Best and Worst States for Small Business

WASHINGTON (MainStreet) -- Which state is the most small-business friendly?

Factors such as taxes, regulatory costs, government spending, property rights, gas and diesel taxes, health care policies and energy costs play a large part in whether a business should locate in a certain state. The Small Business & Entrepreneurship Council takes these measures and ranks the 50 states and the District of Columbia annually based on their public policy climates for entrepreneurship.

"Low corporate and individual tax rates can make all the difference, especially for a small business that is just getting started," says Deborah Sweeney, CEO of MyCorporation, an online document preparation service for small businesses. "It may be difficult for a small business to get off the ground in the face of the difficult tax structures and the high cost of hiring employees."

The most recent Small Business Index Survival 2011, released in November, added six measures by which to rank states, making for a total of 44 major government-imposed or government-related costs factors that matter to small businesses and entrepreneurs.

While state tax policy and regulatory costs certainly weigh the most in the overall ranking of each state, given the country's economic climate the SBE Council decided to add state and local debt levels as well as the dependence on federal funding at the state and local level to provide a clearer picture of how friendly or unfriendly each state is for small business.

Another new measure included was state wireless taxes, something that will be particularly important given the amount of business now done online and through smartphones and tablets.

In a suggestion of another reason these factors matter: From 2000 to 2010 the top 25 states on the 2011 Index saw population growth of 13.4%, while in the bottom 26, population growth registered at just 6.3%, the report says.

States business climates are also getting a look from one of the biggest entrepreneurial advocates, The Ewing Marion Kauffman Foundation. Kauffman's 2012 State of Entrepreneurship Address focused on how state and local policymakers can foster start-ups.

"First, with gridlock in Washington, states and localities have more opportunities for reform and fewer institutional obstacles," Kauffman's interim president and CEO, Benno Schmidt, said in his address last week. "Second, our scholars' discussions with entrepreneurs turned up a finding that will be surprising to some: It's state and local laws and regulations that matter to them as much, or more, than federal statutes."

"The bottom line from our reports is simple: States should do all they can to make it easier to start a business," Schmidt said. "Regrettably, many states, in hopes of re-creating Silicon Valley, enact all manner of public programs to promote and help entrepreneurs, but leave in place a legal framework that adheres to a different model of employment."

High capital gains taxes will also chase away investment in certain states, and as we all know, access to capital is one of the biggest hurdles for small businesses, Keating adds.

Property taxes can also be a huge detriment to the formation of business.

"For example, Long Island, New York, already has sky-high property taxes and the emphasis is always on residential taxes, but businesses pay property taxes as well. From a business standpoint, when you look at that issue, it's two things: the bill you're paying as a business; and then also you have to deal with the reality that when it comes to what my employees are paying in taxes and how does that affect my labor pool? If you jack up taxes, you chase people away," says Raymond Keating, the SBE Council's chief economist.

There are other reasons that some states, even if they are tax unfriendly, find themselves with a significant level of entrepreneurism and enterprise, Sweeney says.

"These include states that have investors and scholastic opportunities for entrepreneurial training. California and other states in the Northwest, for example, have excellent schools that focus on training entrepreneurs and investors who are willing to invest in them even during difficult economic times," Sweeney says.

This year's list of the top five small-business-friendly states, as well as a list of the five most unfriendly states, didn't have many dramatic changes as compared with the 2010 Index, but clearly reflect the SBE Council's new measures:

Fifth-worst: Rhode Island

Top personal income tax rate: No. 28 at 5.99%
Top individual capital gains rate: No. 30 at 5.99%
Top corporate income tax rate: No. 43 (tie) at 9%
Top corporate capital gains rate: No. 9%
Gas tax: 33 cents
Wireless tax: 14.8 cents
Internet access tax: No

Rhode Island is a new addition to the list of five-worst states for small business, having knocked California off. Taking taxes and ancillary expenses into account, Rhode Island does not look appealing. High corporate income and corporate capital gains taxes, high property taxes, a state death tax, high gas and diesel taxes and high wireless taxes don't offset the lack of an AMT and a relatively low five-year increase in state and local spending.

The state also has higher-than-average state and local debt as compared with other states and a higher-than-average share of federal government funds as a share of total revenue.

Rhode Island's Gov. Lincoln Chafee talked about the need to confront the state's burgeoning municipal fiscal issues throughout his campaign in 2010. Since taking office he has "consistently stressed the need to help the state's cities and towns better serve Rhode Islanders," and that means small businesses too.

