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How States Can Close Corporate Tax Shelters

Testifying last week before Maryland lawmakers, I explained why the state would benefit from joining the 23 states that have adopted a tax reform known as “combined reporting,” which treats a business composed of a parent corporation and one or more subsidiaries as a single corporation for tax purposes.

States without combined reporting are vulnerable to a wide variety of corporate tax shelters and tax-avoidance strategies in which businesses artificially shift profits to subsidiaries located in “tax-haven” states, as I explained in this 2007 report.  Combined reporting nullifies most of these shelters in one fell swoop.

The following excerpt from my testimony rebuts the claim that adopting combined reporting will make it harder for a state to attract and retain businesses:

[T]he record of combined reporting states in retaining manufacturing jobs . . . may be a reasonable indicator of whether combined reporting has a negative impact on the attractiveness of a state for investment, since manufacturers in theory don’t need to be as close to their customers as retailers, construction contractors, and other types of service businesses need to be and therefore can choose to locate where state and local tax policies are more to their liking.

In the last 10 years, every state except Utah and North Dakota has experienced a net loss of manufacturing jobs.  And yet there is no indication that the presence of combined reporting has played a role in a state’s relative success in retaining such jobs.  Of the 15 states with corporate income taxes that had the best record in retaining manufacturing job in the last decade, 10 were combined reporting states.  (This group of 10 includes Utah and North Dakota.)  Conversely, of the 15 corporate income tax states that lost the greatest share of manufacturing jobs, only two were combined reporting states, and only for a few years at the end of the decade.  There appears to be no correlation between a state’s adoption of combined reporting and its relative success in retaining what are theoretically the most potentially footloose firms and their jobs.

And there is a good reason for this.  All state and local taxes paid by corporations represent no more than 2 percent to 4 percent of their total expenses, on average.  On average, the state corporate income tax represents less than 10 percent of that already small share. And combined reporting will boost corporate tax collections on the order of 10 percent to 20 percent in most states.  It thus should not be surprising that the evidence I’ve just cited suggests that combined reporting has not been a disincentive for corporations to continue investing and creating jobs in states that adopt it.

Click here for the full testimony.