By Andrew Magloughlin
Free State Foundation Legal Fellow
The Tax Foundation just released its 2022 State Business Tax Climate Index—and, unfortunately, Maryland continues its downward slide.
It now ranks 46th overall among the states and the District of Columbia due to bottom-half ratings in each of the measured subcategories.
This is Maryland’s lowest ranking since at least 2014 and possibly marks its all-time low. It should be a clarion call of the need for tax reform in the state.
States compete with other states for businesses, residents, investment, jobs, and revenues by implementing business-friendly tax policies. Maryland’s rank as 46th shows serious room for improvement.
As the Tax Foundation explains, a business-friendly tax environment does not mean tax-free anarchy. It means structuring major taxes with “low rates and broad bases.” The broader the “base,” meaning the total amount of economic activity subject to a specific tax, the lower the rate a state needs to impose to achieve its revenue target.
Five major areas of taxation
The Tax Foundation’s State Business Tax Climate Index assesses a state’s overall performance based on five major areas of taxation that affect business: corporate tax, individual income tax, sales tax, property tax, and unemployment insurance tax. Some states do not assess all of these taxes, but that fact does not guarantee strong performance on the index. Utah and Indiana, both of which rank in the top 10, impose all of the major taxes as Maryland does, but they avoid “complex, nonneutral taxes with comparatively high rates” that detract from Maryland’s economy.
Maryland could improve in virtually every area, because its 46th overall rank reflects its bottom-half performance in every category:
- Unemployment insurance tax (46th)
- Individual income tax (45th)
- Property tax (43st)
- Corporate tax (33rd)
- Sales tax (26th)
Over the years, Maryland has been a consistent bottom-tier performer with unemployment insurance taxes, because it does not have “rate structures with lower minimum and maximum rates and a wage base at the federal level,” which cause uneven burdens on employers.
Maryland has the highest minimum unemployment insurance tax rate in the country at 2.2% and one of the highest maximum rates at 13%. It also relies on a wage base above the federal level.
These factors lead to non-neutrality in the unemployment tax by assessing more tax on struggling businesses and industries with endemic turnover, like retail. It makes little sense to burden struggling businesses with high unemployment taxes when doing so risks more unemployment.
High income tax
Maryland also has a high progressive individual income tax that places it in the bottom 10% of states in this category. This is a problem for Maryland’s business climate because “a significant number of businesses, including sole proprietorships, partnerships, and S corporations, report their income through the individual income tax code.”
Progressive taxes disincentivize labor over leisure for high income earners, which means Maryland’s tax code encourages wealthy individuals to spend money on activities like travel and entertainment instead of hiring workers and investing in Maryland’s economic growth. This disincentive is especially concerning at the state level, where individuals can “vote with their feet” by relocating to lower tax jurisdictions.
Maryland’s income tax also ranks poorly because it is not indexed to inflation, includes a marriage penalty, and double-taxes capital gains and dividends. Maryland could improve its business environment by eliminating or reducing the extent of these problems.
Maryland’s property tax regime falls in the bottom-10. Property taxes are not just taxes on ownership of real property—they also include any tax assessed to tangible or intangible property, such as business inventory taxes, real estate transfer taxes, estate taxes, and inheritance taxes.
Maryland’s poor performance on the Business Tax Climate Index is largely attributable to its property taxes that distort business decisions. For example, Maryland taxes business inventories, a tax that has the effect of discriminating against retailers and forcing businesses to factor tax minimization into sales and procurement strategies.
Maryland also taxes real estate transfers, which increases compliance costs and distorts decisions when businesses or individuals seek to transfer non-liquid assets, including small business and family-owned property.
Maryland is also the only state in the country to levy both an estate tax and an inheritance tax, often causing double-taxation of inherited property. These taxes cause businesses and individuals in Maryland to make decisions about property based on tax strategy rather than economics, so they should be eliminated.
Maryland’s corporate tax ranking is not quite as abysmal as it is in the previous three categories but it still needs work. High corporate tax rates with progressive bracketing discourage businesses, especially when nearby states have lower taxes. In Maryland, corporations pay an 8.25% tax rate on business profits. Imposing a single rate is positive. But 8.25% is a relatively high rate compared to other states, so businesses may be deterred from locating in Maryland, especially when nearby Virginia has a lower 6% rate.
Additionally, Maryland does not conform with federal policy for deducting depletion, which adds complexity for businesses that deal with natural resources. Maryland should reduce its corporate rate and conform with federal depletion policy to attract business.
Sales tax does best
Maryland’s sales tax regime earned the state’s best subcategory ranking, but this ranking was still relegated to the bottom-half thanks to “including too many business inputs, excluding too many consumer goods and services, and imposing excessive rates of excise taxation.”
For example, Maryland’s 6% sales tax rate could be reduced if it didn’t provide a wide variety of sometimes seemingly arbitrary exemptions for various goods and services. Meanwhile, Maryland taxes business production inputs like leases, information services, and office equipment. Businesses likely pass taxes imposed on these items to end users of finished products, on whom the sales tax might apply again. Maryland could improve its ranking by eliminating exemptions for consumer goods and services while exempting inputs—creating a broader base that allows for overall lower sales tax rates.
Worse than adjacent states
The harmful effect of Maryland’s 46th place overall ranking becomes clear when you consider the more competitive rankings of adjacent states. All of the states bordering Maryland have better Business Climate Index rankings, except for the District of Columbia. These states include Delaware, Pennsylvania, Virginia, and West Virginia.
Delaware’s 16th place ranking is the best, and this might help explain why Delaware has the highest population growth rate among Maryland and its neighboring states. Virginia ranks 25th on the Index and also has a higher population growth rate than Maryland. While Maryland has faster population growth than Pennsylvania (29th) and West Virginia (21st), the potential for these states to outcompete Maryland for business and residents solely because of Maryland’s unduly high tax rates and overly burdensome tax policies should alarm lawmakers.
The 46th place ranking on the State Business Tax Climate Index should be a wakeup call to Maryland’s government officials and its citizens. This bottom-dwelling ranking suggests that Maryland’s tax code pushes investment, job growth, and revenue, as well as jobs and potential new residents to other states. And because Maryland’s ranking has continually declined over the last decade, it appears other states are taking the benefits of tax reform more seriously.
Adoption by the legislature of the tax reforms suggested above, and others discussed in the Index, would stop Maryland from losing further ground to other states, including its neighbors, and would help spur more economic growth that would benefit all of Maryland’s residents.
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