Taxes and the Economy of

Taxes and the Economy of Taxes and the Economy Prepared by Dr. Michael R. Pakko Chief Economist and State Economic Forecaster (501) 569-8541 • m...
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Taxes and the Economy of

Taxes

and the

Economy

Prepared by

Dr. Michael R. Pakko Chief Economist and State Economic Forecaster (501) 569-8541 • [email protected]

Institute for Economic Advancement University of Arkansas at Little Rock 2801 South University Avenue Little Rock, AR 72204-1099 (501) 569-8519 • www.iea.ualr.edu

July 2011 IEA Publication Number 11-02

of

Contents

Taxes and Economy of Texarkana, AR-TX

1



Taxes and Firm Location

2



Demographic and Economic Characteristics of Texarkana

2



Tax Foundation Rankings

5



Personal Income Taxes

5



Property Taxes

6



Sales Taxes

7



Business Income Taxes

9

Arkansas Corporate Income Tax 9

Texas Margins Tax 9

Comparing Arkansas and Texas Business Taxes 11

Marginal Tax Rates and Incentive Effects 14

Apportionment Issues 15

Tax-Abatement Incentive Programs

15



Summary and Conclusions

17

References:

19



20

APPENDIX: Additional Tables and Figures

Table A: Annual Average Sales, Income & Expenses of Corporations 20

Figure A: Arkansas Corporate Income Tax Form 22

Bowie County, TX

Miller County, AR

Arkansas

City of Texarkana

Texas

Texarkana, AR Miller County, AR Texarkana, TX Bowie County, TX

Taxes

and the

Economy

M

of

As described in this report, significant differences remain. In particular:

any metropolitan areas include areas on both sides of a state line. Few, however, are as intimately linked as the cities of Texarkana, Arkansas and Texarkana, Texas. Besides sharing a name, the two cities also share a main road, State Line Avenue, which leads to a downtown Federal Building that literally straddles the state line. With no significant natural or geographic boundaries, the Texarkana metropolitan area, with its two co-principal cities, is a unique dual-state entity.

• The structure of Arkansas’ Texarkana income tax exemption has affected the pattern of business and residential growth on the Arkansas side of the state line. • Property taxes are lower in Arkansas, providing incentives for households and firms to locate on the Arkansas side.

The state line that divides Texarkana, AR from Texarkana, TX may be invisible, but its impact is certainly perceptible when it comes to the potential for economic development. Texas and Arkansas have differing tax structures, and both economic theory and empirical evidence suggest that tax considerations are influential factors in the location decisions of households and businesses. This study documents some of the differing characteristics of economic activity on the Texas and Arkansas sides of the Texarkana metro area, and suggests some features of the tax structure of the two locations that might contribute to these characteristics.1

• Sales taxes are lower on the Texas side, encouraging retail activity on the Texas side of the line. • The introduction of the Texas Margins Tax has increased the tax burden on some Texas businesses. It generally provides a lower business-tax environment than the Arkansas Corporate Income Tax. However, for some particular types of businesses, there may be tax advantages to locating in Arkansas. It has not existed long enough to have had any substantial influence on business and economic development, and is unlikely to have a substantive impact in the near future—at least in its current form. Prospective changes to the Texas Margins Tax, however, might affect the relative competitiveness of business taxes on the two sides of the state line.

Residents of Texarkana are no strangers to the impact of these divergent state laws on the development of the local economy. In the past, differences between the usury laws in Texas and those in Arkansas have been blamed for driving many financial activities (including auto dealerships) to the Texas side of the border.2 On the other hand, residents of Texarkana, Arkansas have been exempt from Arkansas state personal income taxes since 1979, as a way of compensating for the fact that Texas has no state income taxes.

• Enterprise Zone programs in the two states have different emphases and priorities. Texas’ program favors large capital projects in impoverished areas, while Arkansas’ supports expansion of existing concentrations in manufacturing and transportation.

1

This study makes no attempt to evaluate or measure causality between the tax structure and economic characteristics of Texarkana. Rather, it serves as a case study positing specific examples of economic effects that have been hypothesized and tested more generally in the academic literature.

2

Greene (2002).

Taxes and the Economy of Texarkana

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Overall, the evidence suggests that for many businesses, the tax structures of Texarkana, Arkansas and Texarkana, Texas tend to favor business location on the Texas side of the border. However, with a personal income tax exemption and lower property taxes, the Arkansas side of the border appears to be more competitive as a residential location option.

statistically significant relationships between tax differentials and business locations.4 In general, the magnitudes of the effects are small – especially for interregional location decisions. Access to markets and raw materials, labor force availability, and other intrinsic factors tend to be far more important. But the consensus of the literature is that differences in tax structure are more important when it comes to intra-regional location decisions of firms.5 This makes Texarkana a likely location for observing such effects.

Taxes and Firm Location In theory, taxes can be an important factor in the location decisions of both households and firms. For households, the location decision is presumed to include the mix of taxes and government services, along with other intrinsic amenities. But for business, taxes are considered to be particularly important because they introduce price distortions that can erode profit margins—the ultimate objective for the firm.3

Demographic and Economic Characteristics of Texarkana Table 1 displays some selected demographic and economic characteristics of the Texarkana, TX-AR metropolitan statistical area, which includes Bowie County in Texas and Miller County in Arkansas. In many respects, it is a very homogenous community. Differences among the two cities and counties in terms of income, education, employment, etc., are small, and generally are statistically insignificant.6

The evidence of the influence of taxes on business location decisions has been mixed. Early studies found little evidence of an effect, but as more data have become available and statistical methods have improved, a growing body of literature found

 TABLE 1: Selected Demographic and Economic Characteristics

Arkansas

Miller County Total Population Median Age (years)

Texas

Texarkana City Bowie County Texarkana City

42,908 29,988 91,617 35,261 37.9 37.5 36.2 34.0

Percent High School Graduate Or Higher

80.4%

81.2%

82.9%

83.3%

Percent Bachelor’s Degree Or Higher

13.9%

17.1%

17.3%

21.5%

Total Housing Units

19,084

13,337

38,443

15,678

Home Value, Median (dollars)

83,300

84,700

84,500

88,800

Occupied Housing Units Owner-Occupied Renter-Occupied

16,249 11,431 33,521 13,525 10,591 6,614 21,439 6,787 5,658 4,817 12,082 6,738

Selected Monthly Owners Costs With A Mortgage - Median (dollars) 881 941 1,027 1,063 Without A Mortgage - Median (dollars) 287 294 349 378 Median Rent (dollars)

590

593

622

637

Median Household Income (dollars)

39,741

40,360

41,364

37,751

Mean Household Income (dollars)

50,850

51,308

56,956

56,562

Per Capita Income (dollars)

19,810

20,100

22,108

23,116

Source: U.S. Census Bureau, American Community Survey, 2006-2008 3

Papke and Papke (1986) point out “tax differentials, as in all other cost differentials, are important for location only to the extent they affect the “bottom line” (i.e. profits); and, consequently, the appropriate measure for meaningful comparisons of tax burdens is the net after tax rate of return on a marginal investment in alternative locations.”

4

Comprehensive literature reviews include Wasylenko (1997) and Ladd (1998).

5

Wasylenko (1997) summarized the literature as follows: “Intra-regional studies produce tax elasticities that are quadruple or more those found in the interregional studies. With other cost and market variables very similar among different locations within a region, fiscal differences within the region play a more significant role in location choice.”

6

That is, the Census Bureau reports margins of error (not reported here) that are, in many cases, larger than the differences shown in Table 1.

Taxes and the Economy of Texarkana

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Figure 2 documents a feature of this populationgrowth surge: the distribution of housing stock vintages on the two sides of the border. A higher proportion of the houses in Arkansas were built in the 1990s and the early-2000s as compared to the distribution of Texas housing stock vintages. This is consistent with the population growth trends shown in Figure 1.

Employment growth rates over the past decade have followed a remarkably divergent pattern on the two sides of the border. Figure 3 displays two measures of employment for Miller County and Bowie County: The Local Area Unemployment Survey (LAUS) measures the number of residents in each county that are employed, while the Quarterly Census of Wages and Employment (QCEW) measures the number of employees by location of employment. Figure 3 shows a widening gap for Miller County, with the number of people employed in the county falling over time, and the number of people living in the county and working elsewhere (presumably, Texas) steadily growing over time. In contrast, the Bowie County data show a widening gap of employment growth in excess of labor force growth during most of the last decade (although it is clear that Bowie County employment has suffered larger losses during the recent recession).

