The Dirty Little Secret of Texas’ Big Business Success

In this post I cover Texas’ huge success rate at luring in big businesses with its relatively low state tax burden before I emphasize how the current tax scheme unfairly burdens the lowest income brackets in the state with far-reaching negative economic consequences even as businesses continue to relocate to Texas.

Luring Big Business: Texas’ Tax Advantage

Rick Perry’s renewed campaign to lure competing states’ businesses — from California to Illinois to New York — seems to be continuing Texas’ long history of winning business and creating more jobs for its residents. At the height of California’s disinvestment woes in 2011, a quarter of the companies that left Orange County ended up in the Lone Star State. Earlier this year, journalists began breaking what is possibly the biggest business relocation story of our times: Illinois-based State Farm Insurance was quietly purchasing about 2.5 million square feet of workspace in Dallas.  In the past two decades, nearly $2 billion net adjusted gross income left New York for Texas.

At the heart of Texas’ efforts to attract new jobs is a pretty impressive record that is proudly displayed on the Texas Wide Open for Business website — it’s pretty difficult to not feel proud to be a Texan if you watch Rick Perry’s latest ad (see the 30-second video down below) targeting new business and domestic immigration. Texas created 337,000 jobs in 2012 — more than any other state in the nation. This has helped draw in 1400 new Texans daily, contributing to the 2nd highest civilian workforce in the country. However, Texas' biggest lure for businesses, a low tax burden with no corporate income tax and no individual income tax, may have very serious downsides.

I’m a huge supporter of big business and I think, as most Texans do, that economic development should be the top political priority of our times. It’s great that Texas is consistently ranked as the best or one of the best states to do business and that it consistently breaks The Tax Foundation’s State Business Tax Climate Index top 10 list. Yet this same conservative research group’s report ranks Texas in the bottom 20 states when it comes to the corporate tax rank, sales tax rank, and property tax rank (basically everything other than unemployment insurance tax and individual income tax).

In fact, Texas’ tax structure has highly troubling implications that are not obvious at the surface-level.

Economics 101: Progressive Taxes vs. Regressive Taxes

Unless you’re an economics or business major, you could probably use a quick a review of the major tax structures (but feel free to skim this section to get to the real meat of this post). Every tax scheme out there is either progressive or regressive. Under a progressive system, there are graduated rates which increase the percentage of income paid in taxes as income increases — a regressive system does the exact opposite. The United States federal income tax rates for single Americans, for example, are progressive (they increase as taxable income increases):

• 10% on taxable income from $0 to $17,400, plus
• 15% on taxable income over $17,400 to $70,700, plus
• 25% on taxable income over $70,700 to $142,700, plus
• 28% on taxable income over $142,700 to $217,450, plus
• 33% on taxable income over $217,450 to $388,350, plus
• 35% on taxable income over $388,350.

Property and sales taxes, by their nature, tend to be regressive because everybody pays the same flat rate. That may seem counterintuitive — a flat rate sounds like a proportional tax, not a progressive or regressive one, right? The trick to understanding the nature of these taxes, which just so happen to be Texas’ sourcees of revenue, is to consider these taxes as a percentage of Texans’ income just as we consider the federal tax rate as a percent of taxable income.

For example, $3000 worth of electronics bought in Austin will be subject to an 8.25% sales tax rate whether they were bought by a John who earns $10,000 a year or a Jane who earns $100,000 a year. For either person, the sales taxes paid would total $247.50. Obviously, this example is unrealistic because you hope that John would not be spending that kind of money on electronics, but you can see that the sales taxes paid would make up 2.48% of John’s annual income while making up just 0.25% of Jane’s. Thus, John has a more difficult time carrying that burden because he’s effectively taxed at a 10 times higher rate than Jane is.

Since taxable purchases like food, clothing, and shelter make up a larger portion of low-income consumers’ budgets, sales and property taxes effectively take out a bigger portion of their income. Texas’ revenue is based on a regressive system which means that it asks its poor to sacrifice more.

Fundamentally Unfair: Poorest Texans Pay More 

Of course, deciding on one taxing scheme over another is a moral decision — as is any other decision where something may be taken from somebody to be given to somebody else. Progressive systems are more moral and more practical for government. Human nature makes it pretty easy for most people to come to this conclusion instinctively once they understand the concepts behind the John and Jane example mentioned above, but it’s also possible to point out that tax progressivity is consistent with recent results in optimal tax research or that government expenditures possibly empower the wealthy more than everybody else anyway.

Yet Texas relies on a regressive system: a 2013 report from the Institute on Taxation and Economic Policy (ITEP) confirmed that the middle 60 percent of Texans pay 8.80% of their income to state taxes while the top 1 percent of Texans ends up paying a mere 3.20%. Meanwhile, the lowest 20 percent of Texans pay a full 12.60% of their income to state taxes — that’s literally about 400% the effective rate for the top 1 percent of Texans. The terrible pattern behind these shocking numbers is easy to contrast with the federal income system mentioned above:

• 12.6% effective total state and local tax rate for Texans in the poorest 20 percent.
• 10.4% effective total state and local tax rate for Texans in the second 20 percent.
• 8.6% effective total state and local tax rate for Texans in the third 20 percent.
• 7.4% effective total state and local tax rate for Texans in the fourth 20 percent.
• 6.1% effective total state and local tax rate for Texans in the next 15 percent.
• 4.8% effective total state and local tax rate for Texans in the next 4 percent.
• 3.2% effective total state and local tax rate for Texans in the top 1 percent.

I praised Texas business to the extent that I did at the start of this post because I know that that is the context against which Texas’ unfair tax system has managed to thrive on the sacrifices of its lowest income residents while the state dedicates about $20 billion a year in tax breaks and other incentives to continue attracting businesses to Texas. Texas’ regressive taxing system is unrealistic and it forces the state to continue obliterating the education system, abandoning the needy on the curbsides, and forcing the elderly out of their nursing homes.

Even with serious budget cuts, Texas ends up having to maintain some of the highest property taxes and some of the highest sales taxes in the nation (which means supporting some of the lowest spending in the nation too). Under Article VIII, § 24(f)-(g) of the State Constitution, two-thirds of any revenue from an income tax would be used to reduce property taxes while the remainder would be dedicated to education spending. Of course, suggesting an income tax within the halls of the Capitol has been tantamount to political suicide, so a business franchise tax was passed instead in 2006 to help lower property taxes. Since then, the problem with this tax has literally been that it does not act more like an income tax: since businesses pay this tax on gross receipts, business owners can be forced to spend their personal assets in trying to carry the franchise tax burden during unprofitable years.

In other words, not only do working Texas citizens suffer from the currently broken taxing system, but so does their ability to establish and run successful small- and mid-sized businesses. Considering that Texas has the third-highest ratio of minimum wage hourly workers and the 11th highest poverty rate despite miraculous job growth, the careful observer cannot help but wonder if the efforts to lure big business have started to lean away from economic development toward corporate welfare — all for the sake of remaining a low-tax utopia for ultra-wealthy business people.