Tuesday, July 25, 2006

Myths About Corporate Tax Loopholes

The Pittsburgh Post-Gazette published a letter to the editor on July 17 from Governor Ed Rendell (“The Legislature Must Enact a Fairer Business Tax Structure”) in which he justifies the failure to cut the corporate net income tax in the new state budget by saying that the legislature hasn't closed corporate tax loopholes.

The only evidence cited by the Governor that there is a problem with loopholes is a statistic that “less than 25% of Pennsylvania corporations pay the corporate net income tax.” He then adds "In many cases these companies do not pay because they rely on tax shelters in Delaware and offshore island havens to decrease reportable net income for Pennsylvania tax purposes."

For years, state officials have been using this statistic that 75% of corporations don't pay taxes to claim that Pennsylvania has too many tax loopholes.

What they fail to explain is that the reason most corporations don’t pay taxes is that most corporations have no income or profits at all (e.g., they may have no sales or employees). In fact, IRS statistics indicate that approximately half of corporations nationally have no taxable income.
In other words, half of the corporations would pay no tax regardless of how many or few loopholes there were.

Of course, if about half of the corporations have no income, then about half do have income. So if only 25% of all corporations pay Pennsylvania taxes, does that mean that half of those who have income are using loopholes? No, it doesn't -- corporations can use state tax credits, exemptions, loss carryforwards, etc. to reduce their taxes. In fact, the new state budget increases the number of opportunities for reducing the taxes that some corporations pay, by increasing the R&D tax credit and increasing the cap on carryforwards of net operating losses. The Governor provides no statistics on how many businesses are using tax shelters vs. state-approved methods of reducing their taxes.

The percentage of corporations paying taxes varies widely across states, but the percentage which pay taxes in Pennsylvania is actually higher than in some states that have tax laws which supposedly have fewer tax loopholes. Although some companies may be using tax loopholes to avoid taxes, it does not appear to be the massive problem the Governor's statistics would (mis)lead you to believe.

Rather than trying to identify and close the specific loopholes that are of concern, the solution that the Governor’s Business Tax Reform Commission proposed was to institute something called "mandatory combined reporting." Under this system, multi-state companies would be required to combine the income from all of their subsidiaries, including subsidiaries that have no operations in Pennsylvania, and then apply Pennsylvania's tax rate to the total.

None of Pennsylvania’s neighboring states have such a system. Corporate site selection consultants have indicated that establishing a mandatory combined reporting system would make Pennsylvania very uncompetitive for business expansions, even if the tax rate were also reduced. Moreover, the Pennsylvania Department of Revenue's own calculations show that under mandatory combined reporting, even if the corporate net income tax rate were reduced significantly, manufacturers would pay significantly more corporate taxes than they do today, making Pennsylvania even less attractive for manufacturing jobs than it is now.

In other words, the "cure" the Governor is proposing would be far worse than the alleged disease.

Twenty years ago, Pennsylvania reduced its CNI tax rate to 8.5%, and its job creation rate soared. Fifteen years ago, it raised the rate again and job creation plummeted. Since then, other states have reduced their tax rates, so that Pennsylvania's CNI tax rate is now second-highest in the country.

If we’re going to attract and retain employers in Pennsylvania, the corporate net income tax rate needs to be reduced now, rather than holding it hostage until other so-called “reforms” are enacted.


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