 FIGURE 1: Population Growth Estimates

 FIGURE 2: Housing Stock Vintages

The populations of the two cities are similar, with Texarkana, Texas just having about 35 thousand residents and Texarkana, Arkansas having about 30 thousand. However, Bowie County, Texas has a total population more than twice that of Miller County, Arkansas. As shown in Figure 1, population growth in Bowie County was higher than in Miller County for most of the 1980s and 1990s, but Miller County population growth has been trending upward for two decades, and surged ahead during much of the most recent decade.

Three-Year Moving Averages

2.5%

Annual Rates of Growth

2.0%

Miller County, AR

20%

Bowie County, TX

Texarkana, AR

Texarkana, TX

16%

1.5%

12%

Percent



1.0% 0.5%

8% 4%

0.0%

-0.5%

0%

-1.0% 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008

2005 or 2000 to 1990 to 1980 to 1970 to 1960 to 1950 to 1940 to 1939 or later 2004 1999 1989 1979 1969 1959 1949 earlier

Year Built

Source: U.S. Census Bureau

Source: U.S. Census Bureau, American Community Survey, 2006-2008

 FIGURE 3: Employment Patterns 22000

Miller County, AR Employment QCEW (Establishment)

45000

LAUS (Household)

Bowie County, TX Employment QCEW (Establishment)

LAUS (Household)

19000

43000

16000

41000

13000

39000

10000 2001 2002 2003 2004 2005 2006 2007 2008 2009

37000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: U.S. Bureau of Labor Statistics

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Figure 4 shows that there are distinct differences in the types of employment on the two sides of the border.7 Employment in Miller County is more highly concentrated in the goods-producing sectors. In particular, employment in manufacturing constitutes an employment-share well above the national average. Employment on both sides of the metro area is more highly concentrated in the broad category of Trade, and Utilities, than the national average. Bowie County is more highly concentrated in service-sector employment, particularly Education and Health Services.

On the Texas side, 18 employers in the database report more than 200 employees. The three largest are in Health Services, indicating the presence of a “cluster” in that sector. Fourth place on the list is a Walmart Supercenter – the only individual retail establishment to make the list.8 The remaining employers listed feature firms in Manufacturing, Government Services, and Transportation and Warehousing.

 TABLE 2: Largest Employers in Texarkana, AR and Texarkana, TX

Within the category of Trade, Transportation, and Utilities, Figure 4 includes location quotient calculations for Retail Trade. Miller County has a slightly below-average concentration in this sector, while Bowie County employs a larger share of its labor force in this sector than the national average. Both counties are very highly concentrated in Transportation and Warehousing. Location quotients for this sector (not shown in Figure 4) are 3.67 in Miller County and 1.74 in Bowie County.

(> 200 employees)

Number of Employees

Texarkana, AR Cooper Tire & Rubber Co. Smith Blair Inc

2000 300

Southern Refrigerated Transport 205 Texarkana, TX

Table 2 shows the largest employers on the two sides of the state line (as listed in a database from ReferenceUSA), illuminating some of the specific reasons for the sector-concentrations in Figure 4. The largest employer by far in Texarkana, Arkansas is Cooper Tire. Only two other individual firms listed in the database report employing more than 200 people; One is a manufacturer and the other is in the Transportation and Warehousing sector.

Christus St Michael Health

1800

Wadley Health System

1050

Collom & Carney Clinic Assn

500

Walmart Super Center

480

Log Jams

450

Bi-State Justice Building

425

Texarkana College

425

TAC Energy

400

Alcoa Mill Products

365

Day & Zimmerman Inc

312

Ledwell & Son Enterprises Inc

310

Life Net EMS

301

Federal Correctional Institute

300

Lone Star Div

300

Bowie County Correctional Center

297

US Post Office

262

Defense Fin & Acct Svc

250

*Retail Trade is a component of the broader “super-sector” of Trade, Transportation, and Utilities.

J&M Poultry

250

Source: U.S. Bureau of Labor Statistics

Source: ReferenceUSA

 FIGURE 4: Location Quotients

(Industry concentrations relative to U.S. averages, 2008)

Natural Resources & Mining Construction Manufacturing Trade, Transportation, & Utilities Retail Trade* Information Financial Activities Professional & Business Services Education & Health Services Leisure & Hospitality Other Services

Miller County, AR Bowie County, TX

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0

7

The Location Quotients (LQs) in Figure 4 represent the share of employment for various sectors compared to the average employment share in the U.S. A number equal to one implies that the employment share in that sector is equal to the national average. Numbers greater than one indicate a higher concentration of employment in that sector than the national average (and vice versa).

8

There is also a Walmart supercenter on the Arkansas side of the border. However, ReferenceUSA lists it as having fewer than 200 employees in 2010.

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Tax Foundation Rankings

Personal Income Taxes

As a point of departure for looking at differences in the two states’ tax structures, consider the State Business Tax Climate rankings from the Tax Foundation, displayed in Table 3. This index is constructed to compare the business-friendliness of states based solely on their tax structures. Lower rates matter, but the Tax Foundation rankings also consider other factors such as ease-of-compliance and economic efficiency.

To some extent, the state income tax exemption for Texarkana helps to level the playing field when it comes to tax differentials between the Texas and Arkansas sides of the border. However, the exemption itself imparts economic incentives that may have led to unintended consequences for development in the region. In particular, the exemption for residents of Arkansas applies only to those who live within the Texarkana city limits. As a result, there is a distinct disadvantage to establishing a residence in Miller County outside the city limits. The pattern of population dispersion in Miller County is consistent with this factor playing a role. Note that in Table 1, the population of Miller County is concentrated in the city of Texarkana, with approximately 70% of the county’s population residing in the city. In contrast, the population of Texarkana, TX accounts for only 38% of the population of Bowie County.

The overall rankings show that Texas ranked 13th highest and Arkansas ranked 12th lowest for FY2011. Both states ranked below the median in two important categories: corporate taxes and sales taxes. Both states ranked above the median for unemployment insurance taxes. There are some interesting differences in the categories of property taxes (where Arkansas has the advantage) and individual income taxes (where Texas has the advantage). In fact, Texas’ ranking is boosted considerably by its high score for having no individual income tax. Because of the Texarkana exemption in Arkansas law, this factor might seem to be rendered moot—at least for residents of the city of Texarkana, AR. Nevertheless, the limited nature of the Texarkana exemption provides economic incentives that are likely to have affected the pattern of economic development in the area.

The personal income tax exemption also skews incentives for business location decisions. The personal income tax code tends to favor business locations within the city because of the Arkansas income tax exemption that applies to residents of Texarkana, Texas. Texas residents who either work in the city of Texarkana, AR or who reside in the city of Texarkana, TX are exempt from Arkansas personal income taxes. The choice to locate a business outside the city limits in Arkansas therefore has the effect of restricting the available tax-exempt labor pool from which to draw employees. All else being equal, this should be expected to raise the wages and salaries required to attract workers to firms outside the city limits.

Personal income taxes, property taxes, sales taxes, and business income taxes each have local components, requiring a more detailed analysis of specific conditions in Texarkana.9 These categories of taxes will be examined in the following sections.

 TABLE 3: Components of the State Business Tax Climate Index for Arkansas and Texas Individual Unemployment Overall Corporate Tax Income Tax Sales Tax Insurance Tax Property Tax

Score Rank Score Rank Score Rank Score Rank Score Rank Score Rank

FY2011 39 4.59 40 4.85 33 3.39 41 5.25 18 5.34 21 Arkansas 4.55 Texas 5.63

13 4.19

46 8.59

7 3.73

37 5.44

9 4.96

29



FY2007 36 4.56 36 4.76 33 3.67 39 4.49 35 5.95 11 Arkansas 4.72 Texas 5.99

10 5.35

17 9.44

7 4.17

30 6.09

6 4.49

36

Source: U.S. Census Bureau, American Community Survey, 2006-2008

9

The unemployment insurance tax structures for Arkansas and Texas are similar, with slightly higher rates in Arkansas accounting for the narrow differences in the two states’ scores and rankings. These are purely state programs, with no specific local context. Moreover, there is little evidence in the academic literature on the effects of differences in states’ unemployment insurance programs. A more detailed analysis of the topic is therefore beyond the scope of this study.

