Taxes reflect what citizens and businesses are willing to pay for their government and the services it provides.
Tax payments as a percentage of income is a generally accepted measure of the size of any tax burden. However, for this measure to be comparable across states, it must combine local and state taxes, since different states allocate the responsibilities of government differently.
Why is This Important?
States must make a trade-off when choosing their tax rates. On one hand, taxes fund valuable and popular government services that would not generally be provided by the market. These services (such as law enforcement, education, transportation, and social services) facilitate business activity and improve the quality of life for residents.
On the other hand, studies have found that a high tax burden might harm a state's business climate and competitiveness, consequently reducing the growth of income and employment. Finding the right balance can be critical to the health of a state's economy and its quality of life.
How is Virginia Doing?
Tax burden measures the taxes collected by state and local governments as a percent of income earned by individuals and businesses in that state. According to the Tax Foundation, in 2010 Virginia had the 20th lowest tax burden in the country at 9.3 percent of income -- below the national average of 9.9 percent. [Eight other states, however, had a tax burden extremely close to Virginia's (ranging from 9.0 to 9.5 percent), so that small changes in the measure will translate into noticeable changes in rankings.] Alaska's tax burden was the lowest at 7.0 percent. Tennessee had a lower rate than Virginia at 7.7 percent. Maryland (10.2%) and North Carolina (9.9%) were higher than Virginia.
A subset of the tax burden comes from corporate taxes. The Tax Foundation’s Corporate Tax Index Rank captures the business tax environment by including both the rate structure and the composition of the tax base. In the Foundation's index for 2012, Virginia was given the 6th best corporate tax index rank in the nation, placing it above its peers: Maryland ranked 14th, Tennessee 13th and North Carolina 29th. Wyoming, Nevada, and South Dakota, which have no general corporate tax at all, received the highest scores.
Virginia is notably business-friendly in other ways. According to a 2011 report done by the Council on State Taxation (COST) in partnership with the business analysis firm of Ernst & Young, Virginia ranked sixth nationally for the lowest tax burden on new investments -- which is a measure of business competitiveness that reflects the tax provisions and tax incentives put in place by state and local governments.
In 2011, the average local per capita tax rate in Virginia was $1,748. The Northern region ($2,484) had the highest local per capita taxes, while the Southside ($829) and the Southwest ($934) had the lowest. The average 2011 tax burden in Virginia -- which is measured as local taxes collected relative to personal income -- was 3.78 percent. As is common in larger metropolitan areas with diverse demands for services, the Northern, Hampton Roads, and Central regions had the highest taxes as a percent of income; the Southside and Southwest regions had the lowest.
What Influences State and Local Taxes?
State and local governments choose what taxes and tax rates to impose. Unlike some states, Virginia state government retains significant control over both state and local taxes and has imposed caps on many local taxes. Localities in Virginia can only levy taxes in those areas authorized by the General Assembly. Localities do, however, retain control over property tax rates. Since the Great Recession of 2007-2009, state and local revenues have suffered sometimes significant declines; as a result, many localities have felt pressured to raise property taxes to help cover their core expenses for services.
The mix of taxes also helps determine the overall tax burden. Some taxes are paid by people outside of the state – for example, lodging taxes paid by out-of-state visitors. Shifting taxes more toward those paid by non-residents can lower the local tax burden for a given level of state expenditures.
What is the State's Role?
State government designs the tax system, chooses the optimal rate of taxation and collects the taxes. An ideal tax system is simple, transparent, equitable, and efficient – but often a challenge to realize. States must choose how to balance these goals when designing their tax systems, and aim for the optimal rate at which to tax in order to match the preferences of residents.
State rankings are ordered so that #1 is understood to be the best.
Data Definitions and Sources
State and Local Tax Burden
Mark Robyn and Gerald Prante, Special Report No. 189: State-Local Tax Burdens Fall as Tax Revenues Shrink Faster than Income. The Tax Foundation (February 2011). www.taxfoundation.org
The Tax Foundation income estimate is Virginia's share of net national product (NNP) published by the Commerce Department's Bureau of Economic Analysis (BEA). The Tax Foundation updates their estimates as new data is received. For example, the tax rate originally reported for Virginia was 9.5 percent in 2006; this was later revised to 10.1 percent.
NNP, which includes profits and excludes depreciation, provides a better measure of "spendable" income than (1) gross domestic product (GDP), which includes depreciation, causing it to overstate income; or (2) personal income, which does not include profits (income contributions through capital gains, dividends and interest), causing it to understate income.
Local Taxes from the Commonwealth of Virginia, Auditor of Public Accounts,
New Investment Tax Burden
Council on State Taxation (COST), "Competitiveness of State and Local Business Taxes on New Investment," April 2011.
www.cost.org/WorkArea/DownloadAsset.aspx?id=78442 -- pdf (1.6 mb)
Corporate Tax Index Rank
Kail M. Padgitt, Background Paper No. 60: 2011 State Business Tax Climate Index, The Tax Foundation (October 2010). www.taxfoundation.org
The rank looks at both (1) the corporate tax rate structure, including the number of tax brackets and the level of income at which the top bracket kicks in, and (2) the composition of the business tax base, including the availability of credits, deductions and exemptions; the ability of taxpayers to deduct net operating losses; and a host of small tax base issues.
The tax burden estimate should not be viewed as a measure of the size of government or its relative efficiency for at least two reasons. First, the burden of a severance tax, or tax on natural resource extraction, typically falls mostly on the owners of the resources. The owners generally have little influence on the market price and, therefore, must absorb the tax, regardless of who physically pays the tax. Paradoxically, severance taxes are among the least damaging types of taxes for a state's economy, since the resources taxed are not mobile and extraction cannot be moved to lower tax states. The Tax Foundation, however, includes the tax paid by the natural resource purchaser in the purchaser's state tax burden. As a result, in states with large private oil resources, such as Texas, the Tax Foundation's estimate understates the burden placed on the owners of the land. In the case of Alaska, the state with the lowest tax burden, the oil reserves are primarily on federal land and, thereby, the burden falls mostly on the U.S. treasury. The low tax burden does not, however, imply that the Alaskan government is either smaller or relatively more efficient.
Second, the Tax Foundation's tax burden estimate does not include the federal government's share of the states' tax burdens. Although the federal government does not pay state taxes directly, those who provide services to federal agencies do pay taxes. A substantial share of these tax payments are shifted to the federal agency purchasers through higher prices. Any shift in payments should not be counted as part of the local tax burden. Because of the very substantial share of federal expenditures in Virginia's economy relative to other states, not accounting for this tax shifting effect will overestimate Virginia's tax burden relative to other states.
See the Data Sources and Updates Calendar for a detailed list of the data resources used for indicator measures on Virginia Performs.