Budget-wise, there are two kinds of states: those who have acknowledged the fiscal crater caused by the new Trump tax law and those that have not. Colorado joined the former camp on August 21, gaveling in a special legislative session to close a $750 million hole in the state’s current-year budget. Among the revenue-raising tax reforms under consideration are two provisions, embedded in a bill that was approved by a House committee on Thursday, that would more equitably tax the profits of big multinational corporations doing business in Colorado.
One would bolster Colorado’s corporate combined reporting regime by including corporate income reported in certain offshore tax havens in Colorado’s potential income tax base.
While combined reporting is the most effective single strategy for clamping down on multistate corporate tax avoidance, Colorado and almost all other states employing it use a “water’s edge” variety of combined reporting that can only reach income reported by corporate subsidiaries located within the U.S. This is problematic because, as ITEP and others have documented for years, large multinationals have developed a huge network of foreign subsidiaries into which U.S. income is shifted on paper to avoid paying state and federal income taxes.
While the best approach to ending this offshore tax avoidance is the adoption of worldwide combined reporting (WWCR), which includes all the income of foreign subsidiaries in a company’s potential state tax base, Colorado is one of a number of states that have taken a more incremental (yet still effective) approach to this problem by adding back income from a “tax haven list” of specified countries that are widely recognized as offshore tax havens.
The main limitation of this approach is that the accepted list of offshore tax havens changes over time and must be modified in response to those changes. This is exactly what the Colorado bill does, adding Hong Kong, Ireland, Liechtenstein, the Netherlands, and Singapore to its list of known offshore tax havens. Most of the states currently employing combined reporting could easily, and productively, follow Colorado’s lead in this way.
Another eminently sensible corporate tax reform on Colorado’s special-session agenda is decoupling from the Foreign Direct Investment Income (FDII) deduction.
Like a china cabinet full of old family “heirlooms,” the FDII deduction is a useless inheritance that many states have forgotten they were given. Enacted in 2017 and expanded by the recent Trump tax law, the FDII deduction was originally designed to encourage multinational corporations to onshore their intellectual property but now operates as a no-strings-attached giveaway to companies that sell products and services to customers in other countries. Because almost every state bases its corporate tax on federal rules, many states automatically adopted the FDII deduction starting in 2018 when Congress did so at the federal level.
If the claim that FDII encourages onshoring ever had a whiff of plausibility, it was because the FDII regime exempted a 10 percent rate of return on U.S.-based assets that contributed to the creation of foreign export sales. This means that corporations can reduce the U.S. tax rate on export sales by locating more of their sales-producing assets to the U.S. – although there is little empirical evidence to suggest that this incentive has had a real-world effect on the location of these assets.
But even when the federal FDII deduction could plausibly be described as encouraging repatriation of intellectual property to the U.S., it made little sense for Colorado or other states to adopt it. Any incentive effect of the deduction would have been spurred by the federal-level deduction, not the more trivial add-on effect of a state piggyback deduction. Moreover, intellectual property onshored because of the deduction could as easily go to California or Arizona as Colorado, raising the question of why Colorado lawmakers would want to subsidize onshoring that only benefits other states.
Changes made to the FDII deduction by the 2025 Trump tax law, enacted in July, eliminated the 10 percent rate of return exemption, which means that that even its advocates can no longer say with a straight face that FDII might encourage onshoring of intellectual property. It’s now a simple export subsidy. All the more reason for Colorado and every other state that currently couples to FDII to stop doing so.
Colorado lawmakers have other sensible progressive options for reducing the state’s newly-unfolding deficit.
A temporary provision that disallows Colorado’s version of the federal qualified business income deduction for high-income Coloradans is set to expire at the end of 2025; one pending bill would make this provision permanent, raising close to $50 million a year in a way that would affect only the very wealthiest state residents.
Similarly, Colorado could decouple from the new tax law’s boost in the itemized deduction SALT cap to $40,000, a move that would also have virtually no impact on low and middle-income Coloradans.
And the newly expanded federal tax breaks for accelerated depreciation and “Opportunity Zones” threaten state revenues in a way that could be avoided by simply decoupling from these federal tax breaks.
Every state faces impending fiscal challenges due to the corrosive effect of the new Trump tax law. Colorado lawmakers are now sensibly facing up to those challenges. As more states inevitably come to grips with the budgetary holes created by the Trump administration, the corporate tax reform strategies being pursued by Colorado this week will be a sensible template for action.
