in fiscal year 2014. The bill would also extend authorization of credits up to the current level of $7.5 million through fiscal year 2016. Productions have to spend at least half a million dollars in Maryland to qualify. The credit was created in 2011.

Maryland, and Baltimore in particular, has received significant attention for the recent filming of HBO's Veep and House of Cards, the first production by Netflix. Supporters of the state film production tax credit argue that these high profile productions create jobs and improve the economy in ways that offset lost revenues. These benefits would be forfeited to states with better incentive programs if the credit is allowed to expire, they argue.

However, film production tax credits are problematic for a variety of reasons. The Center on Budget and Policy Priorities handily summarized the issue thus:

• State film subsidies are costly to states and generous to movie producers. ...Over the course of state fiscal year 2010 (FY2010), [forty three] states committed about $1.5 billion to subsidizing film and TV production...money that they otherwise could have spent on public services like education, health care, public safety, and infrastructure
• Subsidies reward companies for production that they might have done anyway. Some makers of movie and TV shows have close, long-standing relationships with particular states. Had those states not introduced or expanded film subsidies, most such producers would have continued to work in the state anyway. But there is no practical way for a state to limit subsidies only to productions that otherwise would not have happened.
• The best jobs go to non-residents. The work force at most sites outside of Los Angeles and New York City lacks the specialized skills producers need to shoot a film. Consequently, producers import scarce, highly paid talent from other states. Jobs for in-state residents tend to be spotty, part-time, and relatively low-paying work — hair dressing, security, carpentry, sanitation, moving, storage, and catering — that is unlikely to build the foundations of strong economic development in the long term.
• Subsidies don’t pay for themselves . The revenue generated by economic activity induced by film subsidies falls far short of the subsidies’ direct costs to the state. To balance its budget, the state must therefore cut spending or raise revenues elsewhere, dampening the subsidies’ positive economic impact.
• No state can “win” the film subsidy war . Film subsidies are sometimes described as an “investment” that will pay off by creating a long-lasting industry. This strategy is dubious at best. Even Louisiana and New Mexico — the two states most often cited as exemplars of successful industry-building strategies — are finding it hard to hold on to the production that they have lured. The film industry is inherently risky and therefore dependent on subsidies. Consequently, the competition from other states is fierce, which suggests that states might better spend their money in other ways.
• Supporters of subsidies rely on flawed studies. The film industry and some state film offices have undertaken or commissioned biased studies concluding that film subsidies are highly cost-effective drivers of economic activity. The most careful, objective studies find just the opposite.

Even the Tax Foundation agrees that film subsidies make little policy sense. Maryland should let the state film production tax credit expire at the end of this fiscal year, as scheduled.

Tax Free Holiday Not a Good Deal

Starting this Sunday, August 12th, through the following Saturday, August 18th, Marylanders will be able to purchase certain clothing items costing less than $100 without paying the state's 6% sales tax (you can find more information about the holiday here). However, it's not as good a deal as it sounds.

The sales tax holiday was established in 2007 as a way to help families with back-to-school expenses and to promote Maryland retailers. At the time, legislators thought that the state was on track for budget surpluses and could afford the lost revenue. The recession derailed that plan, and the state is still struggling to recover. Now, the sales tax holiday is a loss the state can ill afford.

Estimates are that the sales tax holiday costs the state treasury about $10 million in lost revenues. That's enough money to provide 1,000 families with emergency housing assistance, or state college scholarships for 4,000 students. And it comes as the state begins to grapple with how to fix the remaining $400-500 million structural deficit in the FY 2014 budget.

Since 1997, at least 20 states and the District of Columbia have held tax holidays. They mostly involve clothes, computers, school supplies, and appliances. Florida extended tax holidays to hurricane-preparedness items. Yet many experts don't think stores benefit much from sales tax holidays. Research has found that in many cases removing sales taxes for a few days affects the timing of purchases rather than the volume. Business might be up during a sales tax holiday, but it goes down at other times as people shift their purchases to the tax-free days. One Florida study even showed that retailers raised prices (or lowered their normal discounts) during the tax holiday so they took 20 cents out of every dollar customers saved on taxes.   

