Minnesota’s business lobby frequently complains that business tax rates in the Gopher State are high. Such claims are often based on nominal tax rates—in other words, the rates that are written into state law; however, nominal rates do not take into account various statutory exclusions that reduce the base against which the rate is applied and which have the effect of reducing the amount of taxes actually paid. When gauging differences in the level of taxation between states, economists typically rely on effective tax rates, typically based on tax levels relative to some measure of economic activity. In Minnesota, the state and local business effective tax rate is actually below the national average.
Ernst & Young (EY), in conjunction with the Council on State Taxation (COST) and the State Tax Research Institute, publishes annually a report summarizing state and local business taxes* in all fifty states and the District of Columbia entitled, “Total State and Local Business Taxes.” The most current version of the report is based on tax information from fiscal year (FY) 2015. Based on information from the EY report, the preceding article in this series noted that state and local business taxes in Minnesota per private sector employee are seven percent below the U.S. average. The EY report also includes state and local total effective business tax rates (TEBTR) for all fifty states, D.C., and the entire U.S. According to the EY report:
State and local business taxes are imposed on a variety of tax bases, including net income, input purchases, payroll, property and other tax bases. Therefore, a broad measure of a state’s overall economic activity should be used to determine the measure of aggregate business tax burden that can be compared across states.
The “broad measure of a state’s overall economic activity” used in calculating the state and local TEBTR in the EY report is private sector gross state product (GSP), which equals the total value of annual production of goods and services by the private sector in a state. Minnesota’s FY 2015 TEBTR is 4.5 percent, slightly below the national average of 4.6 percent. The TEBTR for all fifty states, D.C., and the entire U.S. are listed in the chart below in descending order.
Minnesota is in a six-way tie for the 25th rank in terms of the state and local TEBTR. (Ties are common in this ranking because EY rounds the TEBTR for each state to the nearest one-tenth of a percent.) In other words, 23 states and D.C. have higher TEBTRs than Minnesota, five states have the same TEBTR (after rounding), and 21 states have lower TEBTRs. Based on the TEBTR, Minnesota is not a high business tax state, but is firmly situated in the middle of the pack with a rate near the national average.
The energy-producing state of North Dakota has an FY 2015 state and local TEBTR of 9.9 percent—the highest in the nation and more than double the U.S. average. Another energy-producing state—Wyoming—has the second highest at 8.1 percent. Extractive industries such as energy production are generally the target of significant state severance taxes; while the legal incidence of this tax is borne by businesses, much of the burden is effectively shifted onto consumers through higher prices. The EY report is careful to note that the TEBTR is based on the legal incidence of a tax, not the final incidence after taking into account the shifting of the tax on to consumers. As noted in the report:
When a tax can be passed on to consumers, the tax is not a burden in the same way as taxes for which the economic incidence, not just the legal liability, falls on the owners of a business.
For this reason, the state and local TEBTR reported in the EY report is not a complete measure of tax competitiveness. Furthermore, the national average TEBTR is skewed upward by high severance taxes in energy-producing states.
Using data from the EY report, however, it is possible to approximate the national state and local TEBTR excluding seven major energy-producing states.† Excluding these states and the severance taxes that they impose is sufficient to reduce the TEBTR in the remaining 43 states to approximately 4.5 percent—equal to the Minnesota TEBTR.
When we consider the overall level of economic activity, Minnesota is not a high business tax state. The state’s business effective tax rate is below the national average and equal to the average excluding major energy-producing states. Minnesota is also below the national average in terms of the share of total state and local taxes borne by businesses, as we will see in the next part of this series exploring data from the Ernst & Young business tax report.
*The first installment in this series lists the business taxes that are included in the FY 2015 EY report, as well as other information about the EY report.
†The seven energy-producing states excluded from this analysis—identified using various on-line sources—are Kentucky, Louisiana, North Dakota, Oklahoma, Texas, West Virginia, and Wyoming. Energy production is a large portion of the economy of Alaska; however, Alaska was not excluded along with other energy-producing states because of recent large severance tax reductions in that state, as noted in the EY report. Because of these severance tax reductions, Alaska’s FY 2015 TEBTR is below the national (and Minnesota) TEBTR.