In 1994, PAR published "Corporate Tax Burdens in the Southern States: A Comparison." That study compared the tax burdens on eight hypothetical corporations in Louisiana and 10 other southern states. This expanded update of the earlier study examines and compares the business taxes and major tax incentives in 12 states: Alabama, Arkansas, Florida, Georgia, Louisiana, Mississippi, North Carolina, Oklahoma, South Carolina, Tennessee, Texas and Virginia.

The first part of this analysis compares the 2000 tax burden for each of 14 hypothetical firms. These firms were designed to isolate specific tax policy issues and illustrate differences in state tax structures. Seven of the firms were also examined in the 1994 analysis, the other seven were designed to represent the industry clusters targeted by the Department of Economic Development. All firms were assumed to be ongoing concerns no longer eligible for temporary tax incentives. Tax burdens were calculated for typical urban, suburban and rural locations in each state.

The second part of the analysis calculates the total taxes paid in each state by a hypothetical average manufacturer while building and operating a plant for the first 10 years. The calculation includes the major tax incentives that each state could offer in a competitive situation.

The comparison of corporate tax structures employs hypothetical firms and the tax rates of a typical urban, suburban and rural location in each state. This approach differs from the previous study which used statewide average tax rates.

The advantage of using a hypothetical firm is that it provides a consistent base to compare the impact of different state taxes and the net impact of tax structures as a whole. The major disadvantage is that there is no "typical" business firm and a hypothetical firm may not represent any actual firm in the state. If, instead, an actual Louisiana manufacturing firm was used for the comparison, such as a large chemical plant or refinery, it is unlikely that comparable firms could be found in many of the other states.

To facilitate interstate comparisons, the hypothetical firms used here are all assumed to be of the same size ($10 million in assets); balance sheets and income statements are simplified to meet only the basic tax calculation requirements; and differences in the firms are limited to those necessary to reflect major characteristics of the types of firm represented (See Table 1).

The $10 million manufacturing firm would be very small for Louisiana, however, the dollar amount is not important. Assuming the balance sheet ratios do not change, the hypothetical firm's assets could be multiplied by 10 or 100 and the relationship of the various state tax burdens would remain essentially the same.

The hypothetical firms are assumed to have all of their facilities and operations within one state. This simplifies the tax calculations but ignores the advantages that a multi-state or multinational corporation might experience in each state.

The hypothetical firms are also assumed to be corporations whose stocks are publicly traded. The resulting tax comparison would differ somewhat for the many Louisiana firms that are family owned or closely held companies classified as Subchapter "S" corporations or Limited Liability Corporations (LLC's) under federal tax law. Louisiana and most other southern states treat the income of "S" corporations and LLC's differently to avoid double-taxation of owners.

The actual tax rates of typical urban, suburban and rural areas were used instead of average tax rates to show how tax burdens may differ depending on the firm's location decisions within a state.

The seven hypothetical firms used in both this and the previous study include the average manufacturer, capital-intensive manufacturer, labor-intensive manufacturer, no-profit manufacturer, high-debt manufacturer, retail firm and wholesale firm. The simplified balance sheet and income statements are the same as the previous analysis and are shown in Table 1. The same data was used to aid in comparison with the earlier study. Also, an analysis of more current balance sheet ratios showed that the data had not changed significantly.

The balance sheet and income statements for the "average" manufacturer were designed using asset ratios based on federal corporate tax return data for all manufacturers, having assets of $10 million to $25 million, and reporting income in 1991. This data was published by the Internal Revenue Service (IRS) in its "1990 Corporation Source Book of Statistics of Income."

The basic balance sheet and income statement for the average manufacturer were altered only to the extent necessary to produce capital-intensive, labor-intensive, no-profit and high-debt-to-equity versions of a manufacturing firm. The IRS data for specific capital-intensive and labor-intensive industries was analyzed to adjust the ratios to create representative hypothetical firms.

The hypothetical retail and wholesale firms were developed based on IRS data for those industry categories to generally represent firms from those industries. The seven new cluster-based firms included in this study were developed in much the same manner but from the IRS's most recent data published in the "1997 Corporation Source Book of Statistics of Income." All of the hypothetical firms, except the no-profit model, are assumed to have the same ratio of earnings-before-taxes to assets-10%.

For purposes of the first part of the analysis, the firms are assumed to be ongoing concerns. For part two of the analysis, the hypothetical average manufacturer was assumed to have started up in 2000 and its balance sheet was adjusted slightly to reflect the first 10 years of operation.

The hypothetical firms used in this analysis are assumed to be registered as traditional C corporations. The relative tax burdens would likely differ for firms registered as partnerships, S corporations or limited liability companies (LLCs), but a detailed comparison of these forms of business was beyond the scope of this analysis.

