California's Competitiveness

California Has Third-Worst Business Tax Climate in the United States, Foundation Finds

The Golden State maintained its longstanding position of having a business tax climate that is worse than 47 other states, but better than New York and New Jersey.

“The states in the bottom 10 tend to have a number of afflictions in common: complex, nonneutral taxes with comparatively high rates,” the foundation group wrote in its annual report, which ranks the states based on five taxes.

California ranked 46th in corporation tax, 49th in personal income tax, 47th in sales tax, 19th in property tax, and 24th in unemployment insurance tax, the foundation said.

“The five states without a state sales tax – Alaska, Delaware, Montana, New Hampshire, and Oregon – achieve the best sales tax component scores,” the report stated. “Among states with a sales tax, those with low general rates and broad bases, and which avoid tax pyramiding, do best. Wyoming, Wisconsin, Maine, Nebraska, Idaho, Michigan, and Virginia all do well, with well-structured sales taxes and modest excise tax rates. At the other end of the spectrum, Alabama, Washington, Louisiana, California, and Tennessee fare the worst, imposing high rates and taxing a range of business inputs, such as utilities, services, manufacturing, and leases – and maintaining relatively high excise taxes. Louisiana and Tennessee have the highest combined state and local rates of 9.55 percent. In general, these states levy high sales tax rates that apply to a wide range of business input items.”

Several states reduced taxes in 2022, leading to improvements in their rankings. Arizona, for example, moved from 24th to 19th by transitioning from a four-bracket PIT with a top rate of 4.5 percent to a two-bracket system with a top rate of 2.98 percent, a waypoint on the state’s transition to a 2.5 percent single-rate tax. Arkansas moved up three spots, to 40th, by reducing its top PIT rate from 5.9 percent to 4.9 percent and reducing the corporate rate from 6.2 percent to 5.9 percent.

While other states were reducing taxes, California approved a major tax increase with the passage of SB 951 (Durazo), which removes the cap on wages subject to the State Disability Insurance (SDI) payroll tax. Under the current tax rate and wage cap, this effectively represents a 1.1 percent income tax increase on income over $145,600. California’s top PIT rate of 13.3 percent already is the highest in the nation, and the additional SDI tax effectively increases it to 14.4 percent. If voters approve Proposition 30 next month, the top rate will increase to 16.15 percent – more than 5 percent higher than the rate in Hawaii, which has the second-highest PIT in the United States.

The foundation said lawmakers should remember two rules when assessing which changes to make to their state taxes:

  • “Taxes matter to business. Business taxes affect business decisions, job creation and retention, plant location, competitiveness, the transparency of the tax system, and the long-term health of a state’s economy. Most importantly, taxes diminish profits. If taxes take a larger portion of profits, that cost is passed along to either consumers (through higher prices), employees (through lower wages or fewer jobs), shareholders (through lower dividends or share value), or some combination of the above. Thus, a state with lower tax costs will be more attractive to business investment and more likely to experience economic growth.”
  • “States do not enact tax changes (increases or cuts) in a vacuum. Every tax law will in some way change a state’s competitive position relative to its immediate neighbors, its region, and even globally. Ultimately, it will affect the state’s national standing as a place to live and to do business. Entrepreneurial states can take advantage of the tax increases of their neighbors to lure businesses out of high-tax states.”

The foundation additionally noted that many businesses have more ability to relocate now than in the past.

“The modern market is characterized by mobile capital and labor, with all types of businesses, small and large, tending to locate where they have the greatest competitive advantage,” the report stated. “The evidence shows that states with the best tax systems will be the most competitive at attracting new businesses and most effective at generating economic and employment growth. It is true that taxes are but one factor in business decision-making. Other concerns also matter – such as access to raw materials or infrastructure or a skilled labor pool – but a simple, sensible tax system can positively impact business operations with regard to these resources. Furthermore, unlike changes to a state’s health-care, transportation, or education systems, which can take decades to implement, changes to the tax code can quickly improve a state’s business climate.”