Florida Gov. Charlie Crist signed a bill in March that took effect Tuesday that decouples Florida’s corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. from the federal corporate income 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. , retroactive to January 1, 2009. In 2009, the federal government extended a generous depreciation deduction as part of the stimulus package, and Florida now joins several other states in refusing to apply the provision to state taxes.
Until 2001, most states with state-level income taxes copied the federal depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. deduction rules, and businesses only had to keep one set of books and perform one set of calculations for each eligible asset. Beginning with the 2002 stimulus package, however, many states have moved to “decouple,” that is, adopt different depreciation rules for their state. The chief reason states are decoupling is the belief that it will enable the state to collect greater tax revenues than if it stayed “coupled.”
Decoupling is a bad idea for five reasons:
1. Decoupling Does Not “Save” Revenue Because the Revenue Is Just Shifted In Time, Not Lost Permanently. Proponents of decoupling warn of dire revenue shortfalls in the hundreds of millions of dollars “in current and upcoming fiscal years” unless the state decouples from federal depreciation rules. This argument is deceptive because it presents only the first-year revenue loss, without stating that bonus depreciationBonus depreciation allows firms to deduct a larger portion of certain “short-lived” investments in new or improved technology, equipment, or buildings, in the first year. Allowing businesses to write off more investments partially alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. causes revenue increases in subsequent years. Tax Foundation calculations do show a tiny revenue loss, primarily because of the time value of money. This savings is substantially less than many proponents of decoupling suggest. States should be concerned about their long-term fiscal health, and the meager “savings” from decoupling simply aren’t worth other negatives that decoupling causes.
2. Decoupling Causes Increased Compliance and Administrative Costs to Handle Greater Complexity. A principle of sound tax policy is that tax systems should be as simple as possible because the cost of complying with complex tax systems is a real economic loss that distorts incentives and economic behavior. Decoupling violates this principle because it requires businesses to track their activity with two conflicting accounting and tax systems. Businesses must keep two sets of books: one for federal law that uses bonus depreciation, and one for a decoupled state that disallows it. This essentially doubles the cost of complying with the corporate income tax, which would likely harm investment, job creation, and long-term tax revenues.
Taxpayers consistently complain about the complexity of the tax code, and for good reason: in 2005, the estimated time and money cost of complying with the federal income tax cod was 6 billion man-hours worth $265 billion. The code that year stood at 7 million words in 736 code sections, up from 718,000 words in 103 code sections in 1955. Decoupling makes this worse, both by increasing the cost of compliance to businesses, and the cost of administration to revenue officials who track and enforce the code.
3. States That Decouple May Miss Out on Economic Growth Induced by the Stimulus Package. Decoupling unlinks a state from federal tax law, and in this case, would eliminate the state-level growth that may occur from a law designed to increase national economic output. If economic output does increase, it would translate into additional state and local tax revenues for states that remain coupled. While stimulus at the federal level may or may not pay for itself, the higher revenue states receive from not undermining federal tax law and keeping compliance costs low more than offsets the net cost of coupling to the states.
4. Decoupling Negates the Economic Effect of the Stimulus Package. States play an important role in determining the extent of the economic stimulus. State tax systems are intertwined in many ways with the federal tax system. The decision of the states to also adopt bonus depreciation provisions for state tax purposes has implications for the potency of the provision and the resulting economic stimulus. Not only does failure to couple to the federal change reduce the investment incentive associated with the bonus depreciation provision, but the presence of differences between federal and state depreciation systems can act to discourage businesses from using the federal provisions. A similar bonus depreciation provision enacted in 2002 and expanded in 2003 was modestly successful, but one of the frequently cited impediments to businesses using the federal provision was the failure of many states to adopt the change for their own state corporate income tax systems.
5. Decoupling Sends the Signal That the State is Unfriendly to Business and Investment. The extent to which a state welcomes business owners and entrepreneurs making decisions about where to locate investment capital, equipment, and jobs depends on a number of factors that the Tax Foundation attempts to gauge in our annual State Business Tax Climate Index. States can be termed “unfriendly” if they consistently move the state tax system away from a sound tax policy, such as with increased complexity, retroactivity, high burdens, economic distortions, and a lack of transparency.
Decoupling is a move away from sound tax policy, because it increases tax burdens, reduces stability, and exacerbates an already complex income tax code. Businesses should be wary of states that have decoupled, since it signals that the state cares more about illusive (and mistaken) short-term revenue savings instead of long-term economic growth. While remaining coupled or recoupling is not in itself a signal of welcoming new investment, it signals a commitment to principled tax policy.
In short, estimates of revenue “savings” achieved by decoupled are inflated, because the revenue is shifted in time, not lost. However, decoupling produces a year-after-year administrative and compliance burdens that undermine long-term business investment and revenue growth. States that decouple also may miss out on some of the economic growth induced by the stimulus package, while signaling that the state’s tax system is unfriendly to entrepreneurs and business investment.Share