The C corporation is subject to a franchise tax (for the privilege of doing business) and the corporation income tax. Stockholders pay personal income tax on dividends or other distributions. Since 1986, corporations defined under federal law as S corporations can exclude income for state income tax purposes in proportion to the shares held by resident individuals. This avoids double taxation of this portion of the income. The number of C and S corporations is declining--from 117,000 in 2001 to under 114,000 by February 2002.

Since LLCs were authorized in 1992, many new firms have elected this form and some existing C corporations have switched or formed subsidiaries of this type through partnership arrangements. There are currently about 54,000 active LLCs. Most of these are assumed to be relatively small professional or family firms that otherwise might have formed as partnerships.

The advantage of the LLC is that it gives shareholders the limited liability of a corporation but it can elect to be taxed as a partnership. The state treats the LLC for income tax purposes the same as it elects to be treated for federal taxes. When taxed as a partnership, the LLC income is taxed as income of the shareholders. If the shareholders are C corporations, the LLC income passes through to be taxed as the corporations' income.

An added advantage for an LLC in Louisiana is that it does not pay the state's corporation franchise tax. All of the comparison states have LLC statutes but the tax implications vary.

The tax burdens calculated for each of the firms include the federal and state corporate income tax, corporate franchise tax, property tax and sales tax paid on purchases. (See appendix Table A, Table B, Table C, Table D.) This comparison examines the tax structures in three areas for each state: the largest urban area and typical suburban and rural areas.

Assumptions regarding the makeup of inventories, real and personal property and annual purchases of property are based on assumptions used in other comparative studies. While these assumptions are somewhat arbitrary, they provide a basis for comparing taxes. The following are the more significant assumptions and methods used in calculating taxes in this study.

Federal and State Income Taxes. Both federal and state income taxes are calculated using 2000 tax forms. The item "income before taxes," from the hypothetical income statements, is used as the starting point. It is assumed that all income is from sales and that there were no other business receipts.

Two of the states, Alabama and Louisiana, permit deduction of federal income taxes paid. Georgia permits deduction of its own state income taxes. For these states, iterative calculations were required to obtain tax liabilities for each.

Assuming the firms are entirely in-state operations avoids having to apportion income among states. However, most of the states employ similar formulas (see appendix Table C.)

Louisiana gives firms a credit against their income or franchise tax for the property taxes paid on inventory. If tax credit is greater than the income and franchise tax owed, the remainder is rebated by the state (note: in this study the remainder is deducted from the property tax to properly show the effect on the federal income tax.) The effect of the credit is to reduce the property tax burden; however, because the credit is against the corporate income and franchise tax, the tables in this analysis show a reduced income and franchise tax.

Franchise Taxes. The franchise taxes are also calculated using the 2000 state tax forms. Unlike the previous study, filing fees are ignored in this study.

Property Taxes. Devising representative property tax estimates for each state is complicated by the lack of accurate data, the wide variation in rates and assessment practices' and the application of various exemptions and incentives within the states. Temporary exemptions are not applied in the first part of this analysis. It is assumed the hypothetical firms have been in operation long enough for any such exemptions to have expired.

The property tax calculations are based primarily on data from the Minnesota Taxpayers Association's study "50-State Property Tax Comparison Study, Payable Year 2000." The property tax is calculated by multiplying the fair market value by a local sales ratio and then applying the millage rate and assessment ratios. The sales ratios and millage rates for the urban and rural area were provided in the Minnesota study; the data for the suburban area was calculated by PAR. It is assumed the undepreciated book value for buildings and the depreciated book values for personal property, as shown in the balance sheets, represent fair market value. Book values for land and inventory are assumed to be fair market value. The assessment/fair-market-value ratios used are those provided by law.

Sales Tax. While the state sales tax is typically a major portion of the total sales tax, variations in local rates can have a significant impact on tax burdens. For this reason, the three different locales were selected for each state and the statutory tax rates applied.

The rate of personal property replacement was set assuming a 6.7-year life for manufacturing property and a 20-year life for retail and wholesale. The same rate of purchases, 30% of net personal property, was applied to all categories for manufacturing firms and a 10% rate for retail and wholesale firms. The various state and local special rates and exemptions were applied where appropriate to the categories of personal property purchases.

Taxes and Costs Not Included. Unemployment insurance taxes and workers' compensation are significant corporate costs. However, these were not included in the scope of this analysis. Also excluded are a number of relatively minor taxes, which vary greatly among the states. These include special excise taxes such as Louisiana's communications tax.

PART 1. TAX BURDENS OF ONGOING FIRMS

The following analysis compares the 2000 corporate tax burdens for the 14 hypothetical firms in 12 southern states. The tax calculations do not include any temporary tax incentives offered by the states. The firms are assumed to be ongoing concerns, which have exhausted any incentives they may have initially received.

