Thinking Correctly about Fiscal Federalism, State Sovereignty, and H.R. 1956
September 27, 2005
In the next few weeks, many tax commentators will argue that the physical presence rule (generally embodied in H.R. 1956, which will be heard today in the House Subcommittee on Commercial and Administrative Law) would violate the principles of federalism, would short-circuit a state-led solution to corporate tax complexity, would violate state sovereignty, and would increase tax sheltering. The following thoughts are important to remember when evaluating these claims:
1. One of the driving issues behind the calling of the Constitutional Convention in 1787 (and the Annapolis Convention in 1786) was the lack of a power in Congress to regulate commerce among the states. The impotence of Congress in this area was severely impacting commercial relations with foreign nations and between the states themselves.
2. James Madison’s Notes of Debates in the Federal Convention of 1787 reveals that many founders—including two of the most famous—had a great deal of frustration over the usurpation of rights and liberties by the States. James Madison was so frustrated with the States at the time of the founding that he even wanted to give the federal government an absolute veto power over all state legislation. Alexander Hamilton wanted to abolish the States altogether. The small states at the time obviously would have none of that, but the Constitution ultimately did give Congress an absolute veto over state regulation of interstate commerce.
3. Giving the power to regulate commerce to Congress is a judgment that an integrated national market is more important than the taxing authority of the States. Thus, statements such as “Congress should exercise its authority only to further cooperative efforts among the states to simplify …their tax systems” miss the mark entirely. Congress is free to set aside those state tax laws that, in its judgment, negatively impact interstate commerce and thereby hinder national economic growth.
4. H.R. 1956 would not exacerbate corporate tax sheltering. The states have a number of ways to fight corporate tax shelters. Lee Sheppard says that combined reporting is the best tool, arguing that “…[e]very single tax shelter trend identified by the MTC in its tax shelter report is directly traceable to the failure to require combined filing.” A federal physical presence requirement will not keep the states from fighting tax shelters.
Just yesterday, we released a report showing how the physical presence standard for business activity taxes is consistent with the benefit principle of taxation as well as international tax practice. Click here to read the report.