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The pattern of business locations in Miller County is consistent with these incentive effects: The database of business for Miller County from ReferenceUSA lists a total of 1674 businesses in Miller County, with 1,521 (over 90%) located within the Texarkana city limits. In contrast 3,512 of the 4,600 businesses in Bowie County (about 76%) are located in the city of Texarkana, TX.

population growth on the Arkansas side of the border that is disproportionate with job growth. Moreover, the surge in residential construction in the 1990s and early part of the 2000s suggests that the national building boom during that period was more evident on the Arkansas side of the border than on the Texas side. One finding in the academic literature is that property taxes can be particularly important for business location decisions when property is taxed at a higher rate for commercial purposes than for residential use. This is not the case for either Arkansas or Texas, so differences that do exist in property tax rates across the border are unlikely to matter as much for location choice than they do in other states.

Property Taxes Property taxes are important for both households and businesses. For households, taxes on residential property can constitute a large share of a family’s overall tax burden.10 Additionally, localities and states often levy taxes on the personal property or equipment owned by a business.11

 TABLE 4: Tax on Property with Assessed Value of $100,000

According to the Tax Foundation analysis, property taxes accounted for 37% of total taxes remitted by businesses in 2006. Since property taxes can be a large burden to business, they can have a significant effect on location decisions, a conclusion that is supported by academic research on the topic.

Texarkana, Texas Taxable Value = Assessed Value: $100,000 Tax Rate Tax (Percent) = Tax Rate * Value / 100 Bowie County 0.32700 Texarkana ISD 1.33900 Texarkana 0.58310 Texarkana College 0.09679 Total 2.34589

The Tax Foundation rankings use weighted averages of local property taxes, finding that on average, property tax collections per capita are $520 in Arkansas and $1,393 in Texas. As a percent of income, the figures are 1.86% for Arkansas and 3.59% for Texas. One factor that lowers Texas’ score is the fact that property taxes are assessed against intangible property and inventories. Arkansas also imposes taxes on inventories and its score is lowered by the presence of a real estate transfer tax and a 0.3% tax on firms’ capital stocks.

327.00 1,339.00 583.10 96.79 2,345.89 2.35%

Texarkana, Arkansas Taxable Value = 20% of Assessed Value: $20,000 Tax Mileage = Millage * Taxable Value / 1000

Table 4 compares property tax rates specifically for the two sides of Texarkana. Direct comparison is complicated by the fact that Texas property taxes are imposed directly on assessed value, whereas the Arkansas property tax rates are applied to 20% of assessed value. Table 4 shows the hypothetical tax bills for a property valued at $100,000. In total, the tax rate on the Texas side of the border is 2.35% compared to 1.10% on the Arkansas side. That is, property taxes in Texarkana, Texas are more than twice as high as property taxes in Texarkana, Arkansas.

General Fund 5 Debt Service Fund 2.5 Firemen’s Pension 1 Policemen’s Pension 1 Library 1 Miller County School District 38.9 County 5.5 Total 54.9

778.00 110.00 1,098.00 1.10%

Nevertheless, the tax rates shown in Table 4 represent a clear tax advantage for Arkansas, and it is likely a factor in the pattern of residential development in Texarkana. As observed earlier, there is an increasing trend of

Difference TX-AR

1,247.89 1.25%

100.00 50.00 20.00 20.00 20.00



Source: Assessors’ Offices of Miller County, Arkansas and Bowie County, Texas.

10 Census Bureau statistics for 2008 show that property taxes account for more than 30% of all tax revenue for state and local governments in the U.S. 11 Mark, McGuire and Papke (2000) estimated that a tax hike on personal property of one percentage point reduces annual employment growth by 2.4 percentage points. Bartik (1985) estimated that a 10% increase in a state’s average business property tax rate results in a 1-2% decline in the number of new plants. In a follow-up examining the location decision for small business start-ups, Bartik (1989), found that property taxes, in particular, have a strong negative effect. Bartik speculates that property taxes are particularly important for small business formation because they are owed regardless of the profitability of a business.

Taxes and the Economy of Texarkana

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Institute for Economic Advancement

When it comes to very small differences in sales tax rates, time and transportation costs are often substantial enough to offset incentives to travel to the low-tax jurisdiction for shopping. The differences between tax rates on the two sides of the border in Texarkana, however, are significant. The tax rate in Texarkana, Arkansas is 17.6% higher than the tax rate in Texarkana, Texas. This is large enough to give some advantage to Texas as a preferred location for retail business.

Sales Taxes Although sales taxes are ostensibly paid by the customer, the burden of the tax is shared between the buyer and the seller. In a situation where shopping alternatives are literally across the street from one another, economic theory suggests that demand is likely to be very elastic (price sensitive), raising the share of the tax burden borne by the seller. Sales tax differences should matter for the location of retail firms within a region, and evidence suggests that it does indeed matter.12

One reason that sales taxes matter for general business location decisions is the fact that sales taxes often apply to a firm’s purchases of equipment and materials.13 The Tax Foundation report on Business Tax Climate tracks the taxable/exempt status of 21 different categories of business spending. For most of these categories, the sales tax treatment under Arkansas law and Texas law are the same. Business expenditures that are taxable in both states include office equipment cleaning services, repair services, and custom software. Categories that are taxable in Arkansas and exempt in Texas include manufacturing machinery, utilities, and motor vehicle leasing. Categories that are exempt in Arkansas but taxable in Texas include downloaded software and professional and personal services.

Table 5 compares the sales tax rates on the two sides of the State Line Avenue in Texarkana. At 6.0%, the state sales tax in Arkansas is lower than the 6.5% rate in Texas. However, local option sales tax rates are higher on the Arkansas side of the state line. Texarkana, Arkansas also faces a special 1% sales tax that goes to the state to compensate for the lack of personal income tax revenue. Miller County collects 1.5% and the city of Texarkana, Arkansas adds on another 1.5%, for a total sales tax rate of 10%. In Texas, Bowie County sales taxes are only 0.5%, with an additional 1.5% added on by the city of Texarkana, Texas. As a result of these lower local tax rates, the total sales tax rate on the Texas side is 8.5%.

The two states also differ with regard to some business-to-consumer transactions that are taxable or exempt. For example, groceries are exempt from sales taxes in Texas, but are taxed at a reduced rate of 1½% in Arkansas.14 Auto rentals are subject to sales taxes in Arkansas, but not in Texas. Both states, however, collect special excise taxes on motor vehicle rentals.

 TABLE 5: Sales and Use Taxes in Texarkana Arkansas Texas Arkansas

6.00% Texas

6.25%

Miller County

1.50% Bowie County

0.50%

Texarkana City

1.50% Texarkana City

1.50%

Special State Tax*

1.00%

Total Tax

10.00% Total Tax

In fact, motor vehicle rental taxes are one category among many special excise and sales taxes that Arkansas and Texas (along with many other states) impose in addition to sales and use taxes. Some selected examples of these special taxes are compared in Table 6.

8.25%

*An extra sales and use tax of 1% is collected by the state in lieu of personal income tax. Source: The Sales Tax Clearinghouse

 TABLE 6: Selected Excise Taxes and Other Sales Taxes Motor Vehicle Leasing Gasoline Tax Diesel Tax Cigarette Tax Restaurant Hotel ST (30 days) (cents/gallon) (cents/gallon) (cents/pack) Arkansas 2%* 2%+3%* 10% 1.50% 21.8 22.8 115.0 Texas -- 6%+7%* 10% 6.25% 20.0 20.0 141.0 Mixed Beverage Distilled Spirits High Wine Low Wine Beer Ale & Malt Liquor (sales tax) (cents/gallon) (cents/gallon) (cents/gallon) (cents/gallon) (cents/gallon) Arkansas 14% 258.0 77.2 27.2 23.4 22.0 Texas 14% 240.0 40.8 20.4 38.1 39.0 Source: U.S. Census Bureau, American Community Survey, 2006-2008 12 For example, Mark, McGuire and Papke (2000) find that higher sales taxes are associated with a significant reduction in employment growth. 13 In his study of the location decisions of small businesses, Bartik (1989) found that the sales tax had the largest impact among all taxes considered, particularly when the sales tax applied to the purchase of business equipment. 14 The grocery tax was reduced from 2% to 1½% as July 1, 2011.

