It is common for businesses to complain about taxes without considering the benefits that they provide. Taxes are not collected and then buried in a hole. They are used to provide education and public safety, protect property rights, and construct and maintain public infrastructure, among other things—all services which benefit businesses. A complete comparison of business tax levels between states should take into account the benefit businesses derive from the expenditure of tax dollars. Minnesota is fairly typical of the nation as a whole in terms of such a business tax-to-benefit ratio.
This article completes a series that examines state and local business tax information compiled annually by Ernst & Young (EY) in a report entitled, “Total State and Local Business Taxes”.* The most current version of this report examines business tax levels in all fifty states and the District of Columbia for fiscal year (FY) 2015. Previous installments in this series have shown that state and local business taxes per private sector employee, effective business tax rates, and the business share of total state and local taxes in Minnesota are slightly to significantly below the national average.
The EY report also compares states in terms of the level of state and local taxes relative to the benefit that businesses derive from state and local spending, based on a methodology developed by economists at the Federal Reserve Bank of Chicago. According to the report, business taxes can be evaluated in the context of the benefits received by businesses through the reduction in businesses’ non-tax costs due to government spending. For example, if two businesses pay the same amount of taxes but one receives greater benefits from government spending, the ultimate tax cost is not the same for both businesses. The EY report calculates a business tax-benefit ratio, which is an estimation of the taxes paid by businesses in a state relative to the benefits they receive from public spending.
Because education is the largest single category of state and local government spending, the business tax-benefit ratio is particularly sensitive to assumptions regarding the allocation of the benefit of education spending between businesses and households. According to the EY report:
While economic theory suggests that individuals are the primary beneficiaries of education due to higher wages, business owners can benefit if an educated workforce generates higher returns to capital. Returns to capital would increase if workers do not completely capture productivity gains through higher wages or if an educated workforce improves the productivity of capital (e.g., an educated or trained worker may know how to use machines in production more efficiently, resulting in fewer breakdowns or work stoppages)… Education can increase profits through indirect channels as well. For example, increasing education may reduce property crime, lowering business costs and increasing the return to capital.
Due to the importance of assumptions regarding the distribution of public education benefits between businesses and households, the EY report calculates the business tax-benefit ratio under three separate assumptions: (1) no portion of state and local public education expenditures benefit business; (2) 25 percent of these expenditures benefit business; and (3) 50 percent benefit business.
Under the first of these assumptions, U.S. businesses paid just over $3 in state and local taxes for each dollar of benefit they derive from state and local public spending in FY 2015. By contrast, under the third assumption, U.S. businesses paid just over $1 in taxes for each dollar of benefit they derive from public spending.
As was the case in FY 2014, the FY 2015 business tax-benefit ratio in Minnesota is comparable to the U.S. average. Under the first assumption, Minnesota’s business tax-benefit ratio is slightly below the national average, indicating that Minnesota businesses receive slightly more benefit from public spending per business tax dollar than do businesses in other states. Under the second and third assumptions, Minnesota’s business tax-benefit ratio is slightly above the national average. In general, Minnesota does differ significantly from other states in terms of the benefits they derive from public spending relative to the taxes they pay, regardless of the education assumption used.
Minnesota’s rank among states in terms of the business tax-benefit ratio does vary depending on the assumption used, but Minnesota is near the middle of the pack under all three. For example, Minnesota ranks 33rd in terms of the business tax-benefit ratio under the first assumption (i.e., 31 states and the District of Columbia have a higher business tax-benefit ratio, while 18 have a lower ratio). Meanwhile, Minnesota is in a ten-way tie for the 18th rank under the third assumption (i.e., 16 states and D.C. have a higher business tax-benefit ratio, nine states have approximately the same ratio, and 24 states have a lower ratio).† The chart below illustrates the business tax-benefit ratios for all states under each assumption, with states listed in descending order based on their ratio under the first assumption.
Energy-producing states tend to have higher business tax-benefit ratios than other states. For example, Wyoming’s business tax-benefit ratio is nearly three times greater than the national average under all three assumptions. As noted in the second article in this series, energy-producing states tend to impose significant severance taxes on energy production, which is largely exported to consumers; however, even if we exclude these states,‡ Minnesota tax-benefit ratio is still within 0.1 of the average ratio among the remaining states under all three assumptions. Excluding energy-producing states does not substantively alter Minnesota’s status as a “middle of the pack” state in terms of the business tax-benefit ratio.
The EY report is a valuable source of information for students of Minnesota tax policy, since it is compiled by national experts with no axe to grind in the Minnesota business tax debate. Information from this impartial source shows that Minnesota business taxes per private sector employee, Minnesota’s business effective tax rate, Minnesota’s share of total state and local taxes paid by businesses, and Minnesota’s business tax-benefit ratio are each approximately equal to or below the national average.
*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.
†Ties among states in terms of the business tax-benefit ratio are common under the second and third assumptions because the EY report rounds these ratios to the nearest one-tenth. A graphic provided in the EY report allows the rank under the first assumption to be more precisely determined (i.e., without ties).
‡The energy-producing states identified for purposes of this analysis are described in a footnote to the second article in this series.