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(April 2005) Considering all local and state taxes, Pennsylvania's total tax burden is competitive with many other major states, based on analyses by the non-partisan Tax Foundation and the Pennsylvania Economy League of Southwestern Pennsylvania. For example, typical manufacturing firms pay slightly lower taxes in Pennsylvania than the average of other major states, while typical business service firms pay slightly more than average.

However, because information on local taxes is hard to obtain and can vary significantly from one part of a state to another, most businesses and site selection consultants judge the tax burden based on state taxes. The major exception is Philadelphia which imposes income and gross receipts taxes on businesses in the City at high enough levels that they can't be overlooked.

Pennsylvania's two major state business taxes are the Corporate Net Income tax and the Capital Stock and Franchise tax. Pennsylvania's Corporate Net Income Tax rate is 9.99%, the third highest rate in the nation after Iowa and North Dakota, and the highest flat rate in the nation. The median rate in the nation is about 7.5%. The current state Capital Stock and Franchise Tax - which is scheduled to be phased out by 2011 -- is 5.99 mills.

Many Pennsylvania businesses pay both the Corporate Net Income Tax and the Capital Stock and Franchise Tax. In most other states with a Capital Stock and Franchise Tax, a business pays only one of the taxes.

The impact of these two major business taxes can vary significantly between different types of firms. The significance of the Capital Stock and Franchise Tax is readily evident. On the other hand, major operating exemptions significantly reduce the state tax burden for manufacturers. These exemptions became law many years ago when manufacturing was a much larger part of Pennsylvania's economy.

Click here for more about the effect on comparative tax burden of both taxes for a typical business service firm and other related charts.

What are the issues?

For Pennsylvania state business taxes, here are three.

1. Sticker shock. Economic developers and others involved in industrial location decisions consistently cite the negative "first impression" Pennsylvania's tax structure currently gives businesses. This is due in large part to the comparatively high nominal rate of the Corporate Net Income Tax, even though further investigation usually reveals a much lower effective rate. The amount of tax paid is lower than expected based on the high rate because, as a rule, Pennsylvania allows more deductions and credits than to other states. A 1-2% reduction in the rate - to between 7.99% and 8.99% - would place Pennsylvania more in line with other states, based on corporate tax rates.

2. Affording a rate reduction. Lowering the Corporate Net Income Tax reduces state revenues and that means it's a "cost" to the state's budget. Reducing the rate to 8.5%, for example, would reduce revenues by almost $250 million - about 1% of the state budget.

Opponents of business tax reductions point to the sacrifices on the spending side needed to accommodate any revenue reduction in what many consider a tight budget for both this year and next. Most often cited? Funding cuts in Pennsylvania's Medical Assistance program.

Proponents argue an increase in economic activity over time, stimulated by the more competitive tax structure, could generate enough new state revenues in business and personal taxes to significantly or completely offset the rate reduction.

3. Capital Stock and Franchise Tax phase-out. The Capital Stock and Franchise Tax is currently being phased out and is scheduled to be eliminated by 2011. The original phase-out schedule has been delayed twice to help meet revenue shortfalls. This will be a major tax reduction for those firms which pay the tax, especially firms that don't qualify for exemptions.

Proponents of the phase-out on schedule believe eliminating the tax will have a major positive impact on the competitiveness of Pennsylvania's tax system, and it will help re-establish an impression of predictability for tax levels.

As with other business tax reductions, opponents fear the impact on the spending side of the budget because nearly $900 million in annual receipts will be reduced to zero over the next six years.

The Debate Will Continue

Efforts to reduce business taxes always stirs controversy. The current debate began with Governor Ed Rendell's proposal to restructure business taxes beginning in 2007. Although the Governor's proposal is revenue neutral - increases will offset reductions - will it have an impact on the state's competitiveness? If not, what's ultimately needed? Is the return to the economy and, ultimately, the state treasury sufficient to warrant tax reductions? How will lost revenues be replaced, at least in the short term? Answers to these and many other questions often remain elusive, making decisions to reduce business taxes that much harder.