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Short-term motor vehicle rental taxes are one of several special sales taxes that impact visitors to the area. In both states, the tax rate on rentals less than 30 days is 10%. In Arkansas, auto rentals are also subject to sales taxes. For rental contracts longer than 30 days, the rate is equal to the state sales tax in Texas. In Arkansas it is equal to the state sales tax plus 1.5%. Hotel taxes are another example of taxes on visitors: On both sides of the border, hotel rooms are subject to both state and local hotel occupancy taxes. In Texarkana, Texas the occupancy tax is 6% state and 7% local, for a total of 13%. In Texarkana, Arkansas the rate is 2% state plus 3% city, plus sales and use tax. Other special excise taxes that are paid at the retail point-of-sale include fuel taxes and cigarette taxes. The tax on gasoline in Texas is 1.8 cents per gallon lower than in Arkansas, and the Texas tax on diesel fuel is 2.8 cents per gallon lower. For cigarettes, Texas has the higher tax -- $1.41 per pack compared to $1.15 per pack in Arkansas.15 Alcoholic beverages are a popular target of special sales and excise taxes. For retail carryout, the Arkansas side of the metro area has a clear advantage: being a wet county. Bowie County, Texas is a dry county, allowing only sales by the drink in licensed restaurants. For competition between restaurants and hotels on opposite sides of the border, the tax rates matter. The excise taxes on alcohol shown in Table 6 include per gallon taxes and additional excise taxes on cases and barrels that are collected on the wholesale level. Arkansas has higher taxes on wine and wine coolers. Texas has higher taxes on beer and ale.16 Both states have a retail mixed beverage tax. Although the mixed beverage tax rate is the same on either side of the border, the tax bases differ. In Arkansas it is the mixed drink itself that is taxed – 14% on top of sales tax. Sales of beer and wine are subject only to the sales tax. In Texas, the tax per drink depends on the type of license held by the seller. If the seller has a mixed beverage license, all drinks (including beer and wine) are subject to the 14% tax. For holders of lesser licenses, beer and wine are taxed at the regular sales and use tax rate.

Sidebar: Another difference in state Arkansas regulatory structure that has long Usury Laws impacted business on the two sides of the border – particularly for the retail sector – is the restrictive usury laws that are written into the Arkansas constitution. Greene (2002) cites the usury restriction as a fundamental obstacle to retail development on the Arkansas side of the border. The Arkansas restriction put a cap on the interest rate that can be charged by all Arkansas-chartered banks and finance company. The limit was five percentage points above the Federal Reserve discount rate. So, for example, in 2010 when the discount rate was 3/4%, the maximum interest rate allowed in Arkansas was 5-3/4%.* In practice, restrictive usury laws make it impossible for small retailers and finance companies to offer credit at all. When credit risk requires that all but the most creditworthy customers be charged rates above the usury cap, the resulting equilibrium is characterized by no credit at all. Federal law superseded the state restrictions for banks and credit unions, but for retailers who wanted to offer in-house financing to customers, the law was prohibitive. This put a particular burden on retailers of durable household goods and used car dealers (see Bell, 2011). In November 2010, a ballot initiative to change the constitution to allow higher finance rates passed. Assuming that the amendment survives legal challenges, the new limit on consumer finance loans is 17%. The retention of any limit runs the risk that some potential customers will not have access to credit, but the new threshold will certainly expand opportunities –particularly in the present low-interest rate environment. The relaxed usury limits have been especially welcomed by small auto dealers and furniture sales outlets. In the cross-border metropolitan region of Texarkana, the new amendment helps to level the playing field in the retail business. *In 2003, the Federal Reserve changed the nature of the Discount Rate. Prior to that year, the discount rate was the rate charged on “adjustment credit,” and was set below the market-determined federal funds rate. In 2003, adjustment credit was replaced by “primary credit,” with a new interest rate – the primary credit rate – that was set above the federal funds rate. Arkansas law never officially recognized the change.

15 Arkansas also imposes a tax on soft drink sales of 21 cents per gallon. However, the tax exempts sales in “an Arkansas city or unincorporated town which is divided by a state line from an incorporated city or town in an adjoining state and which has a population less than the population in the adjoining city.” 16 The tax on beer in Texas is higher due to a $6.00 tax per barrel, compared to the $0.25 per barrel tax in Arkansas.

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Institute for Economic Advancement

Business Income Taxes

 FIGURE 5: Arkansas Corporate Income Tax Rates

Business income taxes have an obvious effect on business location decisions. Even on an interstate-average basis, these direct taxes on a business’ profits or earnings have been shown to have a statistically significant effect.17

7% 6% 5%

In the Tax Foundation scores for Business Income Taxes, Texas moved from a ranking of 17th in FY2007 to 42nd in FY2008, dropping below Arkansas. In FY2011, Texas dropped to 46th place compared to Arkansas’s ranking of 40th. The dramatic decline in the Texas ranking was associated with its adoption of a “margins tax,” which the Tax Foundation characterizes as a “gross receipts tax.”

4% 3% 2% Average

1% 0%

Gross receipts taxes are criticized because they tend to result in “tax pyramiding” in which a final good is taxed several times as it moves through various stages of the production process. Gross receipts taxes also tend to impose a larger burden on low-margin businesses relative to higher-margin businesses. They also apply regardless of profit or loss: Firms with negative net revenue are still liable for tax payments on gross receipts. The Texas margins tax has some features that tend to mitigate these drawbacks, but inefficiencies remain. One important feature is a generous standard exemption that excludes many of the businesses in Texarkana from paying the tax at all.

0

20

40

Marginal

60 80 100 120 140 160 180 200 Taxable Income ($Thousands)

Source: Arkansas Department of Finance and Administration

revenue that matters.) Figure 5 illustrates the relationship between Arkansas’ average and marginal tax rates. The treatment of business losses is an important feature of the Arkansas Corporate Income Tax that distinguishes it from business taxes in Texas. For small business in particular, which tend to experience business losses during their start-up years, the ability to offset tax liability by carrying-over business losses from year to year is a distinct advantage. As will be described below, the Texas Margins Tax imposes a tax liability on all firms with positive gross revenue, whether they are profitable or not.

Before describing the Texas margins tax in more detail it will be useful to describe the Arkansas Corporate Income Tax, which corresponds more closely with Federal taxes and with the business income taxes of other states.

Texas Margins Tax

Arkansas Corporate Income Tax

Although Texas has no explicit corporate income tax, it has long had a “franchise tax” that applied to the capital or retained earnings of firms. Effective January 1, 2007, Texas implemented a new “margin tax,” which is basically a general gross receipts tax. The rate is 1%, calculated on a fairly broad tax base. Exemptions include sole proprietors and general partnerships. Initially, the tax allowed for a graduated “discount” for firms with gross receipts of less than $1 million. Effective for the 2010 tax year, however, firms with gross receipts less than $1 million are exempt from the tax altogether.

Arkansas has a standard corporate income tax that generally mirrors the structure of the Federal corporate income tax. The tax base is net income – that is, taxable income is calculated as gross receipts less expenses and other deductions (See Figure A in the Appendix). The exemptions and deductions include cost of goods sold, interest, rent, taxes, employee and officer compensation, depreciation, advertising, etc. What is left as net revenue or “taxable income” (on line 30 of the Arkansas Corporate Tax Form) is intended to represent business profits.

The tax base for the margins tax equals total gross receipts less:

The rate schedule for the Arkansas corporate income tax is steeply progressive, rising from 1% for the first $3,000 of net revenue up to 6.5% for net revenue above $100,000. Because of the progressive rate structure, the average tax rate is lower than the marginal rate. But for many business decisions, it is the marginal rate that matters. (For example, in the decision to expand the scale of business operations, it is the tax rate on additional net

• Cost of goods sold (COGS), or • Labor compensation costs (including benefits), or • 30% of gross receipts. This formula tends to favor some business over others, depending on their relative shares of these particular costs.

17 Bartik (1985) estimated that a 10% increase in a state’s corporate income tax rate resulted in a 2-3% decline in the number of new plants in that state.

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Other important features include: • The tax rate is 1.0% for most firms, but it is 0.5% for businesses engaged primarily in wholesale or retail trade.

 FIGURE 6: Cost of Goods Sold and Total Labor Compensation for Various Industry Groups Agriculture

• Firms with gross receipts of less than $10 million have the option of using the E-Z method, in which gross receipts are taxed, with no deductions, at .575%.

Mining Utilities

• Firms with gross receipts of less than $1 million are exempt from the tax altogether.