State and local taxes alone comprise one-third or more of the total taxes paid by most of the hypothetical firms. The state/local tax burdens (excluding federal taxes) are calculated for each of the seven basic firms, by state and locale and are presented in Table 2. Among the 12 southern states, Louisiana's state/local tax burden ranged from highest for a capital-intensive manufacturer located in an urban area to fifth highest for a suburban labor-intensive manufacturer. The urban area in Louisiana had a higher tax burden for all the firms due to the higher property tax millage and sales tax rate.

The state/local tax burden for each of Louisiana's hypothetical manufacturers was above the 12-state average in each case. The labor-intensive firm was closest to the average (4%-9% higher) while the no-profit firm was up to 47% higher than average.

Louisiana's two hypothetical non-manufacturing firms (a wholesaler and retailer) generally ranked in the mid-range among the 12 states and were at or below the southern average for each of the three locations. The one exception was the urban retailer, which ranked 3rd highest with taxes 5% above the average.

The ranking comparison above looks only at the state and local taxes. The following analysis considers the federal income tax as well. Because much of the state and local tax burden is deductible for federal tax purposes, federal taxes serve to partially offset differences in state/local taxes. (See Table 3.) When federal taxes are added, the range in tax burdens a firm would face in the various states is substantially narrowed.

Average Manufacturing Firm Louisiana is second or third highest, depending on location, among the southern states in the state/local tax burdens placed on the hypothetical average manufacturing firm. (See Table 2.) The rank increases to the highest in the urban area and second highest in the rural area when federal income taxes are included. (See Table 4.) This increase is due to Louisiana's high reliance on sales taxes, which are not directly deductible in calculating the federal income tax. The Louisiana firm's tax burden is 22%-31% above the southern average for state/local taxes, but drops to 8%-10% above the average total tax burden. The lowest state's tax burden is about 85% of the Louisiana tax for this firm.

The Louisiana firm's property tax is shown in Table 3 to be well above the average. However, this is only because the inventory tax credit ($61,088 in the urban area, $43,200 in the suburban area, and $42,786 in the rural area) is shown deducted from the income and franchise tax, rather than from the property tax, to reflect how taxes are actually paid. If the credit were subtracted from the property tax instead, the Louisiana firm's property tax would appear about average while the franchise tax would remain well above average. The firm's sales taxes are three times the southern average and its franchise taxes are more than double the southern average, except in the urban area where the inventory-tax credit also reduces the franchise tax.

Capital-Intensive Manufacturing Firm Compared to the South as a whole, a relatively large share of Louisiana's manufacturing industry is capital-intensive in nature. The capital-intensive industry differs from the average manufacturer in that plant and equipment comprise a larger percentage of its total assets while current assets (receivables and inventory) are a smaller share. Also the ratio of sales to assets is typically lower.

Louisiana's state/local tax structure places the ongoing, capital-intensive firm at a disadvantage compared to the average manufacturing firm with the same total assets and income. (See Table 3.) The hypothetical capital-intensive firm's state/local tax burden is at least 34% above the 2000 southern state average. (The average manufacturer was 22%-31% higher.) Even after the offsetting effect of applying federal income taxes, the capital-intensive manufacturer's total taxes are still 13%-18% above the average. The Louisiana firm's total tax is ranked number one in all three locations, and is roughly 20% above that in the lowest taxed states. (See Table 5.)

The major single factor accounting for the higher tax burden is the sales tax treatment of manufacturing machinery and equipment (MM&E). A heavy investment in equipment presumes that equally heavy replacement and repair costs will be required. In the case of the hypothetical firm, Louisiana's sales taxes are more than three times the southern average.

Louisiana is one of only two southern states that do not exempt or significantly reduce sales taxes on replacement purchases of MM&E. The other state, Florida, gives a slight break by not allowing a local sales tax on MM&E.

Labor-Intensive Manufacturing Firm Labor-intensive firms generally differ from the average manufacturing model in having a larger share of their total assets in current assets (inventory and accounts receivable). Plant and equipment are a correspondingly smaller share of total assets. The labor-intensive firm also has a much higher ratio of sales to assets.

Louisiana places a somewhat lower tax burden on the hypothetical labor-intensive firm than on the other manufacturing models, but the firm's total taxes still slightly exceed the southern average. (See Table 3.) The lower taxes are due primarily to a lower level of purchases subject to sales taxes by this type of firm and the effect of the inventory tax credit.

Property taxes are heavier on the labor-intensive model than on the other hypothetical manufacturers examined, largely because of the proportionally large share of assets in inventory. For this reason, the inventory tax credit is particularly important to the labor-intensive firm. The credit ranges from $64,179 to $91,633 among the three locations. The impact of this is shown in Table 6, where the income tax is reduced to zero and the franchise tax is significantly lowered in all three locations.

The labor-intensive firm would be sensitive to interstate differences in labor-related costs. However, this study does not address costs of unemployment insurance taxes or workers' compensation insurance.

