Business Journals across the state and beyond ran the happy news: a study by Ernst & Young shows that North Carolina's business tax rate of 3.9% is the lowest in the nation.

That's exciting, I thought, so I went online and found the study. Too bad it doesn't say what the Business Journals say it does. E&Y shows that NC's business tax receipts as a percentage of total private-sector economic activity are low, but that doesn't correlate directly to low business taxes.

The website of the group that commissioned the survey, the Council on State Taxation, says questions should be addressed to Joe Crosby, so I emailed Joe Crosby and asked him about the BizJournal articles. He replied, "That portion of the BizJournal article is factually inaccurate."

He adds: There is no statutory 3.9% rate. We’ve computed an effective tax rate, which is simply a comparison of taxes paid to something else—in this case, total private sector economic output in the state. We think that is a useful comparison, but it’s not the “final word” on anything. One could choose another base, such as business profits, and one would end up with a much higher effective rate – based on previous research, an effective tax rate based on profits would be around 30%. We don’t use the profits figure because it’s tough to measure at the state level and it bounces around year-to-year. My point, though, is “3.9%” isn’t necessarily low—the base used to generate that figure is the entire economy, so one would expect the number wouldn’t be “high”.

More from Crosby after the jump.

Joe Crosby from COST:

As noted in the study, the share of state and local taxes that are initially imposed on businesses (as opposed to individuals) isn’t a good measure for making state to state comparisons due to the wide divergence between the states in terms of their overall tax burden. In other words, the business share of taxes in State A and State B may be identical, but, if State A’s overall tax rate is one-half of State B’s, then State A’s business tax burden will be one-half of State B’s even though the “share” is the same.

A better measure for state-to-state comparisons, which is provided in the study, is state and local business taxes paid as a percentage of the state’s private sector economic output—an effective tax rate (ETR). In other words, for every $100 worth of goods and services produced in the state, how much is extracted from business in the form of state and local taxes?

For North Carolina, the ETR is 3.9%, the same as Connecticut, Delaware, Oregon and Virginia, and higher only the District of Columbia.

The purpose of this study, though, isn’t to say that one state’s taxes on business are “low” or “high” but rather simply identify the existing burden as measured by legal incidence (as opposed to economic incidence—from an economic perspective, all business taxes are ultimately paid by real people). The study can’t answer the question as to whether a state’s business tax structure is “competitive”, though.

The key to a state’s economic competitiveness from a tax perspective is how heavily, compared to other states (particularly the regional competitive states), a state taxes highly mobile capital (investments in machinery, equipment and real property).  The answer to this question requires disaggregated, industry-specific analysis of state and local business taxes by tax type.

For example, detailed studies done in Ohio, Michigan, Pennsylvania, and Virginia show that capital-intensive manufacturing industries tend to face higher effective tax rates than other sectors of the economy, particularly services. Relatively high ETRs on these industries will have a larger negative impact on a state’s competitiveness than relatively high rates on more labor intensive services or industries selling predominantly in local markets.  As another example, the high ETRs on extractive industries in Alaska and Wyoming do not measure tax burdens on mobile capital as most of those taxes are exported to consumers of the extracted products (e.g., oil and coal) in other states.

Comments

[John Hood]

Well done, Ed. We have been urging people for years to read the COST study more carefully, as it does not establish what some think it establishes. There is, of course, plenty of room for legitimate and spirited debate about the importance of state and local taxes in economic competitiveness, but the first step surely is to find a common frame of reference.

[bill]

Ed,
Nice work.
Bill

[gregflynn]

Ed, the version of the story that you linked to was badly edited from the original feed.

The original story reflects Joe Crosby's comments and the key paragraph is:

The report, prepared by tax experts at Ernst & Young, found that combined local and state taxes paid by North Carolina businesses amount to 3.9 percent of the gross state product. That rate tied North Carolina with four other states - Connecticut, Delaware, Oregon and Virginia - as having the lowest U.S. business tax burden.

[Ed Cone]

That graf from the version at the Triangle BJ is more accurate, but I'm not sure you can call it the "key paragraph," coming as it does after a hed and opening graf that read:

"Study: N.C. biz tax burden tied for lowest in U.S.

"Businesses in North Carolina enjoy the lowest tax burden in the United States, according to a study prepared for the Council on State Taxation."

[gregflynn]

By key paragraph I meant the paragraph that was distorted by the edit. Having read the study I don't find an inaccuracy in the intro. The devil is in the details but there's only so many caveats that can fit in a headline/intro. There is nothing wrong with the original study.

From Joe Crosby
"Greg -- Ed Cone and I engaged in a series of emails. In one he asked if the following quote from the BizJournal was accurate:

"That study shows that North Carolina's state and local applicable business tax rate is 3.9 percent, tied with four others for lowest in the nation."

I responded that it was not. The quote from the BizJournal fails to distinguish between a statutory rate, which is in the law, and an effective rate, which is calculated by comparing taxes paid to something else (in this case, state private sector economic output).

The E&Y/COST study is accurate."

[Ed Cone]

Right. I don't dispute the COST study, I merely point out that it was seriously misrepresnted by the Biz Journals, and apparently by a press release from the Gov's office.