State Tax Climate Issues

Douglas L. Lindholm

President & Executive Director

Council On State Taxation (COST)

dlindholm@cost.org

NCSL Fiscal Analysts Seminar

October 5-6, 2016

State Tax Climate Issues and

Misperceptions

#1: Suggestions for improving state tax administrative climate

#2: Assertions that businesses don’t pay their fair share of state taxes

#3: State corporate income tax revenues are declining; personal income tax revenues are increasing

#4: Big businesses benefit from loopholes not available to small businesses, so let’s “level the playing field”

#5: Unitary combined reporting creates fewer tax distortions than separate entity filing, and is an effective way to close “loopholes”

#6: States should impose sales taxes on services to keep up with our expanding service economy

#7: In the name of transparency, corporate tax returns should be made publicly available

#8: Gross receipts taxes are an effective way to tax businesses

#9: State tax haven “blacklists” are an effective way to recoup millions in profits parked offshore

#10: How should states cope with targeted tax incentives?2

Tax Climate Issues

#1:

Suggestions for improving

state tax administration

(“The Best and Worst of State Tax

Administration”)

3

• Areas Evaluated:

– Independent Tax Dispute Forum

– Pay-to-Play Tax Litigation System

– Even-handed Statutes of Limitation / Interest

Rates

– Adequate Appeal/Protest Period

– Transparency

COST State Administrative

Practices Scorecard (2013)

Independent Tax Dispute Forums

HI

ME

RI

VTNH MA

NYCT

PA NJ

DC

DE

WV

NC

SC

GA

FL

ILOH

MIWI

KY

TN

ALMS

AR

LA

TX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

OR

ID

NV

CA

VA

MD

WA

AK

IN

A

B

C

D

Pay-to-Play Tax Litigation System

HI

ME

RI

VTNH MA

NYCT

PA NJ

DC

DE

WV

NC

SC

GA

FL

ILOH

MIWI

KY

TN

ALMS

AR

LA

TX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

OR

ID

NV

CA

VA

MD

WA

AK

IN

A

B

C

D

Even-handed Statutes of Limitation

HI

ME

RI

VTNH MA

NYCT

PA NJ

DC

DE

WV

NC

SC

GA

FL

ILOH

MIWI

KY

TN

ALMS

AR

LA

TX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

OR

ID

NV

CA

VA

MD

WA

AK

IN

A

B

C

D

Equalized Interest Rates on

Assessments and Refunds

HI

ME

RI

VTNH MA

NYCT

PA NJ

DC

DE

WV

NC

SC

GA

FL

ILOH

MIWI

KY

TN

ALMS

AR

LA

TX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

OR

ID

NV

CA

VA

MD

WA

AK

IN

A

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Adequate Appeal / Protest Periods

HI

ME

RI

VTNH MA

NYCT

PA NJ

DC

DE

WV

NC

SC

GA

FL

ILOH

MIWI

KY

TN

ALMS

AR

LA

TX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

OR

ID

NV

CA

VA

MD

WA

AK

IN

A

B

C

D

Transparency in Guidance & Rulings

HI

ME

RI

VTNH MA

NYCT

PA NJ

DC

DE

WV

NC

SC

GA

FL

ILOH

MIWI

KY

TN

ALMS

AR

LA

TX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

OR

ID

NV

CA

VA

MD

WA

AK

IN

A

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Overall Grades: State Tax

Administration

HI

ME

RI

VTNH MA

NYCT

PA NJ

DC

DE

WV

NC

SC

GA

FL

ILOH

MIWI

KY

TN

ALMS

AR

LA

TX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

OR

NV

CA

VA

MD

WA

AK

IN

A

B

C

D

Tax Climate Issues

#2:

Assertions that businesses don’t

pay their fair share of state taxes

12

Bumper Sticker by Citizens for Tax Justice:

13

COST Business Tax Burden Study

14

Businesses paid more than $688 Billion in U.S. state and local taxes in FY2014, an increase of 2.2% from 2013

• How Much Do Businesses Contribute to State Revenues?

– US Average for FY 2014: 44.8% of all state and local tax revenues

Remarkably, the business share of SALT nationally has been within 1% of 45% since 2000

COST Study, Total state and local business taxes: State-by-state estimates for fiscal year 2014, October 2015

What do Businesses Pay?

15

FY 2014 Total State & Local Business Taxes, Nationwide

36%

21%8%

12%

8%5% 10%

U.S.

Property

Sales

Corporate Income

Excise Tax

Unemployment Insurance

Individual Income

License & Other

FY 2014 COST Business Tax Burden Study Published 9/201516

Share of State and Local Business Taxes Paid by Businesses

See generally, COST Business Tax Burden Studies, available at www.cost.org.