No-Profit Manufacturing Firm The hypothetical "no-profit" firm is simply the average manufacturer with no net income for the year (this assumes that sales equal expenditures). Because there is no federal income tax on the firm, the state/local tax burden is of paramount importance. The break-even assumption would lower the Louisiana firm's state/local taxes to approximately 76% of those paid when the firm's income equaled 10% of its assets. (See Table 7.)

Whereas total taxes for Louisiana's average manufacturer were 8%-10% above the southern average, total taxes for the no-profit manufacturing firm were 36%-47% higher than the southern average. Louisiana's tax structure clearly is less sympathetic to a firm having a bad year than is the average southern state tax structure. Louisiana's high franchise tax and sales taxes are the main reasons for this difference. While the troubled firm cannot avoid the franchise tax, it can avoid the impact of the sales tax to some extent by reducing its replacement purchases of MM&E. Thus the sales tax serves as a further disincentive for a troubled firm to remain competitive replacing and updating obsolete equipment.

It should be noted that the inventory tax credit is a refundable credit paid directly by the state to the firm if its corporate income tax and franchise tax liability is insufficient to cover the full amount. In this study the remaining credit is removed from the property tax, thus the property tax appears to be closer to the southern average than that for the profitable average manufacturer. (See Table 3.)

High-Debt Manufacturing Firm The high-debt manufacturing firm is the hypothetical average manufacturer with the balance sheet altered to increase long-term debt from 15% to 30% of total assets with a corresponding reduction in stockholders' equity from 50% to 35%. This shift primarily affects the franchise tax liability, which is typically based on capital stock, net worth or some measure of equity.

Only Louisiana and Oklahoma add long-term debt to net worth to get the franchise tax base. A balance sheet shift from equity to debt does not change the franchise tax base in these states. Thus the high-debt firm's tax burden is not different from the average manufacturer's tax burden in these states. (See Table 8.) The high-debt structure also does not affect Tennessee's firm as the franchise tax is based on the higher of net worth or real and personal property. The property measure is the higher amount in this case and is unchanged by an increased debt position. Texas is also not impacted by the change in debt because the franchise tax is based on the higher of taxable capital or taxable earned surplus. The taxable earned surplus is unchanged by the amount of debt and, because it yields the higher tax in this instance, the franchise tax remains unchanged.

For the other southern states with franchise taxes, reducing the amount of capital stock or total net worth reduces the franchise tax base. When debt is increased, the Louisiana high-debt manufacturer's state/local tax burden as a percent of the southern average, increases slightly as compared to the average manufacturer. (See Table 3.) This slight increase is due to the fact that the franchise tax is 5% or less of the Louisiana firm's total taxes and even a smaller percentage in most other southern states.

Some argue that including debt in Louisiana's franchise tax base places an undesirable added burden on top of the debt service a firm must pay for borrowed capital. High debt ratios are considered a sign of company weakness and for a troubled firm, forced to borrow, the argument may hold. A family-owned or closely held firm may prefer to borrow capital rather than sell stock.

For healthy, publicly traded firms additional capital can be raised either by increasing equity or increasing debt, that is by issuing more stocks or by issuing more bonds. The decision is an economic one (depending largely on interest rates) designed to provide the greatest benefit to stockholders. Removing debt from the tax base in such cases may provide an added incentive for firms to choose debt over equity expansion.

Non-Manufacturing Firms- The two hypothetical non-manufacturing firms are designed to represent the basic characteristics of retail and wholesale industries. Each of these broad industry groups comprises a vast range in size and types of firms, most of which are far smaller than the average manufacturing firm. For purposes of this comparison, the assets of each hypothetical firm are set at $10 million. This would be above average for a retail or wholesale firm, but relatively small for a manufacturer.

A major difference between the hypothetical non-manufacturing firms is the lower assumption of purchases by the non-manufacturers, which substantially reduces their relative exposure to Louisiana's high sales taxes. In addition, their high percentage of assets in inventory leads to a large inventory tax credit which reduces the state income tax to zero, and substantially reduces the franchise tax. (See Table 9 & Table 10.) As a result the Louisiana non-manufacturing firm's state/local tax burdens are below the southern average in all but the urban area, and even then the state/local tax burden is at, or just slightly above, the average. (See Table 3.) When federal taxes are added, each of the firms come within one percentage point of the southern average total tax burdens.

Cluster Manufacturers The firms added to this analysis include a hypothetical pulp and paper board mill, an industrial chemicals and plastics manufacturer a fabricated metal products manufacturer, an electrical and electronic equipment manufacturer, a ship building manufacturer, a scientific instrument manufacturer and a water transportation company. Due to the way the basic hypothetical industries were set-up, each of the hypothetical cluster firms fits into one of the five broad basic categories. The pulp and paper mill, chemicals and plastics manufacturer and water transportation company are capital-intensive industries. The fabricated metal manufacturer and electrical equipment manufacturer fit into the average manufacturer category while the ship builder and scientific instrument manufacturer are labor-intensive industries. As seen in Table 3, the tax burdens faced by each of the cluster firms closely match the tax burdens of the related basic type of manufacturing firm.

