Next week, Wyoming’s Revenue Committee will meet to consider an idea which gained traction during the 2019 legislative session: the National Retail Fairness Act, which would impose a 7 percent 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. on C corporations with more than 100 shareholders that operate in the retail, accommodations, and food services industries. For a state which has never imposed an income tax—on either individual or corporate income—this would represent a significant development.
During the Great Depression, Wyoming policymakers strenuously debated the relative merits of income and sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. es, but by the close of the 1930s, the choice of a sales tax over income taxes had been firmly entrenched. In 1974, voters ratified a constitutional amendment providing that, should an income tax ever be adopted, it must allow a credit against income tax liability for any sales, use, or other ad valorem taxes paid to the state—not a prohibition, but certainly a significant impediment to income taxation, either individual or corporate.
Proponents see the National Retail Fairness Act as a modest step, limited to select industries and targeted at multistate chains. It is a perception bolstered by the belief that most of the collections under the new tax would not constitute an additional burden on businesses but would merely redirect revenues that otherwise would have been collected by other states. It is easy to understand how policymakers drew this conclusion, as it hinges on a misunderstanding of an important, but somewhat arcane, provision in other states’ 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. es. But it’s also important to provide clarity on this issue, so that decisions about the National Retail Fairness Act can be made with a full understanding of how the tax would, and wouldn’t, interact with the tax codes of other states.
The argument for the National Retail Fairness Act representing more of a tax shift than a tax increase is based on a provision of many states’ corporate income tax codes called the throwback rule, which allow states to apportion untaxed sales income earned out-of-state to their own tax system under certain circumstances, and tax it at their own rates. (For a primer on throwback rules, click here.)
These throwback rules, though important, can be arcane and are often poorly understood. They are often characterized as the ability for a state to impose its corporate income tax on sales income that is not taxed in another state—and Wyoming, of course, does not tax any such income at present. Rep. Jerry Obermueller (R), the bill’s sponsor, was referencing this notion when he referred to throwback rules as a “hidden tax” on Wyoming consumers, asking, “If every consumer in Wyoming had to fill out a tax return form and send their money to Arkansas, that would get their attention, wouldn’t it?” As he saw it, “They’re paying a tax and the only mechanism to get it back is good government, and that’s what we’re working [on] here.”
This is, however, an oversimplification of what throwback rules are and how they work, one with important ramifications for a no-income tax state like Wyoming and for the impact of the National Retail Fairness Act in particular. Throwback rules aren’t a way for a state to tax the sales income another state has left untaxed, but rather the sales income that is untaxable, an important distinction.
States have significant, but not unlimited, powers of taxation. Both the U.S. constitution and federal statutes place a few limits on state authority to levy taxes. One of the more significant limitations comes from a federal law, Public Law 86-272, which prohibits states from taxing income arising from the sale of tangible property into the state by a company whose only activity in that state is the solicitation of sales.
For example, if a company based in Oklahoma makes sales into Colorado, but the orders are processed in another state, the products are shipped from another state using a common carrier, and all production was undertaken in another state, with no Colorado presence by the seller, then Colorado lacks nexus to tax the company. However, the moment it establishes nexus—by, say, the presence of a single employee or so much as one in-state sales kiosk—all its Colorado activity is subject to 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. .
Throwback and throwout rules are designed to allow states from which sales originate to tax the income from those sales in cases where the destination state, which would normally do so, lacks the jurisdiction to levy tax on a given company. In the scenario given above, if sales into Colorado could not be taxed by that state, the origination state (Oklahoma) would be able to “throw” those sales back into the numerator of its apportionment formula, essentially taxing those sales as if they took place in Oklahoma.
The leap of logic undertaken by Wyoming policymakers is understandable: due to the state’s decision not to impose a corporate income tax, an out-of-state company’s sales into Wyoming are not taxed there, and thus—the logic goes—they must be thrown back into other states’ 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, to the extent that they have throwback and throwout rules, as 25 states and the District of Columbia do.
This is, however, incorrect, since throwback rules do not ask whether economic activity in another state is taxed, but whether it is taxable. Throwback has two requirements, both of which must be satisfied:
- The taxing state must be the location from which the tangible property is shipped; and
- The income is not taxable in the state of the purchaser, either because that purchaser is the federal government or because the destination state lacks jurisdiction to levy a tax.
There are companies with sales into Wyoming that are not taxable in the state, because they lack sufficient nexus. Many other companies are, in fact, taxable—even if Wyoming chooses not to levy a corporate income tax. What matters, for purpose of the throwback rule, is not that Wyoming does tax a company, but that, from a federal perspective, it could—that it has the legal authority to do so.
That makes a huge difference, since part of the argument for the National Retail Fairness Act has proceeded from the assumption that chain retailers, hoteliers, and restaurateurs operating in the state are paying corporate income taxes to other states on their Wyoming activity, and that this would no longer happen if Wyoming imposed its own corporate tax on their in-state activity. But, to the extent that Wyoming is legally permitted to tax their activities—and it would, by definition, have nexus to tax companies with a physical presence in the state, like restaurants, hotels, and retail stores—no other state is able to “throw back” that income into their own apportionment formulas now.
Ultimately, policymakers must decide whether they wish to abandon Wyoming’s distinction as one of two states without a corporate income or gross receipts taxA gross receipts tax is a tax applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. , and whether a tax singling out such a narrow set of industries is appropriate. More generally, however, Wyoming legislators appear genuinely committed to avoiding new taxes, and the intention here seems to be to redirect to Wyoming taxes that are already being collected elsewhere. Unfortunately, that is not what the National Retail Fairness Act does, because the proposal relies on a misunderstanding of the workings of throwback rules.
The Equality State faces important decisions. Just today, two coal mining operations declared bankruptcy, with about 700 employees laid off. Resource extraction accounts for about 20 percent of the state’s GDP, so price fluctuations in coal, oil, and natural gas create substantial revenue volatility. An evaluation of the state’s sources of revenue is appropriate, but it should not proceed on the basis of a misunderstanding.
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