A New (and Better) Study Informing Minnesota Business Tax Competitiveness

Recently, the Tax Foundation in Washington, DC launched another salvo to inform the unending debate over the competitiveness of Minnesota’s state and local tax system. The Foundation’s new report, Location Matters, is a very different animal from their other and far more famous state tax ranking report, the State Business Tax Climate Index (Climate Index). The frequently-cited Climate Index perpetually concludes Minnesota has one of most hostile business tax climates in the nation. But as we have discussed before (Tax Climate Groundhog Day), the Climate Index ranks tax systems based on adherence to sound tax principles, and the inescapable subjectivity and assumptions associated with such an attempt makes those findings highly controversial and debatable.

What makes Location Matters different – and much more informative and useful in actually evaluating state tax competitiveness – is that it quantifies and compares actual tax burdens on similar types of business facilities across the country. The Tax Foundation accomplishes this by creating several “model” firms ranging from corporate headquarters to call centers. Each model type is given a set of operating assumptions and parameters (e.g. employees, building size, salaries, purchases, sales, profit, etc.) that remain the same from state to state. National auditing and accounting firm KPMG then calculates what the total tax bill for each model type would be in each state. The result, in the words of the Tax Foundation, is an “’apples to apples’ comparison” and “comprehensive calculation of real world tax burdens.”

How did Minnesota turn out? The 2015 results suggest the state engages in a Jekyll and Hyde tax treatment of Minnesota businesses.

The differences among the rankings illustrate how a tax code’s design can be just as influential as the rates themselves. In Minnesota, both manufacturing and research and development facilities score well for several reasons. For starters, when determining how much a firm’s total income is subject to state tax, Minnesota uses the company’s ratio of in-state sales to total sales – excluding consideration of how much property it owns and labor it employs within the state. We exempt business equipment and inventory from property taxation and exclude manufacturing inputs from sales taxes. We also offer an R&D credit. All these features help mitigate the effects of our higher corporate income tax rates.

Sometimes, however, higher tax rates simply swamp tax code features. For example, according to the report, Minnesota’s “sourcing rules” – which locate income where the benefit is received – are favorable to operations like call centers. But we rank near the bottom of the nation for this type of firm because our relatively higher unemployment insurance, sales, and property taxes overwhelm that beneficial feature.

It’s interesting to note that our two lowest scores are associated with firm types that are perhaps the most “captive” or at least aren’t particularly mobile. Retail establishments will exist wherever people are, regardless of tax burdens. The corporate headquarters results are particularly worth pondering. The state’s performance with respect to both its national share and growth of corporate headquarters is rather remarkable. With the substantial number of Fortune 500 and other large companies headquartered in the state, other items clearly mitigate tax disadvantages, including national leadership in workforce quality and quality of life.

But it also helps that it’s a big deal to uproot and move management and leadership infrastructure – so companies that “grow up” here tend to stay. When those ties no longer exist because of business changes, Minnesota history conveys a more complicated story. It’s difficult to think of a merger or acquisition situation involving a major Minnesota company where the resulting entity retained or moved its headquarters presence here. These rankings make that history a bit more understandable.

As with any study of this ambition and nature, important caveats exist. The findings only pertain to “C-corporations” – and not to businesses organized as partnerships or other entities in which business income is “passed through” and taxed as part of owners’ personal income. The universe of firm types is certainly greater than those presented here. And above all the assumptions used to generate the model firms have potentially huge implications for state rankings and what a firm’s actual tax rate would be. To keep the study as manageable as possible, it assumes model firms do business in all fifty states but only have significant employees, property, and facilities in the residence state. Tweaking any of these (and related) assumptions could have big implications for state rankings and effective tax rates.

Nevertheless, model firm studies like these are one of the best methods available to get a handle on state tax competitiveness. And the findings offer a smorgasbord of things to consider for anyone interested in pursuing business tax relief and/or reform in future legislative sessions.