Table 11 summarizes Louisiana's corporate taxes with the average for the southern states based on the current tax structure and three different structures to offer perspectives on several tax policy issues.

Sales Tax on Machinery and Equipment The large share of the sales tax borne by businesses generally goes unrecognized. In Louisiana, business carries a particularly large burden due to the sales taxes they pay on large~ ticket machinery and equipment items essential to their operation.

Louisiana is the only southern state which does not exempt or significantly reduce sales taxes on the initial purchase of MM&E. Florida exempts initial purchases but taxes replacement purchases at the state level. Besides Louisiana, four other states taxed MM&E replacement purchases, but at much lower rates. Louisiana's high sales tax rates compound the problem. This tax has a particularly significant impact on capital-intensive firms and manufacturers operating at a loss or break-even point.

Sales taxes made up 27%-30% of the state/local tax burden of the hypothetical capital-intensive firm in Louisiana and a large portion of that sales tax was paid on MM&E.

Those states that provide exemptions for MM&E do so to encourage location, expansion and modernization. Adding another 8% or 9% to the cost of equipment purchases is a definite disincentive.

An additional problem for Louisiana is that the sales tax on MM&E is not directly deductible for federal tax purposes. Thus, there is no immediate reduction in federal taxes to partially offset the sales tax. Instead, the sales tax is capitalized as part of the MM&E value and expended over time as the asset is depreciated.

If Louisiana was to remove the state sales tax on MM&E; the state/local tax burden would decrease significantly and move closer to the southern average. However, most Louisiana manufacturers located in the urban area would still face state/local tax burdens well above the southern average for similar locations. Once, federal income taxes are added in, all but the no-profit firm and the urban capital-intensive firm come within 10 points of the southern average with the total tax burden still ranking high. If Louisiana was to exempt MM&E from both state and local sales taxes, all firms, except for the no-profit urban manufacturer, would be within 4 points of the southern total tax burden average. Most of the firms would rank near the mid-range for total tax burdens.

Corporate Income and Franchise Taxes The corporate income tax and franchise tax must be considered together in comparing state tax burdens. Texas, for example, has no income tax per se but its franchise tax plays the role of both franchise and income tax. The Texas tax is based either on taxable capital or net income and 80% of the franchise taxpayers pay based on net income.

Corporate income tax and franchise tax comparisons are complicated by Louisiana's inventory tax credit. If the inventory tax credit is removed from the property tax instead of the income and franchise taxes, a more accurate picture emerges: Louisiana's initial income tax liability is about average for the southern states and its franchise tax is more than twice the average. While much higher than average, Louisiana's franchise tax only makes up about one-tenth of the state\local taxes.

Louisiana differs from most states by including debt in its franchise tax base. Firms typically have a choice between issuing debt and selling stock to raise capital. While other states, in effect, provide a small incentive for using debt, Louisiana's tax does not favor either source of funds. Some have proposed eliminating debt from the base to aid family-owned or weaker firms for whom raising capital by selling stock is not a viable option. Table 11 shows that removing debt in combination with exempting state and local sales tax on MM&E would reduce the state/local tax burden of Louisiana firms. These changes would move the tax burden rankings for most of the hypothetical manufacturing firms down 3 to 6 positions, from the top tier of southern state tax payers to about the middle. Retail and wholesale firms would, of course, not be affected by the change in MM&E taxes but would benefit from the removal of debt from the franchise tax base.

Federal Corporate Income Tax Offset Federal taxes make-up roughly two-thirds of the total tax burden of most of the hypothetical firms in this study. Because most state and local taxes are deductible for federal tax purposes, federal taxes tend to offset much of the differences in state and local tax burdens. The higher the state/local taxes, the lower the federal taxes, and vice versa.

State/local tax burdens on the hypothetical average manufacturing firm, in the southern states, ranged widely with the lowest being about 45% of the highest. After federal taxes were figured in, the range in total tax burdens is substantially narrowed, with the lowest state total being about 82% of the highest.

The federal income tax rate at the margin is 34% on corporate income of $1 million--the income assumption for all of the hypothetical firms except the "no-profit" manufacturer. If the state increases a tax that is deductible for federal purposes by $1, the firm's net tax liability only rises 66 cents because its federal tax is reduced by 34 cents. However, if a nondeductible state tax (e.g. sales tax) is increased $1, the firm pays a full $1 in net additional tax.

The same principle applies to state tax decreases. The firm would keep the full $1 of a $1 decrease in a nondeductible state tax. But if a tax that is deductible for federal tax purposes (e.g. franchise tax) is decreased by $1, the firm only keeps 66 cents and the federal government takes the other 34 cents. This is shown in Table 11 where changing the franchise tax makes the total tax burden move closer to the southern average.

