Take the State Corporate Income Tax… Please!
In 1983, Ronald Reagan proposed eliminating the federal corporate income tax. Last week, Michael Boskin took up the charge. I have another idea: Get rid of the state corporate income tax.
State corporate income taxes are lineal descendents of the federal version and share many of its flaws. They doubly tax income at the firm and individual level, penalize businesses that organize as corporations, and reward debt versus equity finance. They also are very sensitive to the business cycle, and tend to plunge when the economy sags.
But wait… there’s more. Businesses often span many states. States differ in their rules for reporting and apportioning corporate income. Multi-state corporations hire vast armies of tax planners to exploit these differences. Hence, we see holding companies in Delaware, squishy definitions of business vs. non-business income, and so-called “nowhere income” that somehow is not earned — or taxed — in any state.
The federal government adds another wrinkle by tweaking definitions of the tax base. For example, the American Recovery and Reinvestment Act extended bonus depreciation and small business expensing to encourage capital investment. Similarly, governors often treat the corporate income tax as their very own economic development slush fund by offering various tax credits and incentives for firms to move to their state. Corporate CFOs return the favor by complaining about state and local tax compliance costs. Go figure.
Worse, for those of us who worry about state and local government finances, the state corporate income tax brings in little revenue (4.6% of total tax receipts in 2009). One could argue that this figure reflects last year’s economy, but it’s a long-term trend. Bill Fox and LeAnn Luna show that corporate income taxes have been falling as a share of profits since the late 1980s.
What to do? Some states have undertaken fundamental tax reform. Ohio jettisoned several business taxes including the corporate income tax and replaced them with a gross receipts or corporate activity tax (CAT). California’s tax commission proposed a business net receipts tax (BNRT) modeled on a Value Added Tax to replace the corporate income tax and reduce personal income and sales taxes. Each approach has its strengths and weaknesses, but neither is a panacea.
A more fruitful solution may be to go after the most egregious abuses — for example by requiring combined reporting for all business income so that firms can’t shift profits to subsidiaries in low- or no-tax states. States may also want to extend the corporate tax to other types of businesses, such as partnerships, that benefit just as much from state-funded roads, police protection, courts, etc. even if their owners reside out of state. Charles McClure, along with my Tax Policy Center colleague, James Nunns, and Swaroop Chary would do just that by taxing sales, property, and payroll directly rather using them in a formula to apportion income among states.
Sad to say, the state corporate tax is probably here to stay. The ability for states to piggyback on federal corporate income tax legislation, regulations, and case law is too tempting. Again paraphrasing that well known tax and marital expert Henny Youngman, you can take the state corporate income tax everywhere, but it will keep finding its way back!