Even in the most progressive states, the corporate tax raises a pittance. Oregon brings in more money from its lottery than from its corporate tax. Maine hauls in more revenue by placing levies on tobacco and alcohol than by taxing corporate profits. And Connecticut raises almost as much cash from its amusement tax as it does from its corporate income tax.
The demise of the tax is attributable to aggressive planning on the part of corporate America. In 2000, 77 percent of all registered corporations in New Jersey, for instance, paid only the statutory minimum tax of $200. Ten of those corporations had combined profits attributable to business in the state of $2 billion.
Aggressive planning is only possible by virtue of state law. Legislators are inundated with the message that corporate taxes cost jobs, deter economic growth and cause businesses to relocate. More imaginary than real, the message resonates with legislators and has resulted in a proliferation of tax incentives given to businesses that promise to relocate to or remain in the state--at a cost of shrinking the tax base by billions of dollars.
The lobbying has also resulted in technical changes to the corporate tax laws that neither the public nor most political leaders really understand. In 24 states, for example, corporations can avoid tax simply by creating related entities in no- or low-tax states. Those related entities make nothing, sell nothing and employ no one. They exist only in the desk of a lawyer yet allow hundreds of millions of dollars of corporate taxes to go uncollected. In addition, 26 states have laws that prevent them from collecting income tax on "non- business" income, i.e., income not earned from the main business operations. Not surprisingly, tax planners have found ways to turn business income into non-business income. Corporations also make use of pass-through entities such as limited liability companies, S corporations, and partnerships--entities that are not subject to corporate tax and are often created for no other purpose than tax avoidance.
Perhaps even more ominous, the rules for determining how corporate taxable income is calculated are changing. Traditionally, states calculated corporate tax liability based on the amount of a company's property, payroll and sales in a state. Now, the trend is to allow corporations to calculate the tax based only on the amount of sales in a state. That means that corporations with substantial property and payroll but little sales can avoid virtually all corporate tax liability. To complicate matters, federal law prohibits income taxation of corporations that merely sell in a state. Corporations that plan well--and many do--are not taxed where they manufacture or where they sell.
But corporate profits should be part of a state's tax base. For starters, there's a lot of revenue there. States could collect enough in corporate taxes to close most of their budget gaps. In addition, the corporate levy helps diversify the tax system and alleviate pressures on other taxes. But if corporate entities are not taxed, the burden of paying for government falls more heavily on individuals and small businesses. The best reason for taxing corporations, however, is that they benefit from services provided by the state, such as police, fire, health, education and transportation. They should pay for those services.
Legislators can change tax codes to ensure that all corporate income attributable to a particular state is taxed by that state. Laws can be reformulated to prevent tax avoidance by clever planning techniques. Political leaders can take a more responsible approach to using tax incentives as a means of spurring economic development. The states can work toward achieving more uniformity in their corporate tax structures, which would result in a more efficient tax system for governments and taxpayers. Those interested in reform should read an article by Michael Mazerov of the Center on Budget and Policy Priorities about the revenue that could be raised by closing three corporate tax loopholes.
Opponents will argue that corporate taxation deters economic growth. And many legislators and governors will listen, despite the ample research showing that the effects of corporate taxation on business development are at best minimal. It will take political courage to advocate the cause of corporate tax reform. With state budgets still in precarious shape, there is no better time to exhibit such courage.