SHARE OF STATE AND LOCAL TAXES

PAID BY BUSINESSES, 2000 to 2014

17

Why Tax Business at All?

• Who really pays business taxes?:

– Labor (lower wages)

– Consumers (higher prices), or

– Owners (smaller investment returns)

• Best Rationale: Businesses should pay for benefits provided

by governments

– Dilemma: How to account for spending on education

• “Tax to Benefit Ratio” for US businesses: 3.35/1 (1.23/1 if

50% of education spending benefits businesses)

18

Tax Climate Issues

19

#3:

State corporate income tax

revenues are declining; personal

income tax revenues are

increasing

20

Economic Role of the Corporate Income Tax

• Bill Fox, et al.: “…there is little [economic] justification for the state corporate income tax.”

• Charles McClure: “It is hard to think of a good reason to tax corporate income….The case against state corporate income taxes is even stronger.”

• OECD: “…corporate income taxes are the most harmful type of tax for economic growth.”

21

10.9% 10.4% 8.3% 8.5% 8.4% 9.9% 10.7% 11.3% 10.8% 9.6% 9.0% 9.3% 9.1% 9.3% 9.4%

State and local CIT and other business activity tax collections as share of total state and local business

tax collections

22

Trend to watch: Growth of Pass-Through Entities (PTEs) Taxed under the PIT

• In 1980, PTEs accounted for 20% of total US business income; In 2012, PTEs accounted for 64% of US Business income (Tax Foundation Report)

• In 2014, 52% of state income tax revenues were received from state personal income tax revenues (COST/EY Study)

• PTE’s pay a lesser average combined federal/state rate than C Corporations: 19% v. 31.8% (NBER Study)

• Growth of PTE’s will have significant future impact:– Federal tax reform implications (corporate integration?)

– Federal and state audits of partnerships as entities

– Growth of PTE’s accounts for much of the growth in income inequality over last three decades (NBER)

23

Tax Climate Issues

24

#4:

Big businesses benefit from

loopholes not available to small

businesses, so let’s “level the

playing field”

25

26

Tax Climate Issues:

#5:

Unitary combined reporting creates fewer tax distortions than separate entity filing, and is an effective way

to close “loopholes”

27

Mandatory Unitary Combined Reporting

• Judicial doctrine, vague definitions

• Assumes all entities in group have same level of profitability

• No Federal conformity for unitary groups

• Complex compliance & audits; encourages costly litigation

• Does not provide a stable revenue source

• Fiscal estimates speculative; creates winners & losers

• Does not improve “fairness” of tax system

• Other tools available to combat “income shifting”

Tax Climate Issues:

#6:

States should impose sales taxes on business services to keep up with our expanding service economy

30

45%

LEGEND

Lowest GSP

Mid GSP

High GSP

53%

36%

39%

State and Local Sales Taxes Imposed on Business Input Purchases, 2011

41%

N/A

57%

N/A

28%

53%

49%

55%47%

34%

52%

43%

39%

46%

33%

37%

55%

53%

45%

49%

53%

43%

34%

33%

44%34%

39% 35%

46%

51%

29%

32%

37%

40%

49%

N/A

33%

41%

39%

N/A

39%

46%

40%

36%

COST Sales Tax on Business Inputs Study, Published 2013

32%42%

N/A

31

“What’s Wrong With Taxing Business Services?”

• COST Study on Problems with Taxing Business Services: April 4, 2013

– “Pyramiding” of the tax leads to arbitrary and hidden differences in effective

sales tax rates on different goods and services that distort consumer choices;

– Lack of transparency in sales tax base creates higher “hidden” effective tax

rates making it difficult to determine who bears the burden of the tax;

– Taxes on intermediate purchasers put companies at a competitive

disadvantage and encourages them to relocate;

– Encourages companies to self-provide business services, reducing efficiency

and competition;

– Detrimental impacts on a state’s business tax competitiveness; and

– Extremely difficult compliance, sourcing, and definitional burdens for

taxpayers and tax administrators alike.32

Tax Climate Issues:

#7:

In the name of transparency,

corporate tax returns should be

made publicly available

33

Corporate Return Disclosure

• From the US Congress Joint Committee on Taxation (2000):

– Taxpayers have a justifiable expectation of privacy in the extensive information they furnish under penalty of fine or imprisonment.

– Our tax system is based on voluntary compliance. Many observers believe that the degree of voluntary compliance is directly affected by the degree of confidentiality given the information that is provided to the IRS.

– If returns and return information were publicly available, it would invite a variety of intrusions into a taxpayer’s privacy.

