Just Taxes Blog by ITEP

Five Ways States Can Recoup Corporations’ Massive Federal Tax Giveaway

Five Ways States Can Recoup Corporations’ Massive Federal Tax Giveaway

March 2, 2018

Aidan Davis
Aidan Davis
Senior Policy Analyst

Corporate America is doing alright. Corporate profits soared last year, and 2018 has already brought a major windfall in the form of the Trump-GOP tax law, which dramatically cut the federal corporate tax rate from 35 percent to 21 percent and shifted to a territorial tax system, giving income earned offshore by U.S. companies a free pass by no longer making it subject to U.S. taxes.

The catch is that most individuals are not seeing the same boon. As ITEP has reported, the Trump-GOP tax law mostly benefited high-income households and wealthy investors, while offering little to low- and middle-income Americans.

Federal lawmakers are clearly uninterested in ensuring that corporations and the wealthy pay their fair share. But states have options to help remedy this mistake and recoup some lost revenue.

Where Has All the Corporate Revenue Gone?

As a share of the economy, federal and state corporate tax payments have fallen dramatically over the last quarter century despite booming corporate bottom lines.

In a 2017 analysis, ITEP found that the state effective corporate tax rate paid by Fortune 500 corporations was just 2.9 percent of their U.S. profits. Since the average statutory state corporate tax rate is about 6.25 percent (weighted by the size of state economies), that means that more than half of their profits went entirely untaxed over the study period (from 2008 to 2015).

Several factors continue to drive this decline. States have cut tax rates and enacted lucrative “incentives” as part of a race to the bottom, as illustrated most recently by the states’ and cities’ efforts to land Amazon’s second headquarters. Corporations use accounting gimmicks and otherwise manipulate loopholes in state tax systems. And the tax-cut-happy federal government has played a role as well, eroding state corporate tax bases indirectly because of states’ ill-advised linkages to the federal tax system, some of which—such as the shift to a “territorial” system—could lead to large state revenue losses.

All of these developments have undermined states’ ability to require corporations to pay their fair share for funding public investments that help their businesses subsist and thrive. However, there are steps that states can take to help restore corporate income taxes as progressive, popular ways to fund state programs. And the timing for these efforts couldn’t be better: with corporations just having received a major tax cut through the Trump-GOP tax bill, state lawmakers have a strong case that at least some of that giveaway should be recovered and invested in public priorities like education and infrastructure, which are vital to economic success for people and businesses of all types.

Here are a few options states have to regain lost revenue while revitalizing this important and progressive tax.

1.      Enact Combined Reporting

Combined reporting requires large companies who operate in multiple states to calculate the profits of their various branches and subsidiaries in one single report. They then follow existing rules to allocate those profits to the states in which they operate. This seemingly simple step nullifies many strategies businesses may use to avoid taxes.

Taking this one step further, states that have already adopted combined reporting can improve their reporting game by moving toward “worldwide” combined reporting. This step would expand reporting beyond U.S. based companies and their subsidiaries, targeting international tax avoidance.

Read more on combined reporting here.

2.      Eliminate “Nowhere” Income

“Nowhere” income is the portion of a business’ sales that is not attributed to any state, and that results in a portion of corporate profits going untaxed. Nowhere income arises from a mismatch between the laws that establish when a corporation has crossed the taxability or “nexus” threshold in a state and the rules that divide a corporation’s profit for tax purposes among states. This phenomenon can be avoided by use of a throwback rule that would assign any corporate profit that cannot be taxed in the state(s) where customers are located to the state(s) where the goods are produced.

Read more on “nowhere” income here (PDF).

3.      Consider Alternative Corporate Taxes

An alternative minimum tax (AMT) would ensure that, regardless of the number of loopholes corporations are able to take advantage of, they pay some tax. A number of states couple to the federal corporate AMT, but it was repealed under the Trump-GOP tax law. States should consider creating a lower-rate backstop that would be simple to administer or a flat-dollar minimum tax that would also act as a backstop to ensure that large corporations pay something.

Another alternative would be to require a surcharge on large companies doing business in the state. California lawmakers recently proposed a policy that would require a payment of 7 percent on top of the state’s 8.84 percent state corporate tax rate for companies over a certain size.

4.      Stop Providing State Corporate Tax Subsidies

States can stop giving away corporate taxes in the name of economic development. Despite the high cost of divvying out these incentives, individual states and localities see little benefit, and the national outcome is a zero-sum game, or worse. States should coordinate with one another to slow or stop this destructive race to see who can provide the largest corporate handouts. They can also ask more of corporations that receive public dollars—such as jobs that pay a living wage—and can entirely sunset ineffective tax giveaways.

Read more on tax incentives here.

5.      Decouple from Federal Tax Giveaways

States use federal income definitions as a starting point in calculating their own corporate tax base, but every state has the option to “decouple” from specific corporate giveaways. The Trump-GOP tax law temporarily allows businesses to use “full expensing.” This practice allows businesses to subtract the cost of machinery and equipment in its first year of service from their gross receipts, rather than following “depreciation” rules where they subtract part of the total cost each year. The new law also expands rules that grant expensing to small businesses. To avoid considerable short-term revenue loss from this policy, states can decouple.

The new Trump-GOP tax law also includes a one-time “deemed repatriation” tax on offshore profits. Taxing deemed repatriation is a complex issue, under consideration in some states, that could potentially bring in revenue.

With the Trump-GOP tax giveaway, corporations can now afford to give some money back to those who need it most. States should consider these five options to claw back some of that lost revenue and use it to benefit all state residents.