BEYOND THE NUMBERS
States Shouldn’t Use 2017 Federal Foreign Tax Rules to Justify Tax Cuts
Some states have enacted, or are considering, changes in their corporate income taxes in response to federal corporate income tax changes in the 2017 federal tax law. In so doing, they are laying the groundwork for future fiscal problems by cutting taxes in anticipation of a “windfall” they may not receive — particularly when state authority to enact such provisions may not hold up in court.
The debate has centered on how states might incorporate two new federal tax provisions on multinational corporations’ offshore profits into their own corporate tax laws. The first provision treats more than $2 trillion in offshore profits that corporations previously accumulated as if those corporations paid them all back to the U.S. parent company in 2017, subjecting them to immediate tax at a reduced rate. The second provision seeks to nullify future abusive international income-shifting essentially by imposing a minimum tax on above-average corporate profits attributable to foreign activities.
While state piggybacking on both provisions may generate some revenue eventually, a few states have cut taxes or repealed their own anti-profit-shifting rules, or have considered doing so, in anticipation of a significant and immediate revenue gain:
- In March, Georgia enacted a corporate rate cut, partially paying for it by piggybacking on the federal provision subjecting future offshore profits to a minimum tax. But just days after the governor signed the bill, corporate representatives sent a letter to the legislature threatening to sue if it didn’t repeal the provision. Lawmakers agreed, opening a $20 million to $30 million annual hole in the state budget.
- Oregon was next, taking action in early April. In exchange for an estimated $140 million one-time “windfall” from its share of the federal tax on existing offshore profits, the governor and legislature repealed an effective law of 2013 that prevented the artificial shifting of profits to well-known foreign tax havens like Bermuda and the Cayman Islands, which yielded at least $28 million a year.
- Kansas may be about to make a similar mistake. The House is considering a Senate-approved bill that would use expected revenue from piggybacking on both new federal provisions to help finance an increase in the state’s standard deduction and an accelerated phase-in of itemized deductions that were previously capped. Any revenue generated by the federal tax on existing offshore profits would be one-time, while the expanded standard deduction would drain revenue year after year. Worse, policymakers are considering all these changes in the absence of an official revenue impact estimate and after an acknowledgement by the Kansas Department of Revenue that uncertainty about how the two federal provisions will be reported on federal tax returns “makes estimation of changes in Kansas tax revenues not possible to quantify.”
States are right to try to capitalize on both federal tax provisions. Regarding the one-time tax, for example, state tax experts Darien Shanske and David Gamage observed, “There is overwhelming evidence that at least a substantial portion of the earnings parked abroad were, in fact, earned in the United States and should always have been part of the domestic corporate tax base.”
Nonetheless, this revenue may not show up in state treasuries for many years. That’s because organizations representing major multinational corporations are poised to challenge in court any state efforts to piggyback on the provisions, which could block such revenue for some time. Pointing to a 1992 Supreme Court decision restricting states' ability to tax international income, Ernst & Young tax expert Steve Wlodychak noted, “There are some very, very serious constitutional questions that have to be determined.” Indeed, a leading law firm representing corporations in their tax disputes with states has organized a coalition to restrict states from piggybacking on the new federal rules, implying that corporations will sue if states move ahead.
Although the 2017 federal law (including its new international rules) is deeply flawed, states should take advantage of the opportunity to recover revenue they previously lost due to international income-shifting, and to protect themselves from such income-shifting as much as possible in the future. But they can’t afford to use this “windfall” to finance tax cuts or anything else until the legal issues are resolved and they know how much revenue they’ll receive.