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Location Matters: A Comparative Analysis of State Tax Costs on Business

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From The Tax Foundation, August 25, 2015

State and local taxes represent a significant business cost for corporations operating in the United States and can have a material impact on net operating margins. Consequently, business location decisions for new manufacturing facilities, corporate headquarter relocations, and the like are often influenced by assessments of relative tax burdens across multiple states.

The Tax Foundation, in collaboration with KPMG, set out to develop and publish a landmark, apples-to-apples comparison of corporate tax costs in the 50 states. Tax Foundation economists designed seven model firms, and KPMG modeling experts calculated each firm’s tax bill in each state. Each firm was modeled twice in each state: once as a new firm eligible for tax incentives, and once as a mature firm not eligible for such incentives.

The Location Matters study, together with our annual State Business Tax Climate Index, provides the tools necessary to understand each state’s business tax system, the burdens it imposes, and a roadmap for improving it.

PDF: ⇓ Download Full Report

State Comparisons: HAWAII

Graph of Effective Tax Rates in Hawaii (see above)

Excepting heavily incentivized research and development (R&D) operations, mature firms generally experience above-average tax costs in Hawaii. The state sources service income to the site of the income-producing activity, exposing all service income from operations like call centers and distribution centers to in-state taxation.

Despite relatively modest corporate income tax rates and the state’s decision to forego a throwback or throwout rule, its sourcing rules drive up costs for both call centers and distribution centers. Distribution centers, however, benefit from very low property taxes, substantially lowering their overall tax burden.

A generous new tax credit for research activities boosted the mature R&D firms to fourth nationwide. The effective tax rate for new R&D firms actually fell into negative territory at -0.6 percent due to the refundability of the credit, which covers 20 percent of in-state R&D expenses.

More than in other states, Hawaii’s sales tax (called the General Excise Tax) applies to sales between businesses rather than just to the end consumer. As such, manufacturing machinery is taxed in Hawaii, so the cost of equipment and other inputs for manufacturing firms is significantly higher in Hawaii than in other states.

Hawaii imposes some of the highest tax costs in the nation on both new and mature labor-intensive manufacturing, with effective tax rates of 16.9 and 14.8 percent respectively, both over 60 percent above the median rates nationwide. The sales tax on manufacturing machinery is a significant factor, and Hawaii’s three-factor apportionment formula, which equally weights sales, assets, and payroll, works against firms with sales largely out of state. These operations also experience a high unemployment insurance tax burden.

Hawaii’s unique tax structure produces highly disparate tax burdens across firms, with effective tax rates ranging from 0.9 to 26.3 percent for mature operations and -0.6 percent to 32.7 percent for new operations. While few states achieve anything close to tax neutrality across firm types, Hawaii stands out as particularly lacking in this regard.

Table of Effective Tax Rates in Hawaii

Model Firm Type Ranking Mature Firm Rate New Firm Rate
Corporate Headquarters 33 14.60% 16.60%
R&D Headquarters 2 0.90% -0.60%
Retail Store 27 15.80% 23.00%
Capital-Intensive Manufacturing 34 12.80% 8.80%
Labor-Intensive Manufacturing 49 14.80% 16.90%
Call Center 44 26.30% 32.70%
Distribution Center 11 21.70% 25.00%
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