– Business competitors could use the information to gain economic advantage.

– A lack of confidentiality could also facilitate the use of return information for political gain.

34

Corporate Disclosure Examples:Abuse? You Decide.

35

Tax Climate Issues:

#8:

Gross receipts taxes are an effective way to tax businesses

• Uneven Stealth Tax: Violates principles of economic competitiveness and transparency

• Unfair Tax: Imposes Significant Tax Burden on Start-Up, Low Margin and Unprofitable Enterprises

• Tax Pyramiding: Imposed at Every Level of Production

• Least Economically Neutral Tax

• “There is no sensible case for gross receipts taxation…. [Gross receipts taxes] do not belong in any program of tax reform.”

COST/Tax Foundation: “Gross Receipts Taxes in State Government Finances: A Review of Their History and Performance,” John Mikesell, Indiana University, Published January, 2007

Gross Receipts Taxes as a Policy Choice

COST/Tax Foundation: “Gross Receipts Taxes in State Government Finances: A Review of Their History and Performance,” John Mikesell, Indiana University, January, 2007. (www.cost.org)

Gross Receipts Taxes as a Policy Choice

Tax Climate Issues:

#9:

State tax haven “blacklists” are an

effective way to recoup millions in

profits parked offshore

40

International Competition

41

Existing State “Tax Haven” Provisions

• Six states (Alaska, Connecticut, Montana, Oregon, Rhode Island, and West Virginia) plus DC currently have some form of a “tax haven” provision that seeks to include certain foreign entities in a state’s unitary combined return

• Two approaches:

– 1) Blacklist: Defining a “tax haven” by maintaining a statutory list of foreign jurisdictions (commonly referred to as the “blacklist” approach). MT & OR (current), CT & DC (repealed)

– 2) Criteria: Employ a facts & circumstances test that looks to certain criteria, typically modeled after the Multistate Tax Commission’s “tax haven” definition in the combined reporting model statute.

Council On State Taxation

42

“Tax Haven” State Enactment Status

and 2015/2016 Proposals

AK

HI

ME

RI

VT

NH MA

NYCT

PA

NJ

CT

DE

WV

NC

SC

GA

FL

ILOH

IN

MIWI

KY

TN

ALMS

AR

LATX

OK

MOKS

IA

MN

ND

SD

NE

NMAZ

COUT

WY

MT

WA

OR

ID

NV

CAVA

MD

DC

MTC

*

*

* DC and Connecticut have subsequently repealed or removed the “blacklist”

requirement in favor of “indicia” of tax havens.

Enacted Tax Haven Provisions

Tax Haven “Blacklist” Included or Required in Enacted Legislation

2015 Proposals- Not Enacted

2015/2016 Proposals

2016 Proposals

Paul J. Hartman State and Local Tax Forum 43

• The lists are based on an outdated OECD list developed for transparency & information sharing

• Not limited to island economies, and includes low tax rate and other tax favorable characteristics

• The list creates a huge disincentive for foreign direct investment – few states realize their extent of FDI

• The faulty premise of tax haven legislation: profits booked to these countries are per se tax evasion

• Potential constitutional infirmity (and guaranteed litigation) resulting from tax haven approach

Council On State Taxation

Problems with Tax Haven Legislation:

the Arbitrary Nature of the Lists

44

Council On State Taxation

45

Comparing US PIRG Estimates

to Actual State DOR Data

Jurisdiction

Montana

Oregon

Massachusetts

Colorado

Kentucky

New Hampshire

Dist. of Columbia

PIRG Estimate

$35 million

$225 million

$991 million

$246 million

$187 million

$98 million

$284 million

State Estimate

$7 million

$18 million

$79 million

$46 million

$65 million

$5 million

$3 million

Fiscal Impact of Proposed Tax Haven

Legislation in Various States

45

Released March 1, 2016 (www.cost.org)

46

Tax Climate Issues:

#10:

How should states cope with

targeted tax incentives?

Council On State Taxation

Questions?

dlindholm@cost.org

Tax Foundation Rankings

– TF 2015 State Business Tax Climate Index:

(Best: Wyoming; Worst: New Jersey)

• North Carolina: 16th (44th in 2014)

• Louisiana: 35th (32d in 2014)

• Ohio: 44th (42d in 2014)

• Minnesota: 47th (same)

• New York: 49th (same)

– Considerations:• Measures 5 taxes: PIT, CIT, SUT, PT, UIT

• The absence of a major tax is a significant factor;

• Different business taxes are weighted differently;

• Severance taxes are not included

Tax Foundation Study: Weighting of Taxes

Source: Texas Taxpayers and Research Association