How States Can Close Corporate Tax Shelters

February 27, 2012 at 12:20 pm

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.

In Case You Missed It…

February 24, 2012 at 3:58 pm

This week on Off the Charts, we focused on the federal budget and taxes, the economy and unemployment, Temporary Assistance for Needy Families (TANF), and housing policy.

  • On the federal budget and taxes, Richard Kogan showed why former House Speaker Newt Gingrich’s claim regarding the potential savings from repealing the civil service laws is incorrect.

    Kathy Ruffing explained that switching from the official Consumer Price Index (CPI) to a “chained” CPI would trim the growth of benefit programs and boost future tax revenues.

    Chuck Marr outlined our analysis of the President’s corporate tax reform framework.

  • On the economy and unemployment, Michael Leachman noted that the Recovery Act continues to save jobs and support the economy.

    Chad Stone listed three important facts about unemployment insurance (UI), and we highlighted our analysis of the changes that the recent legislation to continue federal emergency UI makes to the UI system.

  • On TANF, LaDonna Pavetti pointed out that when Congress recently extended the program, it failed to fund Supplemental Grants, which 17 mostly poor states have relied on to help operate their TANF programs.
  • On housing policy, Barbara Sard cautioned that proposals to raise rents on households with little to no income who receive federal housing assistance could create serious hardship or even homelessness.

In other news, we released reports on the President’s corporate tax reform framework, a new Congressional Budget Office report on the impact of the Recovery Act, and switching to the “chained” consumer price index.

When Reforming Corporate Taxes, Don’t Forget the Deficit

February 24, 2012 at 1:03 pm

We released a brief analysis of the President’s corporate tax reform framework this morning.  Here’s the opening:

The Administration has advanced a coherent framework for corporate tax reform that could lead to a more efficient corporate tax regime.  The framework’s main weakness is that it seeks no deficit-reduction contribution from corporate tax reform, aiming only for revenue neutrality.

Given the nation’s serious long-term budget problems and the painful sacrifices that policymakers will have to impose to put the budget on a sustainable path, it is imperative that all parts of the budget be on the table.  A key test of well-designed corporate tax reform, therefore, is that it contributes to long-term deficit reduction; the Administration’s framework falls short in this critical area.  The framework also lacks detail on how to achieve its revenue-neutrality goal.

To its credit, the Administration’s framework addresses the other key tests of successful corporate tax reform.  It would impose a minimum tax on the overseas profits of U.S.-based firms to correct the tax code’s tilt in favor of overseas investments and to reduce corporations’ incentives to shift domestic profits to tax havens.  It calls for reducing the tax code’s bias toward debt financing of corporate investments and for achieving greater parity between the tax treatment of large businesses with different corporate structures.  Finally, it calls for the elimination of certain industry-specific tax subsidies.

In analyzing this and other corporate tax reform proposals, we measure them against six tests outlined in our newly updated report.  A well-designed corporate tax proposal should:

  1. Contribute to long-term deficit reduction. Corporate tax revenues are now at historical lows as a share of the economy (see graph), at a time when the nation faces deficits and debt that are expected to grow to unsustainable levels.  Although the top statutory corporate tax rate is high, the average tax rate — that is, the share of profits that companies actually pay in taxes — is substantially lower because of the tax code’s many preferences (deductions, credits and other write-offs that corporations can take to reduce their taxes).  Moreover, when measured as a share of the economy, U.S. corporate tax receipts are actually low compared to other developed countries.  All parts of the budget and the tax code, including corporate taxes, should contribute to deficit reduction.  Well-designed corporate tax reform can improve economic efficiency and help on the deficit-reduction front at the same time.
  2. Corporate tax Revenues Near Historic Lows

