Lame Excuses for Not Cutting the Corporate Net Income Tax

The new state budget in Pennsylvania is due this week. Will the Governor and General Assembly use it to fix America’s Worst Business Tax?

At 9.99%, Pennsylvania’s Corporate Net Income (CNI) tax has the highest flat rate in the country. (Iowa has a 12% rate on net income over $250,000, but the rate is only 8% for the first $100,000 in income.) Moreover, Pennsylvania is one of only two states (the other is New Hampshire) that caps the amount of net operating loss carryforwards, which means that startup companies and businesses in cyclical industries pay the high tax rate on more of their income than in other states.

In 2004, Governor Rendell’s Business Tax Commission said that “Pennsylvania’s Corporate Net Income (CNI) Tax rate is not competitive with other states … [it] discourages both new economic development and the retention of existing Pennsylvania businesses.” Earlier that year, a business/labor tax commission said the high CNI tax rate “contributes powerfully to the perception of Pennsylvania as unfriendly to business.”

So with the economy struggling, why doesn’t the state cut the tax?

You’ll hear a variety of excuses and justifications for not cutting the CNI tax rate. Here’s why they are misleading or misguided:

“We need to close tax loopholes before cutting the tax rate.” As evidence that big tax loopholes exist, Governor Rendell is fond of saying that “73% of businesses subject to the CNI tax pay no taxes.” But IRS statistics show that the reason most corporations don’t pay taxes is that half of the corporations in the country have no income or profits to tax. Moreover, in some of the states that supposedly have fewer loopholes, an even smaller percentage of corporations pay taxes than in Pennsylvania. The cure the Governor has proposed (mandatory combined reporting) would be worse than the alleged disease, since it would increase taxes on manufacturers significantly even if the rate is reduced.

“National studies say that Pennsylvania’s business taxes are competitive.” Governor Rendell cites the Tax Foundation’s State Business Tax Climate Index, which ranks Pennsylvania 27th out of 50. But if you look closely at the index, you’ll see that it ranks Pennsylvania 42nd out of 50 states on corporate taxes, i.e., 8th worst. (The better ranking on the overall index is because of the state’s low personal income tax rate.)

“We can’t afford to cut business taxes.” When the state estimates how much it will cost to cut the tax, it assumes the worst case scenario, i.e., no change in the number or size of businesses to be taxed. Yet the whole reason for cutting the tax is that it is deterring businesses from locating and expanding in the state. As an example of why the estimates are too conservative, when Pennsylvania reduced the rate of the Capital Stock and Franchise Tax (the state’s other major business tax) by 33% between 2003 and 2006, the total revenues from the tax increased by over 20%. So in fact, the state can’t afford not to cut the tax.

“Instead of giving tax cuts to wealthy corporations, we should reduce the state’s Personal Income Tax.” At 3.07%, the Personal Income Tax is actually Pennsylvania’s most competitive tax. Of the 41 states with a personal income tax, Pennsylvania has the second lowest rate after Illinois. If the state can create more jobs by becoming more business-friendly, that will increase the revenues from the Personal Income Tax (more jobs = more income = more tax revenues), enabling the rate to be cut in the future.

Twenty years ago, Pennsylvania’s CNI tax was reduced to 8.5%, improving the state’s ranking to 16th. Job creation in the state soared. In fact, the only time in the past 30 years that Pennsylvania’s job growth matched the U.S. rate was in 1987, after the CNI tax rate was reduced. But then the state increased the tax dramatically in 1991, and the state’s job growth rate plummeted.

With Pennsylvania continuing to experience slower job growth than most states, it’s time to stop making excuses. The state needs to cut the Corporate Net Income tax rate significantly this year.

(A shorter version of this post appeared in the Pittsburgh Business Times on June 27, 2008.)