Recent studies show the good, the bad and the ugly of Oregon’s tax system

Two studies out last week paint far different pictures of Oregon’s tax system. The Council on State Taxation (COST) study ranks Oregon favorably for taxes on new capital investment, but the Small Business and Entrepreneurship Council says Oregon’s high income and capital gains taxes are a drain on equity investment and small business growth.  Although the studies may seem to conflict, they actually tell an important story about the good and bad elements of our tax system when it comes to business growth and job creation.

The Ernst and Young Study  for the Council on State Taxation (COST) ranks Oregon 2^nd best in the country for taxes on new capital investment (think manufacturing facilities, office and call center facilities, etc.). Oregon’s single-sales factor apportionment and tour lack of a sales tax on business inputs were the key factors contributing to the favorable ranking.

Oregon, in fact, gained a leg up on other states in terms of its attractiveness for manufacturing and other capital-intensive industries when it adopted single-sales factor apportionment earlier this decade. This is important, because these companies have a choice about where to locate. These companies sell their products globally, bringing in fresh dollars to buoy the local economy. Oregon is a heavily trade-dependent state.

The Small Business and Entrepreneurship Council, by contrast, released this week by the Small Business and Entrepreneurship Council, ranked Oregon 41 out of 50 for its business tax climate.  This study looked not at taxes on capital investment, but at taxes that affect small businesses. On two of the measures in this study-the top rate on personal income and capital gains taxes—Oregon ranks 50^th, with the highest rates in the nation. These taxes matter greatly to small businesses. Most small businesses pay personal, not corporate income taxes. And startup companies need seed capital and a base of successful entrepreneurs to learn from. The individuals and investors who provide this capital and expertise are highly sensitive to income and capital gains tax rates, and Oregon’s highest-in-the nation rates send these folks packing, or keep them away in the first place.

So, there are good and bad aspects of Oregon’s tax system. What should policymakers glean from this? First, they should pat themselves on the back for the enacting single-sales factor apportionment. Manufacturing jobs that could be located elsewhere are more likely to be in Oregon because of this attractive feature of our tax system.

But policymakers should be nervous about the affects of Oregon’s income and capital gains taxes on business startups and economic growth. A significant portion of job and income growth in the U.S. comes from small, rapidly growing companies. These are the companies most impacted by income and capital gains taxes. Oregon’s lopsided tax system acts as a wealth repellant and brain drain. We’re turning away the very people we need to fuel the growth of these companies.

The Oregon Business Plan and Governor Kitzhaber want to create 25, 000 new jobs per year and raise Oregon’s per capita income above the national average by 2020 (Oregon’s current per capita income is just 91% of the US average, compared to Washington State at 105%). In order to get there, we need a climate that fosters the growth of these startup companies.

The best approach would be to fundamentally reform our tax system by introducing a sales tax and reducing our income and capital gains tax rates. We recognize that isn’t likely to happen anytime soon.

So what can policymakers and Governor Kitzhaber do this legislative session to foster small business growth?

Bills are proposed in the legislature to reduce taxes on capital gains, and Governor Kitzhaber included a reduction in his budget. Reducing capital gains taxes will stimulate small business growth and help keep wealth, talent and investment here in Oregon.

To make up for any revenue impact of such a reduction, policymakers could modify Oregon’s personal and corporate income tax kicker and put a portion of it in an emergency reserve fund to be tapped during recessions. Significantly, the kicker doesn’t show up studies of Oregon’s business tax climate because it is unpredictable, and therefore doesn’t influence decisions about where to locate and expand companies. The kicker was established with a laudable policy goal-to manage the growth of government.   Over time, however, the kicker creates a severe drain on our state’s ability to save for the future and to provide critical services (Oregon kicked back $1.3 billion dollars to taxpayers in December 2007 and by January 2009 was talking about cutting school days and senior services to plug a budget hole. The state ultimately raised income and capital gains taxes on high-income earners from an already high 9% to a whopping 11%).

Senators Frank Morse and Ginny Burdick have proposed a series of measures to divert 50% of the personal kicker and the entire corporate kicker to a savings account, while requiring a general fund savings contribution and reducing capital gains rates. Doing would create a win/win/win for new businesses, high paying jobs and quality public services in Oregon.