Construction

Because the Texas Margins Tax allows deductions for either compensation or COGS, it is more properly classified as a “hybrid” gross receipts tax. By exempting the cost-of-goods-sold (or labor compensation costs, whichever is greater), the Texas margins tax adds a level of complexity, but tends, in part at least, to mitigate the problem of tax pyramiding. The exemption for smaller firms also limits tax pyramiding. Gross receipts taxes have also been criticized for penalizing low-margin firms. This is the motivation behind having a lower tax rate for firms engaged in wholesale and retail trade, which tend to have exceptionally thin profit margins. But as will be illustrated below, this is not an issue that is unique to the wholesale and retail sectors. The Texas Margins Tax implies differing effective tax rates for various firms and industries, with the differences depending on cost structures and profit margins. Table A (in the Appendix) shows some characteristics of cost in different industry groups, using data derived from Federal tax returns. Figure 6 displays the two particular categories—COGS (line 2 in Table A) and labor compensation (line 14 in Table A)—which are alternatively exempt from the Texas margins tax. When it comes to the choice of which deduction a business uses to calculate its Texas taxes, a typical firm in the goods producing sectors (e.g. construction, manufacturing, etc.) will clearly choose COGS, which can amount to three-quarters of gross revenue for some businesses. On the other hand, labor compensation costs tend to be somewhat higher in serviceproviding sectors. Typically, neither deductible component of costs amounts to as much as COGS in the goods-producing industries. In some sectors, the average firm would find that the 30% minimum deduction is larger than either of the two deductible cost categories. This difference in cost structures implies that firms in different industries will be paying taxes on different tax bases. Taxes and the Economy of Texarkana

Manufacturing Wholesale Trade Retail Trade TransportationWarehousing Information FinanceInsurance Real Estate-Rental Professional-ScientificTechnical Services AdministrativeWaste MgmtRemediation Educational Services Health CareSocial Assistance Arts-EntertainmentRecreation AccommodationFood Services Other Services

COGS Compensation 0% 10% 20% 30% 40% 50% 60% 70% 80% Percent of Gross Revenue

Source: BizStats, based on 2006 data from the U.S. Internal Revenue Service.

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Comparing Arkansas and Texas Business Taxes

 TABLE 7: The Texas Margins Tax Effective Tax Rates

Figure 7 displays another line from Table A: net revenue or taxable income. It shows that profit margins can also vary considerably from one sector to another. If we consider net revenue to be a measure of business profits, then it serves as an appropriate common base for comparing effective tax rates across industries—and across states.18 The variation displayed in Figure 7 implies that these effective rates will vary considerably across sectors.

(as percent of Net Revenue)

Agriculture 86,500 6.65% 6.08% Mining 198,300 2.90% 2.77% Utilities 80,000 7.19% 5.73% Construction 65,300 8.81% 4.20% Manufacturing 86,800 6.62% 3.80% Wholesale Trade** 42,100 NA 2.81% Retail Trade** 43,300 NA 3.22% Transportation-Warehousing 68,100 8.44% 10.15% Information 133,700 4.30% 5.24% Finance-Insurance 193,400 2.97% 3.62% Real Estate-Rental 160,600 3.58% 4.36% Professional-Scientific-Technical Services 96,500 5.96% 6.37% Administrative-Waste Management-Remediation 66,300 8.67% 8.00% Educational Services 118,800 4.84% 5.14% Health Care-Social Assistance 95,000 6.05% 5.76% Arts-Entertainment-Recreation 134,600 4.27% 5.20% Accommodation-Food Services 76,400 7.53% 8.87% Other Services 72,900 7.89% 8.28%

These differences in effective tax rates are shown in Table 7, and illustrated for some specific sectors in Figure 8.19

 FIGURE 7: Net Profits for Various Industry Groups Agriculture Mining Utilities Construction Manufacturing Wholesale Trade Retail Trade Transportation-Warehousing Information Finance-Insurance Real Estate-Rental Professional-ScientificTechnical Services AdministrativeWaste Mgmt-Remediation Educational Services Health Care-Social Assistance Arts-Entertainment-Recreation

*The E-Z alternative method of calculating the tax is available for businesses with less than $10 million in gross receipts. It is calculated as a straight 0.575% of gross receipts with no exemptions. Figures in red indicate effective tax rates that make it preferable to use the margins tax formula, including exemptions.

Accommodation-Food Services Other Services 0%

Exemption Threshold Effective Tax Rates ($ Net Revenue) E-Z Method* Margins Tax

5% 10% 15% 20% Percent of Gross Revenue

**Firms engaged primarily in wholesale and retail trade are subject to a lower tax rate of 0.5%.

Source: BizStats, based on 2006 data from the U.S. Internal Revenue Service.

18 Although not identical, the net profit margins displayed in Table A1 and illustrated in Figure 7 (which are from Federal tax calculations) generally reflect the same tax base used by the Arkansas tax code. 19 Throughout this analysis, we maintain the (unrealistic) assumption that cost structure is invariant to scale. That is, firms of different sizes will have the same percentages for costs and profit margins. Care should be taken when extrapolating these illustrations to particular firms or sectors. Rather, the estimates should be considered illustrative of businesses having these general configurations of cost structure.

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 FIGURE 8: Effective Tax Rates for Firms in Selected Industries Transportation-Warehousing

12%

6%

10%

Tax as Percent of Net Revenue

Tax as Percent of Net Revenue

Manufacturing

7%

5% 4% 3% Texas Arkansas (Average) Arkansas (Marginal)

2% 1% 0%

0

1

2

3 4 5 6 7 8 Total Revenue (Millions)

9

10 11

8% 6% 4% 2% 0%

12

Texas Arkansas (Average) Arkansas (Marginal) 0

1

7%

7%

6%

6%

5% 4% 3% Texas Arkansas (Average) Arkansas (Marginal)

2% 1% 0%

0

1

2

3 4 5 6 7 8 Total Revenue (Millions)

9

10 11

1% 0%

12

Tax as Percent of Net Revenue

Tax as Percent of Net Revenue

5% 4% 3% Texas Arkansas (Average) Arkansas (Marginal) 2

0

1

2

3 4 5 6 7 8 Total Revenue (Millions)

9

10 11

12

Professional-Scientific-Technical Services

6%

1

Texas Arkansas (Average) Arkansas (Marginal)

2%

6%

0

12

3%

7%

0%

10 11

4%

7%

1%

9

5%

Retail Trade*

2%

3 4 5 6 7 8 Total Revenue (Millions)

Accommodation-Food Services

Tax as Percent of Net Revenue

Tax as Percent of Net Revenue

Information Services

2

3 4 5 6 7 8 Total Revenue (Millions)

9

10 11

5% 4% 3%

1% 0%

12

Texas Arkansas (Average) Arkansas (Marginal)

2%

0

1

2

3 4 5 6 7 8 Total Revenue (Millions)

9

10 11

12

*Firms primarily engaged in wholesale and retail trade are subject to a reduced 0.5% tax rate under the Texas Margins Tax.

Taxes and the Economy of Texarkana

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Consider Manufacturing, which has a very high COGS component (67%). With this relatively large deduction, there is no advantage to using the E-Z method of calculating the tax, so there is effectively a single tax rate that applies to all sizes of firms that are liable for paying the tax. The one-percent tax rate, applied to 33% of gross revenue (after deducting COGS) implies a 0.33% effective tax rate on gross receipts. A typical manufacturing firm has a profit margin of about 8.7% of gross revenue. When assessed relative to this base, the effective tax rate as a percent of net revenue is about 3.8%. This figure can be directly compared to the tax rates under the Arkansas Corporate Income Tax. The Texas tax kicks in for firms with over $1 million in gross receipts, or about $87,000 in net revenue. At this level of net revenue, the relevant Arkansas marginal tax rate is 6.0%. (The Arkansas marginal rate rises to 6.5% at a threshold of $100,000 in net revenue.) For a typical firm in the manufacturing sector, therefore, the Texas Margins Tax results in a lower tax burden than the Arkansas Corporate Income Tax.

Corporate Income Tax. Professional, Scientific, and Technical Services is an example of one sector where effective tax rates in the two states are very close. Labor compensation costs tend to be relatively high in this sector, but not enough to make the E-Z option unattractive. However, firms in this sector also tend to have fairly low profit margins (lower than information Services, for example), so that the effective tax rate on net revenue turns out to be higher. For businesses with gross revenue in the $1 million to $10 million range, the E-Z method implies an effective tax rate of nearly 6%. For larger firms, the Margins Tax calculation implies an effective rate of 6.4%. Over the range that these rates are applicable, the marginal tax rate in Arkansas is 6.5%. Two examples of sectors that might face lower effective tax rates in Arkansas than in Texas are shown in Figure 8—Accommodation and Food Service; and Transportation and Warehousing. Both of these sectors have fairly low COGS, so the Texas tax is imposed on a fairly broad base. They also have very low profit margins, implying that effective tax rates—evaluated relative to net revenue—are particularly high. As a result, over the range of gross revenue for which firms are liable for the Texas Margins Tax, effective tax rates exceed the 6.5% marginal tax rate in Arkansas. This is true for smaller firms that are eligible to use the E-Z method and for larger firms as well. Given the prominent role of Transportation and Warehousing in the Texarkana economy – on both sides of the border – this difference could conceivably be important for evolving business patterns over time.