In its 1994 study, PAR calculated the total tax burden for the start-up and first ten years' operation of a capital intensive manufacturing firm. A southern state comparison was made by applying those incentives which were essentially automatic (such as Louisiana's industrial property tax exemption). The current study attempts to compare the impact of the major tax incentives, including the discretionary ones, that a desirable start-up firm would have a reasonable expectation of receiving.

Considering the wide range of local tax and incentive policies within each state, along with the numerous specialized incentives that might be applied, this comparison is at best illustrative. Selecting a hypothetical firm, location and tax rates involves numerous assumptions, a great deal of simplification and a few subjective or arbitrary decisions.

The balance sheet for the hypothetical "average manufacturing firm," used in the first part of this report, was assumed to be the 10th year of operation. The balance sheet was then adjusted backwards to determine the initial cost of building and equipping the plant--primarily to calculate start-up sales taxes (see Table 12). The cost of the land and inventory remains the market value for property tax purposes for the 10 years. Equipment and other personal property is depreciated and replacement purchases are begun in year six. The building cost is assumed to be the market value for the first five years and is halved for the last five years. (On average this reflects depreciation over 10 years of a 20-year useful life). Inflation is ignored.

The "average manufacturing firm" is assumed to have $10 million in assets at year ten, but begins closer to $12 million. The firm invests $5.6 million in plant and equipment and hires 100 new employees at an average salary of $35,000 per year. The firm size, while small, does not affect the relative application of incentives except in a few instances where states give special breaks for very large investments.

The firm is assumed to be locating in a typical suburban area, not the most developed area in the state, but one that is moderately developed. It would be in the next-to-best tier in those states that determine the level of incentive granted by using a 4- or 5-tier system to classify their counties by level of development. While a specific suburban area was used as the basis for selecting tax rates, adjustments were made in a few cases to assure that the rates were more "typical."

Using the balance sheets and assumed tax rates for each state, PAR calculated the the taxes for the "average manufacturing firm" for the ten years (see Table 13). The ten-year tax totals served as the starting point from which to apply the various states' tax incentives.

The Tax Incentives

The incentives selected for comparison were those generally available in the states. Specifically targeted tax credits, such as those for R&D, very specialized industries, pollution control, recycling equipment, and severely economically depressed areas, were excluded.

Incentives offered for less developed areas were included, however, if those areas encompassed a major portion of the state. For example, Arkansas designates the entire state an enterprise zone (EZ), Louisiana has some 1,700 EZs and economic development zones and Texas has designated roughly half of its counties as strategic investment areas. A number of states use a three- or four-tier system to assign counties, by their level of development, and vary the incentives accordingly. In these cases, PAR applied incentives the less than fully developed tier but not the lowest.

For three of the states, an incentive was applied which is not technically a tax incentive but a series of cash payments based on a percentage of the firm's payroll. (In some cases, the payments are referred to as a refund of the personal income tax withheld for the firm's employees.) This was necessary to provide a comparison with Louisiana's similar Quality Jobs incentive which is offered as an alternative to the state's two EZ incentives.

For purposes of comparison, the Louisiana firm's combined 10-year total state/local taxes were computed without the ten-year industrial tax exemption (TYTE), with the TYTE only, with the TYTE and the EZ incentives and with the TYTE and Quality Jobs.

For each of the 12 comparison states, except Virginia, either two or three major tax incentives are applicable and used to compute the hypothetical start-up firm's taxes. Virginia has very low taxes to begin with and only offers general tax incentives to firms making very large ($350 million) investments. The incentives used for the other states fall into several basic groups: property tax abatements, job tax credits, sales tax abatements, investment tax credits and payroll-based cash payments. However, the criteria, application and value of incentives in each group differ widely by state.

It should be noted that the incentives used for this comparison are those that apply to manufacturing firms. However, some may also apply to other businesses depending on the state and the incentive.

Table 14 shows how the incentives used in this study affect the taxes of the hypothetical firm in each of the southern states. Footnotes to the table provide a description of each of the incentives that were applied.

Property tax breaks are the most common and often the most valuable incentive offered. Ten of the states offer some form of abatement, refund or grant. Except in Louisiana, the incentive is discretionary and is often negotiated. As a result the incentive may only provide partial abatement and school taxes are typically excluded. Typically running 10 years, the abatements range from 4 to 20 years.

Job tax credits are offered in eight of the states, but Louisiana and Arkansas provide it only in EZs. The credit is usually against income and or franchise taxes and is calculated as an amount per new job created. The amount per job or maximum portion of the tax liability that may be used may vary depending on the firm's location, type of firm, wages paid or characteristics of workers hired. The flexibility of the incentive lends itself to wide variations and different targeting strategies.

