State Tax Reform: Targeting Business

Continuing on Ernie’s theme from last Monday, two news pieces caught my attention this past week regarding state tax policy.

One involved a pending bill in California (reported in the BNA Daily Tax Report for Friday, August 11) that would quadruple-weight the sales factor used in apportioning business income in that state. A multistate business faces a practical problem in determining how much income should be taxed in each state in which it has operations. One approach to this problem involves separate reporting for the business operations in each state – which is often not possible for integrated businesses. (For example, how much income does an automaker make from a spark plug plant, when most of its output is put into finished vehicles? It is not an easy question to answer.)

The other approach involves formulary apportionment. The traditional approach looks to three factors: property, payroll, and sales. The rationale is that the income of a business comes from all of these sources, and that the state can expect something in return for its governmental services in each of these areas.

However, some states have decided to overweight sales. A few, like Nebraska and Iowa, go with a single factor – sales only. Others, like the proposal in California, would merely emphasize sales without eliminating the other factors.

Why do this? It is designed to attract business to your state which may export goods to others. Thus, if you want to locate a huge plant with lots of employees in Iowa (with a sales factor only), and you sell mostly to other states, Iowa taxes would be smaller than if Iowa had a three factor formula, with large numbers in the payroll and property categories). California is trying to do the same thing, except in a more muted way (i.e., quadruple weighting does not eliminate the impact of payroll and property).

Of course, if everyone else around you adopts the same formula, the tax advantage of a state with a single factor is reduced, and is effectively now based on the applicable rates. Thus, states must realize that tax rates still matter; fussing with formulas will not necessarily make them more competitive. Moreover, you must also worry that in some cases, the business may be taxed on more than 100% of its income. Just because one state adopts a single factor formula does not mean others must follow suit; using inconsistent formulas can result in more than 100% of the income, which is not friendly by anyone’s definition.


The other article is in State Tax Notes, highlighting limits on state tax revenues. (See McCarthy and Maag, Limits on State Revenue, State Tax Notes, August 7, 2006, at 397.) It contains a helpful chart dealing with the various types of tax limits. Six states have tax limits based on formulas, and sixteen states have supermajority requirements for tax increases. Eleven more are considering additional limits in the coming year. This is a matter that will deserve our future attention. It seems the problem here is much like that of the problem gambler: our legislators should theoretically be able to govern themselves, but we the people feel the need to put some constraints on their freedom to spend our money.

Ultimately, all our topics tie together, no?
Happy Monday.
EAM