The Information Services sector provides an example of how the E-Z method provides a lowertax option for many firms. With low COGS and labor compensation margins, a typical firm in this sector will opt to take the 30% minimum deduction under the Margins Tax. This implies a 0.7% effective tax rate on gross receipts, above the 0.575% rate that applies if a firm foregoes the deduction altogether. As a percentage of net revenue, the E-Z method effective tax rate is 4.3%. Firms with gross receipts greater than $10 million do not have the E-Z option. Their effective tax rate (as a percentage of net revenue) is 5.25%. These rates are higher than those faced by manufacturing, but lower than the corresponding tax rates in Arkansas.

In principle, then, some types of businesses might find it advantageous – in terms of effective tax rates – to locate in Arkansas rather than in Texas. In practice, however, few firms are likely to fall into this category. But the exemption for firms with gross revenue under $1 million means that most firms in Texarkana face no tax obligation under the Texas Margins Tax.

The retail sector has a relatively high COGS, so its effective tax base under the Texas Margins Tax is small. However, the retail sector is characterized by very thin profit margins – 4.33% in the data from 2006 tax returns. As a result, the effective tax rate (on net revenue) that would be faced by retail firms under the standard Margins Tax is 6.44%. Recognizing the impact of the tax on retail and wholesale firms, with their small profit margins, the Texas tax code applies a special 0.5% tax rate to firms in retail and wholesale trade. With this break, the effective tax rate for retail firms is only 3.22%.

Figure 9 shows a distribution of firm sizes on both sides of the border. On the Arkansas side of the border, nearly 66% of businesses have less than $1 million in sales. In Texas, the distribution of firms is more skewed toward the upper end of the $0 to $1 million range, but the share of businesses within this range is nearly 69%. By this account about two-thirds of the businesses on each side of the border are presently exempt from the Texas Margins Tax.

Not all firms face lower effective tax rates under the Texas Margins Tax than under the Arkansas Taxes and the Economy of Texarkana

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In the aftermath of the recession of 2008-09, Texas faces the prospect of significant budget shortfalls, and the Margins Tax has been cited as a part of the problem. A recent task force report showed that the tax collected $3.9 billion in the last fiscal year – far below the $6.4 billion projected.20 And in fact, the Margins Tax has raised far less revenue than expected since its inception.

 FIGURE 9: Distribution of Firm Sizes

(by Gross Receipts)

40.6%

$100M 0%

The outlook for the Margins Tax–as it is presently constituted –is therefore somewhat tenuous. If the pro-rated tax payments for smaller firms were to be reinstated, the Arkansas Corporate Tax might appear more favorable for more of the firms that pay higher effective tax rates under the Margins Tax scheme. If the Margins Tax were scrapped altogether in favor of a more conventional business income tax or a modified version of the former Franchise Tax, it is difficult to anticipate precisely how the balance of cross-border tax incentives would be affected.

7.3% 4.0%

Marginal Tax Rates and Incentive Effects

3.1%

For most decisions, it is the marginal tax rate that matters to a business. Because the Texas Margins Tax displays a flat-rate structure, rather than a progressive structure, the marginal and average tax rates are generally the same.21 This is not true near the cut-off levels of $1 million and $10 million in gross sales. Over narrow ranges around these critical points the effective marginal tax rate can be very high.

2.3% 1.6% 1.8% 1.5% 0.2% 0.4% 0.2%

This is particularly important in the case of the $1 million threshold. Firms with gross sales below this point owe no tax, while those even slightly above it owe tax on their entire taxable sales base. The impact of this borderline effect for one industry, TransportationWarehousing, is illustrated in Figure 10.

Texarkana, AR (1147 firms) Texarkana, TX (2910 firms)

0.3%

 FIGURE 10: After-Tax Revenue, Transportation-Warehousing

5% 10% 15% 20% 25% 30% 35% 40% 45%

Source: ReferenceUSA

After Tax Net Revenue ($Thousands)

Note: Percentages are calculated using only those businesses that report gross receipts in the ReferenceUSA database. The database includes 374 firms in Arkansas (24.6% of the total reported) and 602 firms in Texas (17.1% of the total reported) that do not disclose gross receipts. Many of these are non-profits or government entities.

The exemption for firms with revenue less than $1 million is a recent innovation to the Margins Tax. Originally, smaller firms were required to calculate taxes owed and pay a fraction of the total amount, based on a scale ranging from zero to 100% at the $1 million threshold. In 2010, the fractional scale was eliminated, exempting all smaller firms.

70 69 68 67 66 65 64 63 62 61 60 0.90

0.95 1.00 Gross Revenue ($Millions)

1.05

1.10

20 Ward (2010). 21 Average and marginal tax rates differ under a progressive structure in which one rate applies to the first portion of revenue, a higher rate applies to the next portion, etc. In the Texas Margins Tax, a single rate applies to the entire taxable portion.

Taxes and the Economy of Texarkana

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Below the $1 million level, a business with a fixed profit margin experiences increases in net revenue in direct proportion to increases in gross receipts. Upon hitting the $1 million point, a growing firm would find it had lower after tax net revenue than it did before it surpassed the tax threshold. Indeed it would be more profitable for firms in the transportation/warehousing sector to remain below $1 million than to grow to a range of $1 to $1.09 million. Beyond that point, businesses would make a higher level of profits than smaller firms, but at a lower after-tax rate of profit. The structure of the Texas Margins Tax therefore provides an incentive for firms to remain small enough to benefit from the $1 million exemption.

Each factor is calculated as the Arkansas share of the total. So, for instance, if a business has 30% of its nationwide property holdings in Arkansas, the property factor is 0.3. If 25% of its payroll employment is in Arkansas, the payroll factor is .25. From an economic standpoint, these two nonrevenue factors can be considered as income-based taxes on property and payrolls.23 Consider a firm that has 50% of its sales in Arkansas and 50% in Texas. If its physical place of business is located in Texas and its payroll emanates from that office, then it is liable for the Texas Margins Tax on all of its sales and liable to Arkansas for 25% of its sales (the firm’s property factor and payroll factor in Arkansas are zero, so 1/2 x 0.5 = 0.25). This amounts to a double-taxation, since Texas law does not allow explicit deductions for taxes paid to other states.

Apportionment Issues To this point, the comparison of business taxes in Arkansas and Texas has maintained the unrealistic assumption that a firm does all of its business on the side of the border on which it is located. In practice, many firms have activities that are taxable on both sides of the state line. The methods that the two states use to allocate cross-border income are relevant to the business location decision.

Now consider the same firm with its sole physical location in Arkansas. The one-half of its sales that are made in Texas are subject to the Texas Margins Tax, while 75% of its business is taxable in Arkansas (1/2 x 0.5 + ¼ x 1.0 + ¼ x 1.0=0.75). The ability of firms to deduct taxes paid to Texas from Arkansas taxable revenue helps to mitigate the double-taxation in this case. However, for firms that face higher effective tax rates in Arkansas than in Texas this deductibility only partly offsets the additional tax burden from double-taxation.

The Texas Margins Tax apportionment is simple: the tax is payable on the share of gross receipts received from business in Texas. A firm located exclusively on the Texas side of the border is liable for tax on all of its gross receipts, while a firm on the Arkansas side pays the tax only on that share of revenue received from sales in Texas. All else being equal, this tends to favor doing business from outside the state to avoid the Texas Margins Tax on sales outside of Texas. 22 As we have already seen, however, all else is not equal.

In general, the differing apportionment formulas tend to reinforce the effects of differences in effective tax rates in the two states. Because most businesses face lower rates under the Texas Margins Tax (particularly the small businesses that tend to predominate in the Texarkana economy), this tends to reinforce the incentive to locate a firm on the Texas side of the border.

The Arkansas Corporate Income Tax uses a common three-factor apportionment formula, where the three factors are sales revenue, property, and payroll. In the Arkansas formula, sales revenue is given double weight, so the formula is:



½ x Sales Factor



¼ x Property Factor



+



Tax-Abatement Incentive Programs Given that tax rates provide disincentives to business development and expansion, many state governments offer incentive programs to rebate the taxes associated with establishing or expanding businesses in the state, particularly in underdeveloped or impoverished areas. Both Texas and Arkansas have such programs, although they differ in their scope and emphasis.

