California’s tax climate is the third-worst in the country, ahead of only New Jersey and New York, the Washington D.C.-based Tax Foundation reported October 31.
The nonpartisan group’s ranking – formerly known as the “Business Tax Climate Index” and revamped this year as the “State Tax Competitiveness Index” in recognition that it covers individual as well as business taxes – found that California “combines high tax rates with an uncompetitive tax structure, yielding one of the worst rankings on the Index.”
“The state has a great deal going for it, with its mild climate, excellent research universities, and the ongoing agglomeration effects of Silicon Valley, but a tax code that is uncompetitive and threatens to get worse is increasingly driving jobs to other states,” the report added. “The state’s top marginal individual income tax rate of 13.3 percent is compounded by a 1.1 percent newly uncapped payroll tax, bringing the all-in top rate to 14.4 percent. Additionally, nonresidents must file income taxes if they work even a single day in the state, and California is one of only four states to still impose an alternative minimum tax.”
The new report includes more interactive features that allow viewers to compare each state’s ranking in the five major areas of taxation: corporate taxes, personal income taxes, sales and excise taxes, property and wealth taxes, and unemployment insurance taxes.
“Business taxes affect business decisions, job creation and retention, plant location, competitiveness, the transparency of the tax system, and the long-term health of a state’s economy,” the report stated. “Most importantly, taxes diminish profits. If taxes take a larger portion of profits, that cost is passed along to either consumers (through higher prices), employees (through lower wages or fewer jobs), shareholders (through lower dividends or share value), or some combination of the above. Thus, a state with lower tax costs will be more attractive to business investment and more likely to experience economic growth.”
California received low marks on the competitiveness of its corporate, individual, and sales taxes.
“California is the only state to deny all net operating loss carryforwards; the state’s NOL provisions have been suspended on multiple occasions and are not currently in effect,” the report noted. “It is also the only state to use the outmoded ACRS depreciation system rather than MACRS, and does not allow any accelerated first-year expensing. California has a throwback rule, exposing in-state businesses to additional corporate tax liability for certain out-of-state income that would not be taxed elsewhere. The state is also dramatically out of conformity with the federal tax code, which adds to tax complexity, though it has certain benefits: the state does not, for instance, incorporate global intangible low-taxed income (GILTI), which does not belong in state tax codes but has been incorporated by some states.”
The report does not cite California’s recent law that retroactively changes rules regarding the apportionment of foreign income, amounting to a tax increase that is retroactive for approximately six decades. The law, which has been challenged in court as unconstitutional, is viewed by most California business taxpayers as a major blow to the state’s competitiveness. Along with raising taxes, it threatens the legitimacy of the appeals process by overturning correctly decided decisions of the independent Office of Tax Appeals.
The Tax Foundation found two bright spots in California: overall, California’s property tax system and unemployment insurance taxes were less punitive than those in many other states, ranking 23rd and 25th, respectively.
“Property taxes in California are constrained by Proposition 13 and subsequent enactments that cap growth in taxable assessed value,” the report noted. “This keeps property taxes lower than they would be otherwise – especially for long-time incumbent owners ….”
New York and New Jersey maintained their status as the only two states with tax climates worse than California’s, but they swapped positions. New York now has the least-competitive tax structure. Its high individual income tax rate, combined average sales tax rate of 8.53 percent, and split-roll property tax system contributing to its lowest-in-the-nation ranking, the report said.
The top five states in the report are Wyoming, South Dakota, Alaska, Florida, and Montana – states that do not impose a corporate, income, or state-level sales tax or have rates that are comparatively low.
While California maintained the same ranking it has held for many years, some states increased their competitiveness by improving their tax policies, the report noted.
“Indiana’s individual income tax rate decreased from 3.15 percent in 2023 to 3.05 percent in 2024 due to H.B. 1001, enacted in May 2023,” the Tax Foundation wrote. “The rate is scheduled to drop to 2.9 percent by 2027. Indiana also implemented a filing and withholding threshold to protect nonresidents who spend up to 30 days in the state and removed the transactions threshold from its definition of economic nexus, providing additional protection for small remote retailers. As a result, the state now ranks 10th overall on the Index, an improvement of two places, and improved from 20th to 16th on the individual income tax component.”
In Montana, income tax reforms reduced the top marginal rate to 5.9 percent and improved the state’s competitiveness dramatically. The report said, “Combined with high nonresident income tax filing and withholding thresholds and a well-structured income tax generally, these changes drove a dramatic improvement in the individual income tax component rank, from 22nd to 10th place.”
Taxes are not the only consideration for businesses and individuals but are a major consideration, the report noted.
“[A] well-structured tax code won’t make the Wyoming Basin a metropolis, nor will poor tax structure make Manhattan a ghost town,” the Tax Foundation wrote. “But tax structure does play a role in a state’s economic successes or failures, and often a substantial one. Every state can benefit from a simple, neutral, transparent, pro-growth tax structure.”