A Twentieth Century Tax in the Twenty-First Century: Understanding State Corporate Tax Systems
Background Paper No. 49
No state has ever eliminated a direct corporate tax without replacing it, but proposals to do so are gaining momentum in many states. In 2005, bills were introduced in two states (Georgia and Utah) to eliminate state corporate income taxes altogether. Bills were enacted in Kentucky and Ohio to eliminate the corporate income tax and replace it with a corporate tax on gross receipts (proponents think this will be a pro-competitive swap but in most cases they’re wrong). Lawmakers in these states want to make their tax systems more competitive for jobs and investment in the international marketplace.
Even states that have not contemplated repeal are modifying their corporate taxes. At least five states debated bills to reduce corporate tax rates in the 2005 state legislative sessions. Fourteen states have, or are steadily moving towards, single-sales apportionment for all or some taxpayers. Six states weight sales at least fifty percent or higher in their apportionment formulas. This year, bills were introduced in five more states and enacted in four states to move to full or modified single sales apportionment. Lawmakers in these states believe that general economic growth from a business-friendly tax code will offset specific corporate tax collections. Lawmakers in other states, by contrast, have become alarmed over the perception that state corporate tax revenues are declining.
These states have taken aggressive steps to prevent any “leakage” of tax revenues. Bills were introduced in at least five states to shore up corporate tax collections through the use of combined or unitary reporting. Organizations such as the Multistate Tax Commission (MTC) believe that harmonization of state corporate tax systems will also stem this “decline.” These measures, however, can have a chilling effect on a state’s image as an attractive place to do business, both in the national and international market and thus ultimately harm the state’s economy.
There are thus two groups of state lawmakers: one that sees the corporate income tax (or any direct tax on corporations) as an impediment to economic growth, and another that is struggling to retain corporate income tax revenues. The debate between these two groups rages and even spills over into the halls of Congress, where states that want to retain and fortify corporate income tax revenues urge Congress to help them raise revenue from out-of-state companies. Other state lawmakers urge Congress to clarify and simplify state corporate taxes by adopting a federal physical presence nexus standard. Commentator Lee Sheppard thinks these two groups have reached a “fork in the road” of state corporate tax policy, and states will now have to decide whether to retain the corporate tax or let it naturally wither away.
This paper will catalogue the ways in which state policymakers are responding to the perception that corporate tax revenues are declining. The following specific issues are covered: first, an overview of the multistate corporate tax system; second, a survey and primer of the three major multistate corporate tax issues (nexus, tax base, and apportionment); third, an analysis of the trends and proposed legislative changes in these three areas. The paper concludes that those wanting to keep state corporate taxes are fighting a losing battle and could make their states more competitive for international investment by reducing or eliminating corporate taxes entirely.