¼ x Payroll Factor

In Arkansas, the “Advantage Arkansas” program is established under the Arkansas Enterprise Zone Act (1993). Unlike many enterprise zone programs,

Arkansas Apportionment

22 The economic distortion from this effect is minimized by the fact that apportionment is based on the same criterion (gross sales) as the tax base. 23 McClure (1980). The income-based tax burden on property has been found to be a particularly relevant for capital expenditure decisions by manufacturing firms (Gupta and Hoffman, 2003).

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Advantage Arkansas can be used in any area of the state. In effect, the entire state is treated as an enterprise zone. For qualified businesses that promise to hire a minimum number of new full-time permanent employees, earned income tax credits are available per employee hired and the state provides a refund of sales and use taxes paid for building materials and taxable purchases of machinery and equipment. The minimum number of new employees depends on the type of business.

 FIGURE 11: Enterprise Zones in Bowie County, Texas

The base-level income tax credit is equal to the average hourly wage paid to each net new full-time employee times the number of new employees times a multiplier of 100 (with a $3,000 cap per employee). The program favors counties in economic hardship, providing for a multiplier of 400 (with a cap of $6,000) for counties that are classified as having “high unemployment” (relative to the statewide average).

“distressed county” – a poverty rate over 15.4%, 25% of the population without a high school diploma, and long-term unemployment above 4.9% – automatically qualify as an enterprise zone. Smaller areas also qualify if they represent a Census block group in which at least 20% of the residents have an income at or below the poverty line.

The Advantage Arkansas program applies to a limited number of business types. It includes manufacturers with Standard Industrial Classification (SIC) codes 20 through 39, for which the minimum number of new employees is one or more. One or more employees must also be hired for firms engaged in physical or biological research (SIC 8371). Businesses that provide computer programming services or other computer processing services are eligible if they hire five or more new employees. Twenty-five new employees are required to be eligible in the other specific industries that are covered: Office sector businesses; national, corporate or regional headquarters; distribution centers; trucking/distribution terminals (SIC 4231); coal mining operations, and motion picture production companies (SIC 7812). Each of these types of qualifying businesses is subject to restrictions on retail sales to the general public.

Figure 11 shows the currently designated enterprise zones in Bowie County. There are three covered areas: one section near the county seat of New Boston, a region in the northwest portion of the county adjacent to Red River County (a distressed county), and one zone that covers much of the area within the city limits of Texarkana, Texas – particularly the southern and western portions of the city. Texas Enterprise Zone projects need not be located within designated zones. If they are located outside a zone, they are required to commit that at least 35% of their new employees will be residents of a zone or that they meet the qualifications to be “economically disadvantaged.”24 Businesses located within a zone face only a 25% new employee requirement.

The emphasis on manufacturing, trucking, and distribution may or may not have contributed to the development of concentrations in those sectors on the Arkansas side of the state line, but it surely provides incentives to retain and strengthen those relative concentrations.

The types of businesses eligible for enterprise zone credits and refunds are not restricted in Texas, but there are limits on sales and use tax refunds, with the limits related to the level of capital investment. For capital investments up to $150 million, the maximum refund per job is $2,000, with the maximum number

The Texas Enterprise Zone program is oriented more toward development in specific economically distressed areas. Counties that satisfy the criteria for a

24 To qualify as economically disadvantaged an individual can be disabled, low income, an orphan, an ex-convict or unemployed (within specific definitional categories).

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of eligible jobs capped on a graduated scale from 10 to 500 jobs (over four ranges of capital investment levels). Larger investments—known as Double Jumbo and Triple Jumbo Projects—have a maximum refund for up to 500 jobs at $5,000 to $7,500 per job. Projects are also eligible for Franchise Tax (Margin Tax) credits. Local governments that nominate projects for designation may also exempt local taxes and waive regulations on construction.

The sales tax differential can also effect business decisions outside the retail sector, especially since many business-to-business transactions are subject to sales taxes. Historically, absence of a corporate income tax has given Texarkana, Texas a significant advantage in attracting business investment. This is undoubtedly an important driving force in the expansion of business in Texarkana, Texas relative to Texarkana, Arkansas.

The Texas Enterprise Zone program is less targeted toward specific types of business than the Advantage Arkansas program, but more targeted toward specific disadvantaged areas. The scale of maximum refunds in Texas (and the irrelevance of the Margins Tax for smaller firms) favors projects that commit large capital investments, rather than the smaller incremental projects that are fully eligible under the Arkansas program.

The Texas Margins Tax, introduced in 2007, introduces a new set of tax considerations into the mix: • It is a modified gross receipts tax, so it has features in common with a business income tax and with a sales tax. As a business income tax, a general gross receipts tax is inefficient and inequitable. It often results in “tax pyramiding,” and imposes differing effective marginal tax rates on the business profits of firms in different sectors. It also imposes a tax that is independent of profit or loss, which can be a particularly important consideration for young, small firms that often experience periods of business losses in the early stages of growth.

Summary and Conclusions Both economic theory and empirical evidence suggest that differences in tax structures among subdivisions of a region provide one set of factors that can have significant impacts on household and business location decisions. Texarkana provides a unique case study for observing the effects of such differences.

• Features of the Texas Margins Tax mitigate some of these effects. The exemption of COGS or compensation costs allows firms with particularly high costs in these areas to lower their exposure to taxation. The special exemption for firms in retail and wholesale trade helps to adjust effective tax rates for firms with very thin profit margins. Most of all, the exemption of businesses with gross revenue of less than $1 million serves to partly mitigate each of the general problems associated with a pure gross receipts tax.

The Arkansas income tax exemption for Texarkana residents helps to level the playing field for residents on both sides of the border. Nevertheless, specific features of the exemption generate incentives for residential and business location decisions that are consistent with the patterns we observe: Specifically, the fact that the tax exemption only applies to residents within the city limits acts as a disincentive for any residential and business expansion beyond Texarkana city into Miller County at large.

• The exemption for firms with gross revenue less than $1 million also means that about two-thirds of the businesses in the Texarkana metro area are exempt from the tax altogether. For most firms, therefore, Texas still has no meaningful business income tax, while the Corporate Income Tax in Arkansas applies for all firms with positive net revenue.

Property taxes also affect both business and residential location decisions. Among tax-related factors, this constitutes one of the most important differences for households. For firms, it is only one of many tax effects that can affect business plans. The lower property taxes in Arkansas have contributed to a relatively robust residential expansion in recent years. Business expansion has not followed suit, however, suggesting that other factors are more important.

Overall, the introduction of the Texas Margins Tax does little to weaken the advantage that Texas has over Arkansas in terms of low business income taxes. Assuming that the Margins Tax retains its current structure, it is unlikely to have a substantive impact on the status quo. However, it is likely that changes in the Margins Tax will be contemplated in the future. It has brought in less revenue than anticipated, and Texas is facing substantial budget shortfalls. Prospective

Sales taxes are higher on the Arkansas side of the state line than on the Texas side, providing an incentive for firms in the retail trade sector to locate in Texas. Employment location quotients also show that the retail trade sector is generally larger on the Texas side than on the Arkansas side of the border. Taxes and the Economy of Texarkana

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changes to the tax could make the Arkansas Corporate Income Tax relatively more favorable for some businesses. Enterprise zone programs in the two states have differing emphases. The Texas program tends to favor large capital projects in relatively impoverished areas. The Arkansas program favors expansion of its existing concentrations in manufacturing and transportation. Taking account of all of these factors, tax considerations are unlikely to alter recent trends in the pattern of development across the Texarkana metro area. This pattern is characterized by more rapid growth of business and commerce on the Texas side of the state line, with growth on the Arkansas side of the border more heavily weighted toward manufacturing and favoring residential expansion.