Tax holidays can be confusing too. In Maryland the purchase of clothing under $100 will be tax free; but if you exchange the item after the tax holiday you have to pay tax on the new item (unless you exchange it). If you get a rain check and redeem it after the tax-free week, you'll have to pay tax. The store can’t break up something that’s normally a set (like selling the parts of a suit separately) to get the prices of the individual components under $100 and sell them tax-free. And the tax holiday doesn't apply to accessories, like belts, scarves and neckties.

More importantly, the sales tax holiday provides little relief to low-income Marylanders who are less able to shift the timing of their purchases to coincide with the sales tax holiday.

A better way to help families struggling to stay afloat would be to reform the tax system in Maryland to ensure the long-term revenue needed for services like education, health care, and job training that help people make their own way, take risks, and be productive. Asking out-of-state web-based retailers  to play by the same rules as those on Maryland's main streets would be an excellent start.

Is the sales tax holiday worth it? It provides a little excitement and free promotion for retailers. It gives government officials something to claim credit for. It may help families a little bit with back-to-school shopping, but few shoppers would get excited about a “giant 6%-off sale,” which would amount to the same thing. It costs us, as citizens, real money from our state treasury during a time when Maryland is cutting public services and can ill afford to make the hole we are trying to dig out of even deeper.

The bottom line is the tax holiday is not a good use of our limited resources. Interestingly, both the progressive Institute on Taxation and Economic Policy and the conservative Tax Foundation agree with me.  While the tax holiday might help consumers and businesses a little bit, a strong economy and safety net will help them more. That takes public investment and those investments take money.  There are more direct, less costly ways to help retailers and working families. We can’t afford to be spending money on gimmicks like tax holidays when we still have high unemployment and foreclosure rates, and losses of revenue needed for education and healthcare.

Maryland bucking the trend

Nationally, many states are pursuing a strategy of public disinvestment in order for conservative politicians to demonstrate their opposition to taxes. Some states, like Michigan, New Jersey, Indiana, and Tennessee, are enacting rash and irresponsible tax cuts.    Other states are attempting to go much farther

Some state legislators are proposing to eliminate whole taxes, cutting state revenues by 30 or 40 or 50 percent. Georgia, Kansas and Oklahoma have considered proposals to abolish their state income taxes. North Dakota voters defeated a proposal to eliminate their property taxes only after voters rejected it in referendum.

Governing Magazine’s Penelope Lemov recently interviewed the (progressive) Center on Budget and Policy Priorities’ Nick Johnson and the (conservative) Tax Foundation’s Joe Henchman about this trend. (Disclosure: the Center on Budget and Policy priorities is a major national coalition partner with the Maryland Budget and Tax Policy Institute).

Johnson and Henchman both pointed out that the cuts needed to offset such large revenue reductions can be very harmful to a state.

Henchman: “Depending on what you cut, you will have an economic effect. If you cut education, that might make your state less competitive. There are trade-offs.”

Johnson: “A state could end up with much higher sales taxes and excise taxes, much higher local taxes and larger class sizes, fewer teachers, libraries and cops on the street, and less availability of health care. It's magical economic thinking -- this idea that there's a free lunch to be had.”

So, there’s broad agreement that our taxes do pay for something valuable.

In contrast to the national tax-cut fever, Maryland’s legislature used a balanced approach to balancing the budget this year, including fair and moderate tax increases. It preserved funding for the functions important to our state’s economy and quality of life. Our elected representatives did the obvious and responsible thing.  Yet in doing so, they were bucking the national trend.

 At the same time, we have further evidence to disprove one of the common bogeyman of the anti-tax brigade.  Jeffrey Thompson at UMASS’ Political Economy Research Institute has compiled a very thorough, balanced and readable survey of the research on the economic effects of state taxes on high income taxpayers. The result? “Modest tax increases on high-income households are unlikely to make substantial changes in their work effort or entrepreneurship or make them more likely to leave the state.” There may be more tax-sheltering behavior, particularly among the top 1/10 of 1 percent.

Professor Thompson concludes “The benefits of sustaining appropriate levels of funding on K-12 and public higher education, public safety, and transportation should be weighed against these consequences – as opposed to unsubstantiated fears that the rich will flee a state en masse or shut down their businesses.”

In Maryland, our leaders made these responsible choices. We need to maintain our support for education and our other shared public assets so we have a strong future with growing prosperity that’s broadly shared.