  3. Reduce the tax code’s bias toward overseas investments. U.S. multinationals pay much lower taxes on profits from their overseas investments than on profits from their domestic investments.  That gives corporations a strong incentive to shift economic activity and income from the United States to other countries.  Policymakers should address the features of the corporate tax code that allow so much business activity to escape taxation and that favor foreign investments over domestic ones.
  4. Improve economic efficiency by reducing special preferences. The corporate tax code taxes different kinds of corporate investments at very different rates.  This “unlevel playing field” encourages businesses to choose among investments in substantial part based on their tax benefits, instead of making those decisions based entirely on investments’ real economic value.  Policymakers should level the playing field through corporate tax reform.
  5. Provide more neutral treatment of corporate and non-corporate businesses. Over time, various policy changes have made it easier for companies to enjoy the benefits of corporate status without being subject to the corporate income tax.  Reform should reflect the guiding principle that firms engaging in similar activities and enjoying similar legal benefits should be taxed at similar rates.
  6. Reduce the tax code’s bias towards debt financing. The current corporate tax code encourages corporations to finance their investments with debt (e.g., by issuing bonds) rather than equity (e.g., by selling stock).  This encourages corporations to rely excessively on debt, which, as the recent financial crisis demonstrated, poses risks for both the firms and the broader economy.  The tax code should be more even-handed in treating these two types of financing.
  7. Take specific steps to discourage tax sheltering. If policymakers lower the statutory corporate tax rate to well below the top individual tax rate, they should also establish safeguards to prevent high-income individuals from sheltering their income in corporations in order to pay taxes at a lower rate.

New CBO Report: Up to 2 Million People Still Owe Their Jobs to the Recovery Act

February 24, 2012 at 12:47 pm

A new Congressional Budget Office report finds that the 2009 Recovery Act is continuing to save jobs and protect the economy from what would have been a much deeper recession, as our updated analysis explains.

The Recovery Act achieved its primary goal of protecting the economy during the worst of the recession.  The CBO report finds that the act’s impact on jobs peaked in the third quarter of 2010, when up to 3.6 million people owed their jobs to it.  Since then, its job impact has gradually declined as the economy has improved and certain provisions have expired.

Still, even as of the fourth quarter of 2011, the Recovery Act:

  • increased the number of people employed by between 300,000 and 2 million,
  • increased real GDP by between 0.2 percent and 1.5 percent (see chart below),
  • Gross Domestic Product

  • reduced the unemployment rate by between 0.2 percentage points and 1.1 percentage points (see chart below), and
  • boosted the number of “full-time-equivalent” jobs by between 400,000 and 2.6 million, both by saving jobs and by boosting the number of hours worked. (Without the Recovery Act, many full-time workers would have been reduced to part-time status and fewer would have worked overtime.)


For these and other charts on the economy, see our chart book.

Speaker Gingrich’s Claim of $500 Billion in Civil Service Savings Doesn’t Add Up

February 23, 2012 at 4:29 pm

In last night’s presidential candidate debate, former House Speaker Newt Gingrich said, “if we were prepared to repeal the 130-year-old civil service laws and go to a modern management system, we could save a minimum of $500 billion a year with a better system.”

That’s incorrect.  Here’s why.

Total federal personnel costs in fiscal year 2011 — including indirect costs, like health benefits — were $432 billion, according to the Office of Management and Budget (see Table 11-4 here).  That figure includes the armed forces, which aren’t bound by the civil service laws, and the postal service, which was privatized back in 1989 and is no longer bound by most aspects of the civil service laws.  Subtracting those two groups of workers gives you $247 billion in total compensation for federal civil servants.

Putting this differently, even if we fired all Defense Department personnel who are not in uniform and all Veterans Administration personnel — and that’s half the civil service right there — along with FBI and DEA agents, air traffic controllers, food and mine inspectors, park and forest rangers, procurement specialists, Justice Department prosecutors, Social Security clerks, federal judges, passport officers, patent and copyright agents, and so on, and didn’t replace any of them, we would get only halfway to Gingrich’s $500 billion goal.