Sales tax abatements or refunds are offered in five states and apply to initial start-up purchases. These typically apply to building materials for plant construction and manufacturing machinery and equipment purchases. Two of the five states also allow sales tax refunds or exemptions for a number of years after start-up. (See separate discussion of start-up taxes.) In most states, sales tax exemptions or exclusions for these types of purchases are part of the statutory tax base and are not discretionary.

Investment tax credits against the income tax are offered in four states: 5% of initial investment annually for 20 years (Alabama), 7% of M&E equally over 7 years (North Carolina) and 1% of M&E with a 15-year carry-forward (Tennessee). Texas has a new investment tax credit (effective 2002) which has also been included here. It provides 7.5% of MM&E spread over five years.

Income and sales tax refunds are made available to qualifying firms for the first four years of operation under Florida's unique Quality Industry Target Program.

Payroll-based cash payments are offered in four of the 12 states. These differ from normal tax incentives in that they do not involve an exemption or rebate of the firm's tax liability. They have been included here because they are major incentive programs in those states and are similar to job tax credits employed in other states. However, they are not limited by the firm's tax liability. Arkansas' Create Rebate program provides cash payments of 3.9% of payroll annually for 10 years. Louisiana's Quality Jobs incentive allows up to 5% of payroll annually for 10 years. The Oklahoma Quality Jobs Program pays the firm up to 5% of wages annually for 10 years. South Carolina's Job Development Credit refunds personal income tax withheld from employees in the amount of 2-5% of wages annually for 15 years with tier-based limits.

Table 14 and the summary Table 15 show the total 10-year state/local tax totals for the hypothetical "average" manufacturing firm for each state before and after the incentives are applied. The state/local tax totals, before incentives are applied, range from a high of over $2.3 million in Texas to a low of $1.3 million in Alabama. After applying the incentives selected for this comparison, Florida took the highest position with $1.6 million and, at the other end of the scale, the entire state/local tax liability was more than offset by incentives in four states. The cash payment programs in Arkansas, Oklahoma, Louisiana (with Quality Jobs) and South Carolina not only covered the state/local tax burdens but provided sizeable additional payments to boot--in effect, providing a negative tax.

Care must be exercised in using this comparison, however, for several reasons. Obviously, the packages of incentives offered can differ widely within each state depending on the site selected and how localities exercise their discretion. In addition, the incentives would have different impacts on different firms. For example, a much higher capital investment relative to payroll would reduce the impact of the cash payment programs. Furthermore, a firm might be eligible for a number of specialized tax credits for such things as pollution control equipment, hiring certain types of workers and R&D operations.

Also, in addition to these incentives, the states can provide a wide range of other non-tax incentives--such as loans, loan guarantees, and infrastructure improvements--that change the total incentive package.

A sales tax on the construction and equipping of a plant can be a substantial addition to a firm's initial investment. All 12 of the comparison states tax purchases of building materials, non-manufacturing equipment and other personal property. However, machinery and equipment used in the manufacturing process (MM&E) is the majority of a manufacturer's initial investment and eight of the states fully exempt it from sales taxes. A minor tax is levied in North Carolina and much reduced rates are used in Alabama and Mississippi.

Only Louisiana, fully taxes the initial purchases of MM&E but it does provide an exemption of the state sales tax on MM&E, building materials and other personal property for firms eligible for the enterprise zone incentives. Local taxing bodies may also, at their discretion, exempt the local sales taxes on these purchases, but they often choose not to do so. PAR assumed for this comparison that only one cent of the local 4.5% tax is exempt. The exemption is granted by contract and requires that new jobs be created. New or replacement MM&E purchased after the start-up would only be exempt if new jobs were created and a new contract signed.

Even with the 5% EZ exemption, the Louisiana start-up sales tax far exceeds that of any of the other 11 states. Four of the other states also abate much of their start-up taxes and this includes the two states which have a sizeable, yet reduced, tax on MM&E. If the Louisiana firm does not locate in an EZ or hire workers from an EZ and has to pay the full (in this case) 8.5% sales tax on the initial investment, its outlay would be three times that required in the next highest state. By contrast, the hypothetical firm would pay no start-up sales tax in Arkansas or Florida after incentives were applied.

Federal Tax Adjustments.

While the start-up sales tax can be a significant out-of-pocket cost to a firm at a time when it has no income, the payment is not a total loss. The tax paid becomes part of the cost of the item. As the firm depreciates the asset in the ensuing years, it writes off the tax as an expense thus lowering its federal tax--34 cents on each dollar in taxes paid earlier. For this reason, Table 14 includes an adjustment to the start-up taxes reflecting this savings to show the true net impact of the state and local taxes over time.

While the federal tax softens the impact of state/local taxes the firm pays, it also reduces the benefits of an incentive. As explained earlier in this report, a dollar decrease in state/local taxes on PAR's hypothetical firm results in a 34 cent increase in its federal tax liability. Thus, Table 14 includes an adjustment to show how the federal tax offsets one-third of the impact of any state/local tax incentives granted.

