The index measures the competitiveness of the 50 states’ tax systems and ranks them based on the taxes that matter most to businesses and business investment: corporate income, individual income, sales, property and unemployment insurance taxes, according to the Tax Foundation.

The index measures how well a state’s tax system encourages investment by maintaining a broad tax base and low rates.

“When policymakers are considering tax changes in their states, they should remember two rules: Taxes matter to business, and states do not enact tax changes—increases or cuts—in a vacuum,” said Kail Padgitt, Ph.D., who authored the report.

The index represents the tax climate of each state as of July 1, 2009, the first day of the standard 2010 fiscal year.

According to the index, the top 10 most business-friendly states are:

1. South Dakota

2. Wyoming

3. Alaska

4. Nevada

5. Florida

6. Montana

7. New Hampshire

8. Delaware

9. Washington

10. Utah

The bottom 10 states, from 41st to 50th, are Vermont, Wisconsin, Minnesota, Rhode Island, Maryland, Iowa, Ohio, California, New York and New Jersey, according to the index.

Kentucky’s Rank Improved the Most

New Jersey remained dead last, as it was in the 2009 Index, and Hawaii and Oregon dropped in rank by two spots to 24th and six spots to 14th, respectively.

Oklahoma saw the biggest drop in ranking this year—from 19th in 2009 to 31st in 2010—not due to legislative changes but to the fact that the Tax Foundation was able to obtain much more detailed nationwide data on local-option sales taxes, which are much higher in Oklahoma than in most states (above 4% in several municipalities), according to the organization.

Kentucky's ranking improved the most—up 14 spots from 34th in 2009 to 20th in 2010. Many economically damaging changes were enacted in other states that previously ranked better than Kentucky—especially in the personal income tax—so other states’ rankings fell while Kentucky remained stable, according to the Tax Foundation.

Other tax changes that affected states’ rankings include enactment of so-called “millionaires’ taxes” on high-income earners (often on income far less than $1 million) in states such as Hawaii, New Jersey and Oregon. Ten states also enacted cigarette tax increases this year: Arkansas, Florida, Hawaii, Kentucky, Mississippi, New Jersey, New Hampshire, Rhode Island, Vermont and Wisconsin.

The Tax Foundation is a nonpartisan, nonprofit organization that has monitored fiscal policy at the federal, state and local levels since 1937.