SEVERAL STATES CONSIDERING CLOSING
MAJOR CORPORATE TAX LOOPHOLES
Governors in six states have recommended that
their state adopt a key reform to outlaw a variety of abusive
income-tax-avoidance strategies practiced by corporations such as Wal-Mart, a
new Center on Budget and Policy Priorities report explains.
Eighteen states had already adopted the reform,
known as “combined reporting,” as of the start of 2007. In recent weeks, the
governors of Iowa, Massachusetts, Michigan, New York, North Carolina, and
Pennsylvania all proposed the reform as part of their new budgets. New York’s
legislature approved the proposal on April 1. On March 10 West Virginia’s
legislature enacted a combined reporting bill that was not initiated by the
governor, but which he is expected to sign.
“Six governors decided this year, independently
of one another, that it’s time to make their corporate tax systems fairer and
stronger by adopting this reform,” said Michael Mazerov, a senior fellow at the
Center and the report’s author. “Tax experts have long urged states to take this
step, and this year a growing number of states are listening.”
Reform Prevents Corporations from Hiding Profits
in “Tax Haven” Subsidiaries
To avoid state corporate income taxes, a number
of large, multistate corporations have devised strategies to move profits out of
the states in which they are earned and into states in which they will be taxed
at lower rates — or not at all. They do this by creating subsidiaries largely or
solely as tax shelters in “tax haven” states like Delaware and then artificially
shifting funds to them in the form of royalties or rent.
For example, Wal-Mart has transferred ownership
of all of its stores to a Wal-Mart subsidiary. In most states, this enables
Wal-Mart to deduct the “rent” it pays the subsidiary (i.e., the rent it pays
itself) from the income that is subject to state corporate taxes. The subsidiary
receiving the rent isn’t taxed because it qualifies as a tax-exempt “Real Estate
Investment Trust” under federal and state law.
Strategies like these cost states billions of
dollars in revenue, forcing individuals and small businesses — which lack the
resources to exploit the loophole — to pay higher taxes than would otherwise be
necessary. They also give multistate corporations an unfair tax advantage over
in-state corporations and smaller businesses.
Combined reporting creates a level playing field
for all businesses by treating a parent corporation and most of its subsidiaries
as a single corporation for income tax purposes; the state taxes a share of the
entities’ combined nationwide income. (The precise share depends in part on how
much of the corporation’s total activity takes place in that state.)
Growing State Interest in Combined Reporting
Sixteen states have mandated and successfully
used combined reporting for decades, as the map above shows. Until recently,
however, that group had not expanded at all — not even after the U.S. Supreme
Court ruled in 1983 that combined reporting was both fair and constitutional.
That changed in 2004-05, when Vermont became the
first state in more than 20 years to adopt combined reporting and Texas included
combined reporting in a new business tax it enacted. West Virginia and New York
have adopted the reform in just the past few weeks. And Governor Michael Easley
of North Carolina, Governor Chet Culver of Iowa, Governor Jennifer Granholm of
Michigan, Governor Deval Patrick of Massachusetts, and Governor Edward Rendell
of Pennsylvania have all recommended combined reporting as part of their current
tax and budget packages.
“Combined reporting can bring in revenue to help
a state finance essential public services like education and health care,” said
Mazerov. “Closing major corporate tax loopholes through combined reporting will
make a state’s tax system fairer to state residents and businesses, as well as
stronger over the long term.”
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The Center on Budget and Policy Priorities is a nonprofit, nonpartisan research organization and policy institute that conducts research and analysis on a range of government policies and programs.