Interstate Tax Comparison

The Tax Foundation has just issued a new tax study that compares the “business climates” of each state. The study is quite well done; and it should be a must read for tax “reformers.” As you might guess, New Mexico is in the lower quartile; but certainly not as bad as New York or Hawaii. However, given the rate at which Richardson is cranking up state spending, we may be catching down with them quickly.
A few comments on the study:
1. It does not include property taxes; New Mexico’s position in the rankings would improve if it did.
2. It weighs the components equally, so does not really catch the adverse impact of our gross receipts tax. New Mexico’s ranking would be far worse if it did.
3. It does not include severance taxes. If it did, our corporate tax ranking would be worse.
A little elaboration on point 2:
Federal and state taxes are inextricably intertwined. That being so, we can calculate the effective rate of tax on income for an entrepreneur engaged in providing a service subject to the gross receipts tax. We take into account that the GRT payment is a business expense, that state income tax is deductible on state and federal returns and that the entrepreneur’s taxable income is a certain percentage of her total receipts (say, for example, 50 percent). Give our entrepreneur a somewhat modest income: she is in the 25 percent federal tax bracket, 6 percent New Mexico tax bracket, makes “contributions” to social security and Medicare at the rate of 15.3 percent and has gross receipts that are twice her taxable income. In that case her overall rate of tax on income is 52 percent! Compare that to an equivalent entrepreneur in Texas: her effective rate of tax is 40 percent. Now you can see how the gross receipts tax destroys jobs in New Mexico. Maybe we should call our gross receipts tax the “Texas, Colorado, Arizona Economic Development Initiative.” Since the effective rate of tax on each dollar earned is much higher than is usually thought in discussions of state taxes, the adverse effects of GRT “pyramiding” for New Mexico are a much worse than is usually thought

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One Reply to “Interstate Tax Comparison”

  1. Another key factor in the tax climate is the stability of a state’s tax code. Firms look beyond the present and try to determine whether a good tax climate is likely to stay put. The way our governor is proposing changes all over the tax code, I should think that New Mexico would not do very well on a criterion of tax stability.
    That’s one reason the Foundation favors indexing spending and taxes to inflation plus population growth–so businesses would have more confidence in their future tax burden.

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