A Tax Structure Finely Tuned for… a 20th Century Economy

Virginia business tax rates. Image credit: Tax Foundation, KPMG

A new study by the Tax Foundation and KPMG of state business taxes differs from previous studies, which look at average levels of taxation, by examining how state tax structures affect different types of business. The big conclusion from “Location Matters: The State Tax Costs of Doing Business“: Firms experience dramatically different tax rates because their exposure varies to different state and local taxes.

The study’s analysis of Virginia’s tax structure suggests that established companies experience much lower overall tax burdens than new companies. The Old Dominion ranks second best in the country for mature, labor-intensive manufacturing operations but only 35th for R&D facilities.

Bacon’s bottom line: I have frequently decried the lack of entrepreneurial dynamism in Virginia as a root cause for our sluggish economic performance. There may be many reasons for Virginia’s mediocre growth record in recent years but, based upon the data shown in the chart above, one of them is certainly the structure of business taxes.

In every category analyzed, new firms experience higher effective tax rates than mature firms. Just as important, look at the comparative ratings. Virginia ranks No. 2 in the country for mature, labor-intensive manufacturing companies — neither a growth sector, nor a particularly high-paying sector — but only 35th for R&D, the kind of economic activity every state covets. If we wanted to design an economy for the 20th century, not the 21st, we’ve done a pretty good job.

(Hat tip: Larry Gross)

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  1. LarrytheG Avatar

    When I first looked at this – my initial impression was that Va is not friendly to new business…

    and perhaps that’s why you see both the Gov and localities offering incentives.. because the basic tax structure is not so friendly.

    One thing Va DID look good at – Corporate HQs…

    but all this talk about economic development.

    1. – we have to have an educated workforce and
    2. – we have to be friendlier to business.. at the least – we should
    be competitive with the other better states.

    we might actually want to do what New York is doing.. offering new businesses – tax free status for the first years here.

  2. Gov McAuliffe has been floating some preliminary tax reform discussion.

  3. Cville Resident Avatar
    Cville Resident

    I agree with your post as well as Larry’s comments. It would be in the Commonwealth’s best interest to look at a tax free status arrangement for tech/R&D/biomed firms for a period of 5 years.

  4. TooManyTaxes Avatar

    I’ve read inconsistent comments on New York’s tax-free business startup/expansion program. Not sure who is correct. Is it a flop or a success?

    The older I get the more skeptical I am about feeding carrots to business. An efficient state government focused on the basics, with broad-based taxes and low rates may well be the best attraction to old and new businesses. If I were McAuliffe, I’d start talking with the GA about replacing the BPOL tax with another business tax not based upon gross revenues and that treats all businesses the same. Fairfax County’s BPOL tax rates are all over the map.

    Of course, there are other factors to be considered in attracting business.

    From my observations, Fairfax County is considered to be better run with lower taxes than Montgomery County. And adjusted for sequestration, Fairfax County has done better attracting business and jobs than its cross-river neighbor.

  5. LarrytheG Avatar

    I think what New York is doing is not homogeneous across the state. It’s more like enterprise zones – which I think Va has some form of.

    I think it applies to defined zones – for businesses not already located there – i.e. a new industry that does not compete with existing ones.

    but as TMT suspicions … the devil is in the details and the problem with doing this is lobbyists and influence money get involved.

    but as a state – on the various taxes – we should be competitive with other states.. I think you could – take what PMG did one step further and look at taxes for an industry and compare the amount of industry in states that tax that industry higher or lower than other states.

    it looks like Va taxes distribution centers pretty heavily . are we competitive with other states on that?

    the other thing that is counter-intuitive – I thought taxes had to be applied equally across the board. I did not think you could discriminate.

    I know in our area – you have to charge the same property tax rate for all property regardless of the type… I think…

  6. I am a bit skeptical about the long-term benefits of large giveaways to lure businesses to communities. I haven’t seen the research, but my suspicion is that many locations have experienced a bad return on investment from these kinds of practices. A “bribery” kind of incentive lures companies that are opportunists and will leave for the next special offer well before they have provided the benefits the community was counting on.

