B RUNORI C HAPTER 7 C ORPORATE I NCOME T AXES

O VERVIEW State corporate income and franchise taxes are among the most complicated and controversial components of state revenue systems. The application of the state to interstate corporate business is one particularly complicated area. Controversies naturally arise when states attempt to get their most powerful institutions to pay for government services. Corporate income taxes make up a surprisingly small portion of state revenues. Although the state corporate income tax raises very little revenue compared with other levies, it devours a disproportionate amount of planning and litigation resources.

R ATIONALE FOR THE C ORPORATE I NCOME T AX The corporate income tax compensates for deficiencies in the property tax. The corporate income tax protects the much more significant (in terms of revenue), personal income tax. Without a levee and corporate income, taxpayers might have an incentive to shelter, personal income in corporate holdings. Imposing a tax on corporate profits reimburse the state for the significant services provided the business community. Opponents of corporate taxes often argue that the wealth and economic development created by corporations outweigh the benefits they receive from the state. An important justification for the corporate taxes that it eases – to some extent – the regressivity of state tax systems. The corporate income tax generally has a progressive effect on a state’s overall public finance system.

P OLICY I SSUES : T HE F AILURE OF THE S TATE C ORPORATE I NCOME T AX The state corporate income tax has not been a particularly reliable or stable source of income for state governments. State governments are collecting relatively less and corporate income taxes while corporations are earning relatively more.

T AX I NCENTIVES One important factor in the steady erosion of the state corporate tax base is the pervasive use of targeted tax incentives. These tax expenditures cost state governments (and state taxpayers) billions of dollars in foregone revenue. Tax incentives limit, a state’s ability to tax corporations on their net profits. But the problem is that such incentives are rarely limited to a small number of companies. Once states offer tax incentives to a lucky few corporations, it is very difficult not to offer similar incentives too many companies. The result is a declining corporate tax base.

A BANDONMENT OF U NIFORMITY To promote interstate commerce, many states have modified the formulas they used to calculate corporate income tax. The use of different apportionment formulas among the states essentially disregards the notion that an effective corporate income tax system requires uniformity across state lines. The principle of uniformity requires that all states imposing corporate income taxes use the same (or very similar) rules for determining how corporations are taxed in which states have authority to tax corporate income. If all states adopted the same or very similar rules, corporations would be unable to create “nowhere income” that is not subject to taxes.

A PPORTIONMENT F ORMULAS Evenly weighted three-factor formula: Amount of sales Property Payroll Double-weighted sales factor Single-sales factor. In effect, double-weighting the sales factor benefits corporations with significant property and payroll in the state. Not all corporations benefit from using an apportionment formula with a double- or single-sales factor, since this method increases the tax burdens on corporations that sell a significant share of their products in a particular state, but do not maintain a sizable operations there. Although lawmakers believe that a double- or single-sales factor will encourage companies to expand their presence in the state, there is no real evidence that deviating from the traditional three- factor formula promotes economic development

F AILURE TO R EQUIRE C OMBINED R EPORTING States that do not mandate combined reporting are vulnerable to various corporate tax-avoidance strategies. State’s’ failure to require combined reporting also allows related corporations to shift profits from states with relatively high tax burdens to states with lower or no corporate tax burdens. The failure to require combined reporting also gives companies incentive to establish holding companies in states that do not impose corporate income tax on these entities, such as Delaware, and Nevada.

R ELATIONSHIP WITH THE F EDERAL C ORPORATE I NCOME T AX In virtually every state, the corporate income tax is calculated by reference to federal corporate taxable income. The net amount of adjusted federal taxable income must then be apportioned to the state, according to an apportionment formula – usually some weighted average of in-state sales to total sales, in-state employment compensation to total compensation, and in-state property to total property. As the federal bases narrowed, the amount of income subject to tax by the state is reduced directly. The only way to avoid substantial revenue losses is for states to decouple from the federal corporate tax laws. That is, states would no longer peg their corporate tax base to the federal tax base. The conformity between state and federal laws is intended to reduce compliance and administrative burdens on both taxpayers and governments.

O UTLOOK FOR THE S TATE C ORPORATE I NCOME T AX : S HOULD I T B E I MPOSED ? Given the relatively small amount of revenue generated by the corporate income tax, as well as the high cost of compliance and administration, the relevant question is whether state should impose the tax at all. The tax fails to achieve many of the rationales thought to justify its imposition. It has not played a role in protecting the personal income tax. There are several reasons for ending the corporate income tax. The problems discussed above have decimated the tax; most of them difficult, if not impossible to fix. Many experts believe that the corporate income tax is an inefficient, ineffective method for raising state revenue. With no serious opposition to the state corporate income tax on the horizon, the tax will no doubt continue to exist. Unless state strengthen the tax considerably, however, it will remain a minor source of revenue.

S TRENGTHENING THE C ORPORATE I NCOME T AX State should end the wasteful practice of offering tax incentives to corporations. Tax incentives have essentially gutted the corporate tax base, it states have been unwilling and unable to stop offering incentives to corporations. State could require unitary-based combined reporting for all related corporations. Strengthening the corporate income, tax depends on all the states working towards this goal.