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California Supreme Court to Decide Fate of 48-Year-Old Multistate Tax Compact

4 min readBy: Joseph Bishop-Henchman

I’m in California for a short vacation but tomorrow, the California Supreme Court will hear oral arguments in Gillette Co. v. Franchise Tax Board so I’ll be going to that. (If I can get in – the Court is also hearing arguments in a case about whether Californians can vote on an advisory measure overturning the federal Citizens United decision.)

So what’s the Gillette case? The issue is whether the Multistate TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Compact is a compact or a model law. In 2010, Gillette company (the razor people) sued California for $34 million in tax refundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s. s, invoking a provision of the Multistate Tax Compact that is more favorable than California law. California ratified the Compact in 1974 but in 1993 passed an apportionmentApportionment is the determination of the percentage of a business’ profits subject to a given jurisdiction’s corporate income or other business taxes. U.S. states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders. provision at odds with the Compact provision but did not withdraw from the Compact. The trial court ruled that the 1993 change was effectively a withdrawal from the Compact, but the appellate court reversed, holding that states cannot unilaterally change the terms of interstate compacts without affirmatively withdrawing from them.

Documents from the Multistate Tax Compact’s early days talk repeatedly about the importance of uniformity, efficiency, one auditA tax audit is when the Internal Revenue Service (IRS) conducts a formal investigation of financial information to verify an individual or corporation has accurately reported and paid their taxes. Selection can be at random, or due to unusual deductions or income reported on a tax return. , and the success of other compacts. Compacts by definition are binding agreements between the signatories that cannot be unilaterally altered. California (and the Multistate Tax Commission, the compact’s administrative entity) argue that the Multistate Tax Compact was merely a model law – suggestions that states could take all of, some of, or none at all.

Frankly, this argument requires ignoring a lot of the MTC’s history as well as what the “C” in its agreement name stands for. A number of other interstate compacts are also alarmed by this case, as they only work by being binding on all members and preventing unilateral changes.

Gillette v. FTB is really a compact law case, not a state tax case, but it has state tax implications. The underlying issue is how states divvy up the income of multistate corporations between them for tax purposes. When corporations existed in single states, this was easy: that one state got to impose its tax on 100 percent of the corporation’s income. When corporations began operating and existing in more than one state, some method of apportionment had to be developed, deciding how much of a company’s income each state could tax.

In 1957, a uniform law body recommended that each state adopt uniform apportionment rules, but only three states did. After the U.S. Supreme Court in 1959 removed some limits on state taxation of out-of-state corporations, Congress passed legislation overturning the decision and set up a study committee to recommend further legislation. The Willis Committee in 1964 recommended allowing states to compete on tax rates but making tax bases, including apportionment formulas, uniform. The Willis bill (and the similar Rodino bill later) was introduced several Congresses in a row and would have mandated a uniform two-factor corporate tax apportionment rule, based on the average of property in the state compared to all states and payroll in the state compared to all states.

States panicked, fearing that they would lose the ability to manipulate apportionment formulas to shift tax burdens to out-of-state corporations. To forestall congressional action and show that they were solving the problem, by the mid-1970s, every state had adopted a uniform three-factor corporate tax apportionment rule, averaging property, payroll, and sales. The Multistate Tax Compact and its Multistate Tax Commission (MTC) was set up to further this, with the stated purpose of “bringing even further uniformity and compatibility to the tax laws governing multistate businesses, to give both business and the states a single place to take their tax problems, to provide an agency that can study and make recommendations on a continuing basis with respect to all taxes affecting multistate businesses, to immediately adopt and place into operation statutes and rules establishing uniformity, and to protect the fiscal and political integrity of the states from Federal confiscation.” The uniformity didn’t last long; by the end of the 1970s, states began double-weighting the sales factor or having a single sales factor apportionment rule. Today, only a small minority of states still stick with the uniform provisions.

With the rampant disuniformity of state tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. s and a number of states openly abusing its tax system to shift tax burdens to out-of-state residents and businesses, it’s hard to say how the MTC has succeeded. Model legislation recommended by the MTC is usually ignored, coming as it does from a handful of tax administrators with little input from other stakeholders. A number of states have recently stopped paying MTC dues, and more will probably drop if the MTC succeeds in claiming that what few good requirements it does have are in fact non-binding.

In 1959, visionary members of Congress saw a looming problem where predatory and deliberately disuniform state tax laws would harm interstate commerce and the growth of the national economy. The states stepped in and promised that if Congress would hold off, they would solve the problem themselves with tools like the MTC. June 2017 will mark 50 years of the MTC saying it will solve these problems and that federal uniform rules aren’t necessary. Maybe it’s time we accept that the MTC isn’t working, and the Gillette case might be the first step of that realization.