    Long term prosperity is usually achieved by states that have created an “ecosystem” which encourages business development and long term success. As with any good ecosystem, it contains a diversity of items such as fair, stable and affordable taxes, high quality K-12 and university (research center) education, an adequate trained or trainable workforce, governments that make it easy (zoning, permits, etc.) for businesses to be created and to expand, access to capital (VC’s, Development Corps, strong banks, gov’t incentives), reasonable energy costs, well maintained transportation networks, cultural and recreational resources, and many other factors.

    Some states have had success with special R&D tax credits and other special incentives. But perhaps the most crucial factor is to have communities of the type where people want to live. Businesses cannot sustain themselves without high quality talent. And that talent wants a particular work experience and living experience. We must begin to design our solutions as systems not just single “silver bullet” type of responses.

  7. LarrytheG Avatar

    I’m similarly skeptical about incentives – but the simple truth is that there are more places wanting the jobs than there are businesses these days and the businesses go to where the deal is best.

    but when I look at the charts – I have to ask why is there a difference in how these different industries are taxed – in the first place – within a state like Virginia?

    why shouldn’t the business tax be the same no matter the industry whether it’s R&D or a distribution center?

    Businesses don’t pay taxes anyhow. Those taxes become an expense – a cost of doing business that gets incorporated into the price of what they sell.

    and a company is not going to locate in any area where the expenses make the cost of what they sell – a competitive disadvantage against others making and selling that product or service?

    If Virginia wants more jobs, depend less on govt – they have to look at the costs of doing business for each business and industry because in the end – taxing businesses is risky business anyhow.. it’s like playing with job-creation fire…

    1. TooManyTaxes Avatar

      Businesses may or may not pay taxes. In a free market (as opposed to those operating in one created by crony capitalism), supply and demand determines whether, and to what extent, a business can recover its costs, including taxes. There is an interesting study (now about 20 some years old) about the impact of California’s real estate development impact fees. The study confirmed market conditions were the key factor (is the market hot or cold), but also found out it was much harder to recover the full cost of impact fees from lower-priced housing units than from more expensive ones.

      And even when businesses can pass through the costs, I think there are public policy reasons for businesses to pay some taxes. They are citizens and derive benefit from government operations and services. But still, business taxes should be broad-based in nature, applied fairly and have low rates. Ideally, they should be neutral with respect to the nature of the businesses.

      1. Cville Resident Avatar
        Cville Resident

        Interesting thoughts. But if we ran an experiment in which every state and locality offered the exact same tax burden on businesses, what do you think would happen?

        I have no clue, but I’m interested in the thoughts of others. Climate? Schools? Infrastructure? What would drive business location in a tax-neutral world?

  8. LarrytheG Avatar

    I don’t think it’s the impact fee per se. Higher priced products usually have a larger margin to work with and lower priced much less.

    and just like when Walmart will sell something at less than their cost because it’s price sensitive competitively – they’ll recover it on something else – often something perhaps they got cheaper by buying more of or is a luxury item.. etc..

    They’ll sell milk at a loss but get a 300% markup on a 2 liter soda.

    that’s not govt doing that – it’s competition and by definition – all businesses that DO stay in business – DO recover their expenses and then some.

    businesses that do not recover their expenses go broke.

    1. TooManyTaxes Avatar

      Larry, as I recall reading, the California builders sought (unsuccessfully) to get some relief from the impact fees. Obviously, if they don’t go bankrupt, they are recovering all their costs. However, market forces may prevent them from earning their desired profit level. Assuming the cost of capital is 10%, the requirement to pay impact fees or other taxes or regulatory costs and the associated inability to raise or maintain prices may result in earnings less than 10%. At which point, the business needs to decide whether it can operate at profit levels below its cost of capital; modify its business strategy; or get out of the business.

      I would also think it is a lot easier for a bigger company with a large product line to absorb the costs of loss leaders and, perhaps, government fees and mandates. Walmart has also been very successful in forcing price cuts from suppliers. I would think that, with the exception of landowners, it’s more difficult for builders to wring out similar savings. It might result in the land dropping in value from $3 million to $2.5. In that case, the builder has passed along the economic incidence to the landowner.

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