State Tax Policies on Small Business Spark Debate

Raising taxes may have helped states reduce deficits during the recent recession and recovery, but it had a negative impact on entrepreneurship, small businesses, investment and job creation, an economist said.

"The impact of the severe economic recession that began in 2007 continued to create substantial revenue shortfalls during 2010 legislative sessions," the National Conference of State Legislatures reported. "As a result, state legislatures were prompted to increase taxes and fees for the ninth consecutive year as they worked to shore up state budgets."

Tax increases, though, shift resources away from the private sector, diminish incentives for entrepreneurship and investment, hurt competitiveness and restrain economic activity, said Raymond J. Keating, chief economist for the Small Business & Entrepreneurship Council (SBE Council).

"In the end, economic growth, incomes and job creation suffer," Keating wrote in his column, The Entrepreneurial View.

The SBE Council just published its Business Tax Index , which uses 18 separate measures to pick the winners and sinners in state taxation policy. The ranking showed that some states are moving in a more positive direction or at least allowing bad policies to expire.

Temporary increases in personal income tax rates in California, New Jersey and North Carolina were allowed to fade into oblivion, for example, while the corporate income tax rate fell in Oregon, New Jersey and Massachusetts. California, Oregon, New Jersey and North Carolina were all on the list of the 15 worst state tax systems.

"No doubt these moves were small," Keating wrote. "And in each of these particular cases, given that rates are still so high, and that these states rank poorly in the Business Tax Index, much more is needed to make each state competitive. But at least, these are baby steps in the right direction."

On the one hand, Keating cited New York and Maine for taking steps in the right direction, New York for the expiration of an income tax surcharge at the end of this year and Maine for passing a measure that will reduce its top personal tax rate in 2013.

On the other hand, Illinois was cited as a poster child for poor tax policy in the SBE Council's rankings. A massive tax increase in the Land of Lincoln featured a jump in the personal income tax rate from 3 percent to 5 percent and ballooning of the corporate tax rate from 7.3 percent to 9.5 percent.

"In this climate of tax increases, just standing still or making a few smallish reductions in taxes can be viewed as positive," Keating said. "But especially in the states that rank poorly on the Business Tax Index, substantive and permanent tax relief is needed to spur innovation , investment, economic growth and job creation."

Not everyone in the small-business community feels the issue is so clear-cut, however.

"There are no absolutes when it comes to taxes," John Arensmeyer, CEO of Small Business Majority, another advocacy group, told BusinessNewsDaily. "It's tough to take a one-size-fits-all position on taxes. You have to be pragmatic about these things."

States, Arensmeyer said, are legally bound to balance their budgets and have two tools at their disposal: spending and taxes. When you cut spending, you're taking money out of people's pockets; when you raise taxes, you're also taking money out of people's pockets.

California, he said, addressed the issue by combining spending cuts with a continuation of the income tax surcharge.

"It seems like a good balance," Arensmeyer said.

Some also believe that the SBE Council has not addressed the complete picture.

"It's inaccurate to just say states have raised taxes and leave it at that," said Jon Shure, deputy director of the state fiscal project for The Center on Budget and Policy Priorities. "Every state that has raised taxes has also cut spending by more. If they only cut spending, the size of the cuts to balance their budgets would threaten the economic recovery."

• The 10 Best and Worst States for Business
• South Carolina, Alaska, Iowa Best States for Healthy Job Climates
• Small Business Owners Labor Under Weight of Tax Law

Reach BusinessNewsDaily senior writer Ned Smith at nsmith@techmedianetwork.com. Follow him on Twitter @nedbsmith.