Fourth-worst: Vermont

Top personal income tax rate: No. 46 at 8.95%
Top individual capital gains rate: No. 47 at 8.95%
Top corporate income tax rate: No. 36 (tie) at 8.5%
Top corporate capital gains rate: No. 37 (tie) at 9%
Gas tax: 26.6 cents
Wireless tax: 8.6 cents
Internet access tax: No

Very high income and capital gains taxes plague Vermont's business climate.

The state also imposes a death tax, has high workers comp costs, a high level of state and local spending and a high five-year rate of increase in state and local government spending.

On a positive note, the state does have very low crime, a high state minimum wage and no individual or corporate AMT. Its share of federal funds as a share of its total revenue is slightly above average, while its state and local debt is below average.

Last year, Vermont Lt. Gov. Phil Scott implemented a "Vermont Everyday Jobs" initiative to promote Vermont small businesses as well as strengthen the relationship between the business community and state government.

The program seeks to "find out in a hands-on manner what it takes to make Vermont businesses work," so that the governor can "gain a better understanding of what state government can do to help those businesses work better."

This week Scott visited with the family-owned and run Smugglers' Notch Distillery in Jeffersonville, where he was taken through the bottling and packaging process, "starting by setting up the still for a gin run, washing and labeling the bottles, signing tax stamps, filling bottles, and packing up cartons," according to a release on Wednesday.

 

Third-worst: New Jersey

Top personal income tax rate: No. 47 (tie) at 8.97%
Top individual capital gains rate: No. 48 (tie) at 8.97%
Top corporate income tax rate: No. 43 (tie) at 9%
Top corporate capital gains rate: No. 44 (tie) at 9%
Gas tax: 14.5 cents
Wireless tax: 9 cents
Internet access tax: No

With high income and capital gains taxes and the second-highest property taxes (behind New Hampshire), New Jersey earns a reputation among the least small-business friendly states. But it does have low consumption-based taxes, no individual AMT and low gas and diesel taxes.

And maybe that's why the state is still popular with business. "Interestingly, in states like California and New Jersey, despite traditionally high tax rates that makes it difficult for entrepreneurs, there are a significant number of patents filed. The environment for inventions and ingenuity is ripe in those areas, which make them, despite their tax unfriendliness, often successful states from an entrepreneurial level," MyCorporation's Sweeney says.

No-nonsense New Jersey Gov. Chris Christie implemented an executive order in September to implement the "Red Tape Review Commission" in an effort to streamline regulations and reduce unnecessary burdens and costs associated with regulatory compliance for businesses and nonprofits in the state.

Last week the commission issued a progress report. While it had some success easing restrictions on mandatory independent audits for nonprofits and setting up Web-friendly business license applications and filing requirements for Urban Enterprise Zones, there is still a lot of work to be done.

One issue is improving New Jersey's "inconsistent bidding and procurement process," according to the Feb. 8 release by the Office of the Governor. "State departments often have different bidding rules, including specification for binding, margins and typesetting for hard copy bids."

Also on the agenda this year: "examining obsolete permits and outdated and confusing laws."

Second-worst: New York

Top personal income tax rate: No. 47 (tie) at 8.97%
Top individual capital gains rate: No. 48 (tie) at 8.97%
Top corporate income tax rate: No. 35 at 8.307%
Top corporate capital gains rate: 8.307%
Gas tax: 49.5 cents
Wireless tax: 18 cents
Internet access tax: No

With nearly 200,000 businesses in New York City alone, according to Crain's citing of the SBA and U.S. Census, one would think New York would have more business-friendly policies. But the Big Apple state finds itself ranked second-worst in the country.

Among the various categories states were ranked by, you name it and New York's is probably on the high list. One of the few saving graces of New York (besides the large resident and tourist population in the metro areas) is its low crime rate and relatively low unemployment taxes.

"New York, unfortunately, is a very good example of a state with poor small-business policies. Personal income, corporate income, capital gains, property taxes, gas taxes are all high. And high consumption-based taxes in New York ... it's also the second highest in government debt," SBE Council's Keating says.

Worst: District of Columbia

Top personal income tax rate: No. 44 at 8.5%
Top individual capital gains rate: No. 45 (tie) at 8.5%
Top corporate income tax rate: No. 50 at 9.975%
Top corporate capital gains rate: No. 50 at 9.975%
Gas tax: 23.5 cents
Wireless tax: 11.7 cents
Internet access tax: No

Our nation's capital is, once again, ranked as the worst state for small business.

It has some of the highest corporate income and corporate capital gains rates, high property taxes, even an added tax for S Corps. The District of Columbia also has the highest state and local debt in the country, a high five-year rate increase in state and local government spending and the highest crime rate in the country.

From the measures the SBE Council uses, the only positive looks like a lack of individual and corporate AMT.