Louisiana ranks 3rd highest among the 12 southern states in state and local taxes for the first 10 years of operation of the hypothetical "average manufacturing firm," excluding any incentives and initial sales taxes on construction and equipment. (See Table 15.) Of course, the Louisiana firm would eligible, as a manufacturer, for the ten-year industrial tax exemption. If no other state were to offer any incentives, the TYTE alone would bring the Louisiana tax total down to 11th, just above Alabama.

However, when the start up sales tax liabilities are added to the tax total and the generally available incentives are applied to the other states, Louisiana's 10-year state/local tax burden ranking rises to 2nd highest. When the Louisiana firm is given the EZ jobs credit and sales tax rebate, its ranking falls to 6th--in the middle of the 12-state south.

The Louisiana firm may use either the EZ incentives or the Quality Jobs program, but not both. However, in either case, the TYTE continues to apply. In the hypothetical situation, the Quality Jobs incentive is by far the better deal. When it is applied, the Louisiana firm's tax burden ranking falls to 12th--the lowest in the south. The Quality Jobs payments would cover the firm's full 10-year start-up taxes but provide the largest additional payment as well.

In the specific situation created to compare basic tax incentives in the southern states, Louisiana's industrial property tax exemption, EZ job tax credit and EZ sales tax rebate offer the "average manufacturing firm" a barely average overall tax burden. However, Louisiana's Quality Jobs incentive can help provide the best tax package in the South.

Louisiana has some competitive incentives. The problem occurs when the temporary incentives run out, the firm's taxes rise to 2nd highest in the south. As described in Part I of this report, Louisiana's sales tax treatment of MM&E is the primary reason for the relatively high tax burden on industries that make heavy investments in machinery and equipment. The use of long-term debt in the franchise tax basis also contributes to higher taxes for the Louisiana firm.

Other types of manufacturing firm would have fared quite differently from the average manufacturer in a start-up comparison. A capital intensive firm, with more of its investment in machinery and equipment would have faced even higher taxes than the average firm, a labor intensive manufacturer, lower taxes. Non-manufacturing firms (wholesale and retail) starting up in Louisiana face a tax burdens about average for the South and these firms typically are not eligible for the range of incentives offered to manufacturers except in very poor areas of a state.

The start-up comparison illustrates the range of major tax incentive tools available to the southern states, however, these are only the beginning of the competitive arsenal. Most states also have a vast array of specialized and targeted tax incentives at their disposal. In addition, non-tax incentives--loans, loan guarantees, cash grants, infrastructure, training and other forms of assistance--can be an even larger part of the incentive package than the tax breaks.

The comparison of state tax structures as they apply to ongoing firms indicates once again the need for serious tax reform in Louisiana. While the inventory tax credit has apparently made some improvement, Louisiana's corporate tax burden on manufacturing firms remains relatively high among the southern states. To offset this tax structure, the state has adopted increasingly generous incentives in an effort to lure new firms.

MAJOR TAX POLICY IMPLICATIONS

Inventory Tax Credit

The 1994 PAR report warned against efforts by some to halt the phasing-in of the inventory tax credit. It indicated that the credit could reduce the total tax burden for labor-intensive manufacturers to about the southern average and bring wholesale and retail firms slightly below the average. Current comparisons indicate that those predictions were correct and show significant reductions in the relative tax burdens of each of the hypothetical firms examined, although some still remain high.

Sales Tax on MM&E

The sales tax on the initial and replacement purchase of MM&E continues to be out of line with the practice in other states. The elimination or reduction of this tax, or its impact, would accomplish several desirable objectives. It would significantly reduce the cost of start-ups and expansion or modernization, particularly for capital-intensive firms. An incentive offered at the point of investment is much more meaningful to a start-up firm, which typically begins operations in the "red." Also, this incentive would give the firm an immediate $1 benefit for each $1 in taxes foregone, whereas most later $1 tax breaks require the firm to pass on up to 34 cents to the federal government.

Corporation Franchise Tax

The state's franchise tax remains out of line with other states. The franchise tax could be lowered to about the southern average by cutting the tax rate in half or by removing debt from the tax base. Removing debt would benefit most firms but particularly start-ups, high-debt firms and firms which cannot easily raise capital by issuing stock.

Industrial Property Tax Exemption

The 10-year industrial tax exemption remains one of the more significant tax incentives in the south. It is unique in that its nearly automatic application makes it essentially a part of Louisiana's tax structure. Even with this exemption, Louisiana's start-up tax burden is easily equaled or undercut (substantially in some cases) by other southern states when they apply their generally available discretionary tax incentives.

Tax Reform

The need to revise the entire state and local tax structure to provide an equitable, productive and stable revenue stream to finance governmental operations remains of paramount importance.