State corporate tax reform - things to consider

The February 25 Wall Street Journal included an article - "The State Business Tax Revolt Governors get a jump on corporate tax reform" noting that a few state governors, such as in Iowa and Florida, would like to reduce the state corporate income tax rate. The article contrasts this to President Obama's comment in his state of the union address to reduce the corporate tax rate although his FY 2012 revenue proposals do not include such a plan.

This all raises some questions such as, if states are having budget problems, why consider reducing a revenue source? The answer is economic development. Some lawmakers view a lower corporate tax rate as conducive to keeping and attracting business activity to the state. On the other hand, there are many, particularly individuals, who believe corporations have to pay their "fair share." These can be difficult positions to reconcile and the data is not clear as to what the right answer is.

Some considerations:

• Per 2009 US Census data, 9.4% of total tax revenues in California are from corporate income taxes (compared to 44% for the personal income tax and 29% for the sales tax). Similar data from the Federation of Tax Administrators shows that the average for the 50 states is that 5.6% of total revenues are from the corporate income tax.
• Ultimately, all taxes are paid by individuals. Taxes paid by businesses are ultimately paid by customers in the form of higher prices, employees in the form of lower wages or investors in the form of reduced earnings.
• An article from the Federal Reserve Bank of Kansas City - "Do State Corporate Income Taxes Reduce Wages?" by R. Alison Felix, noted that labor likely bears the greatest burden from the corporate income tax (page 83 - 84). The article notes that the corporate tax can cause corporations to seek the lowest tax rate. When a corporation leaves a state, there is less capital and workers become less productive and earn lower wages. The author notes that this can more adversely affect high-skill workers relative to low-skill workers because higher skilled workers may need access to high cost technology (capital).
• Businesses do use government services and the amount used can vary from industry to industry and the nature of the business. For example, a corporate sales office is unlikely to use as many government services as a shopping mall. But, is income the best measure of use of government services by businesses? Probably not.
• What exactly are corporate taxes? In addition to paying income taxes, they are also subject to sales tax, property taxes and a variety of other taxes including business license taxes at the local level.
• Many factors affect the corporate income tax making it difficult to determine the effect to the state's economy and coffers. For example, nexus interpretations, apportionment and sourcing rules.
• Not all businesses operate in the corporate form. Many businesses operate as sole proprietorships, or some type of passthrough entity (such as a partnership) or as an S corporation. Thus, corporate tax reform does not address the much broader category of business tax reform. Reductions in corporate tax rates may result in lower personal income taxes as other business forms decide to become regular corporations.

I think that a state repeal of its corporate income tax would be attractive to businesses, no doubt. But attractiveness also depends on other taxes it would pay. For example, in California, a business pays sales tax on its equipment and that is easily a 9% increase to the cost of the equipment. Many states exempt equipment purchases by businesses. Infrastructure is also a factor - education, roads, etc. Some local taxes, such as business license taxes may make some local jurisdictions unattractive.

But what about businesses contributing to their use of government services? I think this should be considered. Many of these costs are often local - traffic and police control, such as for a shopping mall. Business license taxes tied to type of industry might help local governments to better handle these types of costs.

It is a complicated analysis and of course, the corporate income tax should not be addressed in isolation of broader state and local reforms. Hopefully states considering reductions in corporate taxes will use that as a stepping stone to looking at the entire tax system and how it can be modernized and made to better meet principles of good tax policy.