Greater Opportunity Through Innovative Change

"There is significant evidence that reductions in marginal state tax rates encourage state economic growth."

"Tax rates on productive behavior should be reduced."

Murphy Commission, 1998

Media reports that German automaker Daimler-Chrysler is considering three southern states (Georgia, Florida and North Carolina), not Arkansas, for a new manufacturing superproject underscore the weaknesses of the state's existing tax structure on capital investment.

The choice of the term "weakness" is not the Policy Foundation's. Fluor GLS, a South Carolina siting and consulting firm, retained by the Arkansas legislature to survey the state's ability to attract a manufacturing superproject compiled a "Tax Strength-Weakness Analysis" for legislators. The Fluor GLS study was undertaken at the behest of state Sen. Bill Gwatney, D-Jacksonville, after other states in the region, including Mississippi, successfully landed manufacturing superprojects.

The Murphy Commission, in 1998, published two studies on Arkansas' tax system that concluded rates were a factor affecting economic development. The studies, authored by Arkansas academics, are 'Taxes And Savings In Arkansas,' (Dr. S. Keith Berry) and 'Improving Productivity By Reducing Taxes' (Dr. Ronald John Hy and Dr. R. Lawson Veasey). They are posted online at the Policy Foundation's site (http://www.reformarkansas.org) under the Murphy Commission link.

The Fluor GLS study, and a related report ('Project Rosewood') documenting Alabama's successful campaign to attract Mercedes-Benz's first North American manufacturing superproject, are revealing in light of media reports that Daimler is considering Georgia, Florida and North Carolina.

Arkansas is not competitive with the three states in key areas of tax policy where Fluor GLS made recommendations to the legislature. The study also discussed Arkansas' ability to offer statutory and discretionary incentives, which are not analyzed in this APF memo.

The Fluor GLS study, which is more than 500 pages (including appendices), compares Arkansas' business tax rates to 12 other states in the region, and concludes they are an important factor that firms consider when making siting decisions for manufacturing super-projects. The Fluor authors observe, "A state's tax structure can be beneficial or detrimental to a company's long term profitability. Firms seeking to locate or expand a facility understand that taxes are a necessary burden that enables the government to provide services to all businesses and citizens of the community. Businesses realize that any location they choose will result in a tax burden for the company. Therefore, companies take into consideration the tax and assessment rates at which taxes are levied in areas being evaluated (emphasis added).

"The State of Arkansas," Fluor GLS' authors observe, "must understand this fact and take the necessary steps to minimize the state tax burden on companies interested in locating or expanding their operations in the state."

The Fluor GLS study makes the following recommendations to the Arkansas legislature:

* Reduce or eliminate the state sales tax on electricity, natural gas, and water. Fluor GLS determined that the State of Arkansas' sales tax on electricity, natural gas, and water are extremely high in comparison to the other states in the study region. Arkansas levies a sales tax of 5.125% on these utilities. Unfortunately, this directly negates the inherently low utility rates available in Arkansas in comparison to the other states in the region.

Natural Gas Used In Manufacturing--Florida and Kentucky levy the highest sales and use tax rate on natural gas used in the manufacturing process followed by Arkansas (third highest). Competitive advantage: North Carolina (lowest rate in survey) and Georgia (fifth highest rate).

Water Used In Manufacturing--Mississippi and Kentucky levy the highest sales and use tax rate on water used in the manufacturing process followed by Arkansas (third highest). Competitive advantage: Florida, Georgia and North Carolina, which all exempt the tax.

* Provide a Federal income tax deduction prior to calculating state corporate income tax liability. Fluor GLS determined that three states (Alabama, Missouri and Louisiana) offer companies the ability to deduct federal corporate income due prior to calculating state corporate income tax. Fluor GLS considers the fact that these three states allow a deduction of the percentage of federal corporate income tax very positive, since it can significantly impact a company's long term profitability. The other 10 states, including Arkansas, do not allow the deduction. Competitive advantage: None.

* Arkansas is one of only two states in the study region that does not allow accelerated depreciation on industrial equipment. A state with the ability to depreciate property faster than another competitive state can positively impact a company's long term profitability. Arkansas is one of only states in the survey that do not have a form of accelerated depreciation. Competitive advantage: Florida, Georgia and North Carolina, which allow accelerated depreciation.

* Reduce or eliminate the state sales tax on construction materials. State sales and use tax rates often differ from the general sales and use tax rate for materials used in the construction or expansion of a facility. The rate at which these materials are taxed plays a role in site selection decisions because these charges can significantly impact initial investment and recurring costs. Florida has the second highest rate. Arkansas is fifth highest. Competitive advantage: Georgia and North Carolina.

* Reduce or eliminate the state sales tax on industrial materials used and consumed in the manufacturing process. Arkansas, according to Fluor GLS, has a very high sales tax on materials that a manufacturer uses, consumes, or destroys during the manufacturing process. Mississippi and Florida levy the highest rate followed by Arkansas (third highest). Competitive advantage: Georgia and North Carolina.

* Reduce or eliminate the state sales tax on intrastate and interstate telephone and telegraph service. Fluor concluded Arkansas levies a high sales tax on both intrastate and interstate telephone services. Competitive advantage (intrastate and interstate): Georgia

* Arkansas has a high State Unemployment Insurance rate (SUI) for new employers. It may be offset by Act 1528, which allows a company to use their SUI experience rating from the state in which they previously operated. Fluor GLS discovered that Arkansas has the highest SUI tax liability of all states in the study region. Arkansas counters that with Act 1528 of 2001, which provides out-of-state employers the ability to use the Arkansas new employer rate of 3.3 percent, or the rate the firm held in the state in which they previously operated.