Fifth-best: South Carolina

Top personal income tax rate: No. 38 (tie) at 7%
Top individual capital gains rate: No. 14 at 3.92%
Top corporate income tax rate:No. 9 (tie) at 5%
Top corporate capital gains rate: No. 11 (tie) at 5%
Gas tax: 16.8 cents
Wireless tax: 9.6 cents
Internet access tax: No

South Carolina has no death tax, no individual or corporate alternative minimum tax and low unemployment taxes. On the other hand, its personal income rate is fairly high compared with other states, workers compensation costs are high and the state has a very high crime rate, according to the report.

"South Carolina is one of those states that has some clear advantages in key areas," Keating says. "They also are one of the states that have a differential in place between personal and capital gains taxes" excluding part of capital gains from taxation.

The state joins the list this year. It replaced Washington state, which moved down the list to rank 15th best. Keating says the change in ranking results mainly from the data points added this year by the SBE Council.

South Carolina clearly benefited from lower-than-average government debt levels and a slightly lower-than-average share of federal government funding versus other states.

Fourth-best: Wyoming

Top personal income tax rate: 0%
Top individual capital gains rate: 0%
Top corporate income tax rate: 0%
Top corporate capital gains rate: 0%
Gas tax: 14 cents
Wireless tax: 8 cents
Internet access tax: No

Along with zero income taxes and capital gains taxes, Wyoming boasts no death tax, "very low" gas and diesel taxes, an excellent ranking on highway cost effectiveness and the lowest electric utility costs in the country, the report says.

But along with that comes high property, consumption-based and unemployment taxes and high workers comp expenses for businesses within the Yellowstone State.

Also, spending levels over a five-year period at the state and local level are the highest in the country, even though Wyoming has the second-lowest debt levels, according to the analysis. Federal funding is also above the national average.

Third-best: Texas

Top personal income tax rate: 0%
Top individual capital gains rate: 0%
Top corporate income tax rate: 0%
Top corporate capital gains rate: 0%
Gas tax: 20 cents
Wireless tax: 12.6 cents
Internet access tax: Yes

The business climate for big and small companies is strong in the state.

Like its cohorts in the top five, Texas demands no personal income, individual capital gains, corporate income, corporate capital gains or death taxes of residents and businesses. The Alamo State also has a low level of state and local government spending and low workers compensation costs.

The U.S. Department of Commerce ranked Texas the top exporting state in 2011 for the 10th year in a row. Roughly $250 billion in Texas-manufactured goods were exported to Mexico, Canada, China, Brazil and the Netherlands, among other countries. Its top exporting industries last year were petroleum and coal products, chemicals, computer and electronic products, nonelectrical machinery and transportation equipment, according to a release last week by Gov. Rick Perry's office.

On the other hand, it has high property and consumption-based taxes, a large number of health insurance mandates and a very high crime rate, the report says.

Second-best: Nevada

Top personal income tax rate: 0%
Top individual capital gains rate: 0%
Top corporate income tax rate: 0%
Top corporate capital gains rate: 0%
Gas tax: 33.1 cents
Wireless tax: 2.1 cents
Internet access tax: No

Nevada also can boast little to no personal or corporate taxes, but the state does have very high consumption-based taxes. Only four other states -- Hawaii, Washington, Wyoming and Louisiana -- beat Wyoming in state and local sales, gross receipts and excise taxes as a share of personal income, according to the report. It also has high unemployment taxes and a high state minimum wage.

Additionally, while its state-level and local debt ranks slightly above average, its share of federal government funds is below average.

Best: South Dakota

Top personal income tax rate: 0%
Top individual capital gains rate: 0%
Top corporate income tax rate: 0%
Top corporate capital gains rate: 0%
Gas tax: 24 cents
Wireless tax: 12.2 cents
Internet access tax: Yes

South Dakota was able to remain in the top spot of the small-business-friendly states not only because it has no personal and corporate tax rates, but because it has the lowest crime rate in the nation and a low number of health insurance mandates. State and local government spending as well as debt remain low (even though it got higher-than-average federal funds), the report says.

"The bottom line is at the top of the list they do not impose any income taxes whatsoever," but what makes the state rank top of the list of friendly states is that it is able to keep other taxes under control, Keating says.

Washington state "is an example where they don't have any income taxes, but they do have high consumption-based taxes. Nevada is also like that, but has a whole bunch of gaming revenue and also has high consumption taxes. Property taxes are on the high side in Texas," Keating says. "South Dakota, even though they have no income tax, its other taxes in these areas aren't so bad."

The state is also able to keep government spending under control and the size of its state government in check, "so the other taxes don't go crazy," he says.

Show Comments

Back to Top