Taxes and the Economy of Texarkana

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References Bartik, Timothy J., “Business Location Decisions in the United States: Estimates of the Effects of Unionization, Taxes, and Other Characteristics of States” Journal of Business & Economic Statistics 3:1 (1985), 14-22. Bartik, Timothy J., “Small Business Start-Ups in the United States: Estimates of the Effects of Characteristics of States,” Southern Economic Journal 55:4 (1989), 1004-1018. Bartik, Timothy J., Who Benefits From State and Local Economic Development Policies? Kalamazoo, MI: W.E. Upjohn Institute for Employment Research, 1991. Bell, Robert, “Retailers Praise Change in Law On Interest Rates,” Arkansas Business 28:2 (January 10-16, 2011), p. 1. Greene, Stephen, “Doing Business in Texarkana Sometimes Means Going Over the Line,” Federal Reserve Bank of St. Louis, Regional Economist, April 2002, 14-15. Gupta, Sanjay and Mary Ann Hofmann, “The Effect of State Income Tax Apportionment and Tax Incentives on New Capital Expenditures,” The Journal of the American Tax Association, Vol. 25 (supplement), 2003, 1-25. Harden, J. William, and William H. Hoyt, “Do States Choose Their Mix of Taxes to Minimize Employment Losses?” National Tax Journal 56:1 (March 2003), 7-26. Helms, L. Jay, “The Effect of State and Local Taxes on Economic Growth: A Time Series-Cross Section Approach,” Review of Economics and Statistics 67:4 (1985), 574-582. Kaza, Greg, “A Texarkana Tax Tale,” National Review Online, May 2, 2007. http://article.nationalreview.com/313800/a-texarkana-tax-tale/greg-kaza Ladd, Helen F., “Effects of taxes on economic activity,” in Helen F. Ladd, ed., Local Government Tax and Land Use Policies in the United States: Understanding the Links, Lincoln Institute of Land Policy: 1998, 82-115. Mark, Stephen T., Therese J. McGuire and Leslie E. Papke, “The Influence of Taxes on Employment and Population Growth: Evidence from the Washington, D.C. Metropolitan Area,” National Tax Journal 53:1 (March 2000), 105-123. McLure, Charles E., Jr. “The state corporate income tax: Lambs in wolves’ clothing.” In H. Aaron, and M. Boskin (ed.) The Economics of Taxation, Washington, D.C.: Brookings Institution, 1980. Prante, Gerald, “Where Do State and Local Governments Get Their Tax Revenue, The Tax Foundation, Fiscal Fact, No. 194, October 9, 2009. http://www.taxfoundation.org/files/ff194.pdf Padgitt, Kail M., “2011 State Business Tax Climate Index (Eighth Edition),” Tax Foundation, Background Paper, No. 60, October 2010. http://www.taxfoundation.org/files/bp60.pdf Papke, James A., and Leslie E. Papke, “Measuring Differential State-Local Tax Liabilities and Their Implications for Business Investment Location,” National Tax Journal 39:3 (1986), 357-66. Ward, Mike, “Report: State Business Tax Falling Short of Expectations,” American-Statesman, November 3, 2010. Wasylenko, Michael, “The Location of Firms: The Role of Taxes and Fiscal Incentives,” in Roy Bahl (ed.), Urban Government Finance: Emerging Trends, Beverly Hills, Sage Publications, 1981. Wasylenko, Michael. “Taxation and Economic Development: The State of the Economic Literature.” New England Economic Review, Proceedings of a Symposium on the Effects of State and Local Public Policies on Economic Development (March/April1997): 37-52. http://www.bos.frb.org/economic/neer/neer1997/neer297c.pdf Wasylenko, Michael and Therese McGuire. 1985. “Jobs and Taxes: The Effect of Taxes on States’ Employment Growth Rates.” National Tax Journal 38:4 (1985), 497–514.

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APPENDIX: Additional Tables and Figures Table A: Annual Average Sales, Income & Expenses of Corporations Sales

Agriculture- Forestry- Hunting-Fishing Mining Utilities Construction Manufacturing 100.00%

100.00%

Cost of Sales

47.44%

45.15%

54.15%

72.55%

67.00%

Gross Profit

52.56%

54.85%

45.85%

27.45%

33.00%

Officers Compensation

2.18%

1.12%

0.33%

2.73%

0.69%

Salary-Wages

7.07%

4.77%

3.80%

4.69%

5.49%

Rent

4.07%

1.62%

0.73%

1.43%

0.76%

Taxes

1.86%

3.11%

3.66%

1.56%

1.59%

Interest paid

1.81%

2.66%

5.17%

0.69%

3.05%

Amortization & Depreciation

4.06%

6.75%

7.11%

1.17%

2.47%

Advertising

0.30%

0.06%

0.09%

0.32%

1.13%

Benefits-Pension

1.06%

1.47%

2.12%

1.21%

1.91%

Other SG&A Exp.

21.50%

13.45%

14.83%

7.12%

7.23%

8.65%

19.83%

8.00%

6.53%

8.68%

Net Profit

100.00%

100.00%

100.00%



Memo: Labor’s Share of COGS 11.24%

9.62%

1.18%

14.37%

9.03%

Labor in COGS

4.34%

0.64%

10.43%

6.05%

5.33%

Total Labor Compensation 15.64% 11.70% 6.89% 19.06% 14.14% (4+5+11+14) Sales

Wholesale Trade

Retail Trade

Transportation- Finance- Warehousing Information Insurance

100.00%

100.00%

100.00%

100.00%

100.00%

Cost of Sales

76.33%

72.14%

30.89%

17.80%

27.49%

Gross Profit

23.67%

27.86%

69.11%

82.20%

72.51%

Officers Compensation

0.97%

0.84%

1.31%

1.22%

1.00%

Salary-Wages

6.77%

8.82%

16.49%

14.14%

8.06%

Rent

1.50%

2.23%

4.89%

2.26%

0.70%

Taxes

1.20%

1.47%

3.09%

2.42%

1.28%

Interest paid

0.85%

0.87%

1.83%

6.43%

20.37%

Amortization & Depreciation

1.11%

1.21%

4.43%

7.59%

1.58%

Advertising

1.04%

1.38%

0.43%

2.43%

0.56%

Benefits-Pension

0.84%

0.94%

3.86%

2.67%

1.11%

Other SG&A Exp.

5.17%

5.77%

25.96%

29.68%

18.49%

Net Profit

4.21%

4.33%

6.81%

13.37%

19.34%



Memo: Labor’s Share of COGS 1.32%

1.09% 13.25%

7.11%

0.14%

Labor in COGS

0.79%

1.27%

0.04%

1.01%

4.09%

Total Labor Compensation 9.59% 11.39% 25.75% 19.30% 10.21% (4+5+11+14)

Source: BizStats.com and author’s calculations.

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APPENDIX: Additional Tables and Figures

(continued)

Table A: Annual Average Sales, Income & Expenses of Corporations (continued) Sales

Real Estate

Professional Administrative- Scientific- Support- Health Care- Technical Waste Mgmt- Educational Social Services Remediation Services Assistance

100.00% 100.00% 100.00% 100.00% 100.00%

Cost of Sales

16.78%

Gross Profit

83.22% 71.20% 55.72% 87.08% 90.67%

Officers Compensation Salary-Wages

4.63%

28.80% 7.44%

44.28% 2.65%

12.92% 4.60%

9.33% 11.66%

17.71% 21.45% 19.50% 28.26% 27.25%

Rent

5.25% 3.21% 1.87% 6.56% 4.16%

Taxes

3.21% 3.02% 4.42% 3.75% 3.49%

Interest paid

4.28% 1.30% 1.30% 1.73% 1.49%

Amortization & Depreciation

8.38%

Advertising

1.48% 1.00% 0.79% 5.18% 0.80%

Benefits-Pension

1.75% 3.08% 2.44% 2.54% 4.17%

1.61%

2.21%

2.25%

1.91%

Other SG&A Exp.

20.47%

19.44%

13.91%

20.34%

26.23%

Net Profit

16.06%

9.65%

6.63%

11.88%

9.50%



Memo: Labor’s Share of COGS 8.07% 22.80% 50.54% 27.52% 23.63% Labor in COGS

1.35%

6.57%

22.38%

3.56%

2.20%

Total Labor Compensation 25.44% 38.54% 46.97% 38.96% 45.28% (4+5+11+14) Sales

Arts- Entertainment- Accommodation- Other Recreation Food Services Services 100.00%

100.00%

100.00%

Cost of Sales

16.27%

32.24%

39.62%

Gross Profit

83.73%

67.76%

60.38%

7.81%

1.89%

4.79%

Officers Compensation

17.95%

19.83%

14.77%

Rent

Salary-Wages

4.78%

5.87%

5.64%

Taxes

5.50%

4.39%

3.19%

Interest paid

2.38%

3.05%

1.36%

Amortization & Depreciation

3.94%

3.03%

2.37%

Advertising

1.96%

2.45%

1.31%

Benefits-Pension

2.25%

1.64%

1.70%

Other SG&A Exp.

23.69%

17.98%

17.96%

Net Profit

13.46%

7.64%

7.29%



Memo: Labor’s Share of COGS 10.91% Labor in COGS

1.78%

16.14% 5.20%

20.28% 8.03%

Total Labor Compensation 29.79% 28.56% 29.29% (4+5+11+14) Source: BizStats.com and author’s calculations.

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APPENDIX: Additional Tables and Figures

(continued)

Figure A: Arkansas Corporate Income Tax Form

Source: Arkansas Department of Finance and Administration

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Institute for Economic Advancement

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