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Lessons from Recent State and Local Tax Reforms

Lessons from Recent State and Local Tax Reforms. Presentation to Connecticut Legislative Program Review & Investigations Committee State and Local Tax Policy Forum Robert Cline, National Director, State & Local Tax Policy Economics Ernst & Young LLP, Washington, DC October 26, 2005.

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Lessons from Recent State and Local Tax Reforms

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  1. Lessons from Recent State and Local Tax Reforms Presentation to Connecticut Legislative Program Review & Investigations Committee State and Local Tax Policy Forum Robert Cline, National Director, State & Local Tax Policy Economics Ernst & Young LLP, Washington, DC October 26, 2005

  2. Overview of CT Business Taxes

  3. CIT: A Very Unstable Tax (US)

  4. Business Tax Bases

  5. Case Study: Ohio Tax Reform Objectives • Number one objective: grow the economy by improving business tax competitiveness • Reduce the tax burden on capital investments, increase taxes on consumption • Impose more uniform (and stable) taxes on all industries and forms of doing business • Reduce out-of-line personal income taxes (top state + local marginal rate of almost 11%) • Deal with an expiring 1% temporary sales tax increase -- $1.5b problem

  6. Ohio Tax Reform Features • Phases out corporate franchise tax (income & net worth components) -- 5 yrs. • 5-yr. phase out of business tangible personal property tax (immediate elimination for new machinery & equipment purchases). • Uniform 21% reduction in personal income tax rates • Permanent 0.5% increase in sales tax • Phases in new 0.26% CAT on sales over $1m for most businesses (excluding financial services and insurance); min. fee of $150 (sales from $150,000 to $1m); no gross receipts cap

  7. Commercial Activity Tax (CAT) • CAT applies to both C-corps and pass-through entities • Destination-based tax: exempts exports but taxes imports – no P.L. 86-272 nexus protection • Excluded from base: interest and dividends • Partial pyramiding relief by eliminating intercompany sales among firms in a consolidated group (elected) • Addressed balance sheet impacts of changes by allowing limited carryover of unused NOLs • Brightline nexus test (MTC): at least $50,000 of property or $50,000 of payroll or $500,000 of taxable receipts • Solves the Cuno problem – converts tax credits to grants

  8. Why Did Reform Happen in Ohio? • Terrible economy: loss of 200,000 manufacturing jobs • Long-running public debate over tax reform & business competitiveness – “system is broken” • Proactive role of the business community: lead by Ohio Business Roundtable and sharply focused on growing the economy – evaluated options for reform • Leadership of Governor and legislature • Need to replace temporary 1% sales tax revenue • No balanced-budget constraint – $3.7b tax cut by 2010 (financed by spending constraints & econ. rebound); no tax-expenditure limits

  9. Tax Reform in Other States • Kentucky Reforms • New law adopts a corporate AMT equal to smaller of .95 mills times gross receipts or 7.5 mills times gross profits (NJ AMA-type tax); firms pay higher of regular, AMT or min. fee ($175) • Mandatory consolidated returns; extends tax to pass-thru entities; top rate lowered to 6% (from 8.25%) • Texas Proposals • Looking at alterative business tax bases: payroll, gross receipts, value added, net worth and profits • Or all of the above? • Michigan Governor’s Proposal • Provide a 35% SBT tax credit for manufacturing personal property, increase profit component of the tax, go to a 100% sales factor, broaden the base and shift insur. to GRT

  10. Tax Reform in Other States (cont.) • Pennsylvania Proposal • Lower CIT rate from 9.99 to 6.99%, accelerate phase out the capital stock and franchise, 100% sales factor • Focus on creating jobs (dynamic feedback effects) • Indiana Reforms (2002) • Repealed gross income and supplemental inc. taxes; expanded ITC and R&D credits • 60% reduction in school real property taxes; phase-out of inventory tax • Tax studies in progress: NY, OK, Utah • MD debating AMA and combined reporting

  11. Property Taxes • Revolt on the near horizon? • Possible proposition 13 in Idaho; KS & TX court rulings; reductions debated in Iowa • Reduction in FL intangibles tax; IN 60% cut in school real prop. taxes; Ohio eliminates business tangible per. prop. tax • CT Urban Rankings (MN Taxpayers Assoc.) • Homesteads: 2nd highest (84% above ave.) • Commercial: 14th highest (33% above ave.) • Industrial: 9th highest (35% above ave.) • State vs. local property tax relief

  12. Value-Added Taxes: MI’s SBT • 44-yr. “experiment” with a modified VAT • Pluses: • Broad-base, low-rate tax (1.9%, no increases) • Very stable, base falls 1/5 as much as profits • Uniform tax on all forms of doing business • Encourages capital investment (CAD) • No pyramiding (does not tax bus. purchases) • Indirect way to tax services • Replaced other taxes: inventory,net worth,CIT

  13. Value-Added Taxes: MI’s SBT (cont.) • Minuses: • What is it? Consumption or business tax? • A destination-based VAT may be borne by consumers in higher prices (STN,12/25/95) • Uniform tax on all forms of doing business: heavier taxes on non-corp., low-profit, labor-intensive businesses (services & retail) • Issues related to apportionment (90% sales) and nexus (P.L. 86-272 does not apply) See: “Should States Adopt a VAT?” in Unfinished Agenda for State Tax Reform, Steve Gold, ed.,1988

  14. Lessons Learned • There is no “best practice” tax system that CT can copy from another state, but trends are evident • Reduce taxes on mobile capital • Increase importance of consumption taxes • Reduce volatility of tax bases • Reform needs to address specific CT issues • Reform must look at the system of taxes • State and local taxes • Business taxes

  15. Lessons Learned (cont.) • If economic development is a key objective, evaluate the impacts of different alternatives on CT’s competitiveness • Dynamic feedback analysis: Ohio, KY, MN, MA, PA • Focus on benefits to private sector • Appreciate the difficulty in expanding sales tax bases to include services – primarily a bus. tax (See Cline et al., STN, Feb. 14, 2005) • Business pays almost 50% of CT sales taxes (COST study, STN, May 9, 2005)

  16. Lessons Learned (cont.) • Need to look more closely at economic (“final) incidence – who ultimately bears the tax burden • Who pays the corporate income tax? • Who pays the gross receipts tax? • Need to recognize tax convergence • 100% sales factor apportionment of CIT • GRTs vs. sales taxes • Nexus considerations: sales tax and CIT

  17. Where Are Business Taxes Headed? • State reforms are reducing taxes on capital investment (corporate income, net worth, property, input sales taxes) making states more competitive – focus is on economic development • Will Congress intervene? ITFA, BAT bill, remote sales tax collection, Cuno • States should consider using stronger revenue growth as an opportunity for longer-run reform or, at least, to unwind recent anti-business tax policy decisions • Business and government should work closely in developing business tax reform proposals

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