Are Pennsylvania's Taxes Uncompetitive?
Which of the state's taxes are really too high? And how much of a tax cut is enough? One of the problems legislators have is that once you start proposing to cut taxes, where do you stop?
Eliminating taxes isn't realistic, so there needs to be some way to define what level of taxes is reasonable. One good way to do that is set a goal of making tax rates competitive with other states. While it would be nice to have lower taxes than other places, we should at least try to avoid being higher, particularly a lot higher.
So how do Pennsylvania's taxes stack up?
Pennsylvania’s least competitive state tax by far is the corporate net income tax. At 9.99%, Pennsylvania has the second highest corporate tax rate in the country (only Iowa is higher at 12%). That hasn’t always been true – in 1990, Pennsylvania’s corporate tax was only the 16th highest. But since then, while 13 states decreased their corporate tax rates, Pennsylvania was one of only 10 states to increase its rate (from 8.5% to 9.99%), and Pennsylvania’s increase was the largest of any of the high-tax states. Not only does Pennsylvania have a high corporate income tax rate, but it also is one of only two states that caps the amount of net operating loss carryforwards (the other is New Hampshire), so for many businesses, including startup firms, Pennsylvania has the worst corporate income tax in the country.
The state’s most competitive tax is the personal income tax. Although many people think the tax needs to be cut because it is so much higher today (at 3.07%) than in the past (it was only 2.1% in 1990), Pennsylvania’s personal income tax rate is still lower than in most states. Seven states have no personal income tax at all, and two only tax dividends and interest. But among the remaining 41 states, Pennsylvania has the second lowest rate after Illinois (which has a 3% rate).
Other states with higher personal income tax rates allow deductions and exemptions that Pennsylvania don't, or they have a graduated tax (which Pennsylvania's Constitution does not allow), and that lowers their effective income tax rate compared to Pennsylvania. But even so, it appears that on balance, Pennsylvania’s personal income tax is lower than the majority of states. That’s good news not only for individuals, but also many small businesses, since subchapter S firms pay the personal income tax instead of the corporate tax.
The sales tax is more complex to evaluate. The majority of states (28) have no sales tax at all or a lower sales tax rate than Pennsylvania’s 6% rate. But many of those states apply the tax to items such as food and clothing, making their effective tax rate higher for many taxpayers, particularly low-income families. (Also, the precise sales tax exemptions in a state, such as whether certain business services are taxed, can make a dramatic difference in the state's competitiveness for particular businesses.) And many states also have city or county sales taxes that boost the total tax rate well above Pennsylvania’s 6% rate or even the 7% rate in Pittsburgh and Philadelphia. Overall, the sales tax in Pennsylvania appears to be better than average in terms of competitiveness.
What about the local property tax? Property tax competitiveness is also challenging to evaluate, because of the wide variation in home values across the country. For example, the median amount of property taxes paid by homeowners in Pennsylvania in 2006 was $2,057, 15th highest in the country. In New York, the median amount was $3,301, which is over 60% more. But New York’s median home value was more than double Pennsylvania’s, so relative to home value, New York’s property taxes are actually 23% lower than Pennsylvania’s. In fact, Pennsylvania has the 9th highest local property taxes as a percentage of home value of any state, and the 11th highest property taxes as a percentage of homeowners’ income. (The Pittsburgh region ranks worse on one measure of property tax competitiveness and better on another than the eastern part of Pennsylvania -- see the previous post for more information on how the Pittsburgh Region, rather than the state as a whole, stacks up on property taxes.)
So Pennsylvania's property taxes are clearly uncompetitive and need to be reduced. But to make the state more competitive, the highest priority has to be cutting the corporate net income tax rate. It’s not a coincidence that Pennsylvania has both the second highest business tax and the 14th lowest rate of job growth of any state in the country. Improving the state’s business climate will help attract new jobs, which in turn will boost revenues in all of the state’s taxes, making it easier to cut property taxes while keeping other taxes competitive.