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States Should Preserve Net Operating Loss Carrybacks

1 min readBy: Joseph Bishop-Henchman

Tax Analysts covers a new study from the Center on Budget and Policy Priorities’s Michael Mazerov (available here) arguing that states should disallow net operating loss carrybackA Net Operating Loss (NOL) Carryback allows businesses suffering losses in one year to deduct them from previous years’ profits. Businesses thus are taxed on their average profitability, making the tax code more neutral. In the U.S., a Net Operating Loss cannot be carried back (only carried forward). deductions. These deductions allow businesses to reduce their 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. bill by applying present day losses against past profits. About half the states allow carrybacks in addition to carryforwards, and a few states automatically go along with changes to federal carryback rules.

We criticized the report’s policy recommendation, since it would hurt whatever stimulative effect the federal carryback change might have:

Tax Foundation Vice President for Economic Policy Robert Carroll told Tax Analysts that states would reduce the potential benefits of the stimulus plan by eliminating their carryback provisions.

“I think they got it wrong,” Carroll said of the study, adding that the best way the federal government can help states is by encouraging economic growth. Carroll also said carryforward deductions are not as beneficial to businesses and the bonus 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. provision in the federal bill would be effective only in conjunction with carrybacks.

Joseph Henchman, tax counsel for the foundation, added that having more states decouple from federal laws would further complicate the tax code.

That we tax income annually is an arbitrary choice. Especially now, we see examples of businesses that posted good profits a few years ago but will have losses this year. Allowing these businesses to smooth out their tax obligations with their income, both backward and forward, reduces the arbitrariness of taxing by year. Allowing one but not the other tilts the playing field.

Ultimately, CBPP justifies its argument by noting that many states are short on revenue. But that doesn’t by itself justify economically harmful, fragmented, and burdensome tax policy for states. There’s no principles here, just a revenue grab.