Monday, August 1, 2016

More Background on IP28 (Measure 97?), cont.

 Fred Thompson checks in with another post on IP28. 

Is it true, as asserted by OCPP and Our Oregon, “that businesses benefited greatly from seismic changes to Oregon’s property tax system in the 1990s,” which caused a “shift in property taxes away from businesses and onto households.” This claim is an important part of the justification for IP-28 (Measure 97?), at least insofar as enactment of this measure is supposed to redress corporate tax gains made at the expense of the citizenry at large, but, in fact, it is probably not true that businesses benefited disproportionately from Measures 5 and 50.

So, let’s start with what is certain.

It is certain that Oregon used to be a high property tax state and that now, because of Measures 5 and 50, it is a middling one. Prior to Measures 5 and 50, Oregon property taxes averaged about 5 percent of disposable income; nowadays they’re more like 3.5 percent, as depicted in the following figure from the Research Section of the Oregon Department of Revenue. As a result of these measures, Oregon’s property tax growth is also a lot more stable (less volatile).

It is also certain that in 2014-15 taxes on residential properties accounted for the lion’s share of property-tax payments, about 57.6 percent, and for about the same share of the state’s net assessed property value. However, it is also certain that Measure 50 caused assessed value to deviate from real market value (or, perhaps, more correctly restored the discrepancies between assessed value and real market value that were commonplace before Measure 5) – over time the faster the growth in real market value, the greater the discrepancy. Evidently, the real market value of residential property has grown faster than the values of other kinds of property. As a result, the average effective tax rate (tax payments/real market value) on residential property is only now 1.06 percent and on owner occupied housing it’s even lower, while the effective tax rate on all other property is significantly higher at 1.32 percent.[1] If anything, this suggests that Oregon’s current property tax system is biased in favor of the owners of residential properties rather than businesses, although the fact that businesses get more than half of the property tax exemptions granted by state and local jurisdictions offsets this bias somewhat.

Finally, it is certain that, over time, residential real-estate wealth has assumed an increasing portion of the burden of the property tax. Prior to Measures 5 and 50, owners of residential properties remitted less than 45 percent of all property tax payments; today they pay well over half.

However, it is by no means certain that this is due to Measures 5 and 50. It is entirely possible, for example, that the real cause is Oregon's system of land-use regulation, which has, over time, increased residential real estate values faster than it has commercial real estate values. One interpretation of the figure above is that the shift, which OCPP attributes to Measures 5 and 50, is simply the result of long-term trends in the relative growth and value of residential real estate, which would have occurred even if Measures 5 and 50 had never happened. This view is entirely consistent with the conventional wisdom, which holds that, by tying residential property taxes directly to booming real market values, Measure 5 inadvertently gave businesses (commercial, industrial property owners) a lot more tax relief than it gave homeowners, that Measure 50’s cuts were aimed at redressing this imbalance and, that, by rolling back residential property tax assessments and restraining assessment growth, they were largely successful.

Other property tax considerations relevant to IP-28

Most local jurisdictions have compensated for the loss of property-tax revenue wrought by Measures 5 and 50 by increasing user fees. Consequently, to the plurality of economists who see property taxes, at least those levied in support of local services (which may or may not include public schools), as user fees, this shift is largely a matter of complete indifference. Furthermore, most of the increased user fees are remitted by businesses, which suggests that, even if Measures 5 and 50 had had the effect of shifting a portion of the burden of property taxes from businesses to residences, user fee increases probably more than made up for the difference (although, as is the case with property taxes, the ultimate incidence of certain of those user fees remains somewhat unsettled, so that is by no means necessarily the case).

There are two important caveats that should be raised here. First, these conclusions do not apply to public schools. Instead, Measure 5 shifted responsibility for school funding from local districts to the state, which has failed to fully offset the effects of Measures 5 and 50, and, over the past 15 years, the state has allowed things to get progressively worse. Second, the state has imposed property-tax rate caps on local tax districts in a dozen or so counties that are not subject to Measure 5 compression (i.e., have combined statutory rates of less than 1.5 percent). Those caps have caused a lot of unnecessary hardship and are stupid.

[1]I calculated an effective tax rate for industrial and business and commercial property as well, 1.41 percent. However, for that purpose I used a different data set, from the census rather than from the DoR, which may or may not be consistent with the figures reported above.

Monday, July 18, 2016

More Background on IP28 (Measure 97?)

Fred Thompson checks in with another post on IP28. 

Over the next 3 months, proponents and opponents of this Measure will make a lot of wild, unsubstantiated claims about what it will or won’t do. My purpose it to try to distinguish sense from spin, as honestly and objectively as I can. Frankly, this is not easy. Not only because IP28 is unlike anything found in the public finance universe and is, therefore, extremely hard to parse, but also because it appears to be nearly everything a good tax is not. Tax experts believe that good taxes should treat the things being taxed more or less equally, that they should be fair, broad based, transparent in incidence and effects, and straightforward in administration. IP28 is unequal, probably regressive, narrow, opaque, and likely to encourage further avoidance. Consequently, every fiber of my being as student of public finance wants to say it’s spinach, to Hell with it. But I’ll do the best I can, starting with claims made about the existing tax system.

Proponents of IP28 claim that “Oregon has the lowest corporate taxes in the country.” What that means to an economist is that Oregon ranks dead last in corporate income tax (CIT) collections or that the growth of its CIT collections have lagged those of all other states.[1] Clearly, neither of those claims is true.

This figure shows the composition of each state’s tax portfolio in 2008 by tax type. CITes are represented in powder blue, personal income taxes (PIT) in light pink. Oregon’s CIT receipts as proportion of disposable income ranks 25th out of 50 states – right smack dab in the middle of the pack.[2] The most distinctive thing about OR compared with other states is its heavy reliance on the PIT – the fairest and most transparent of the tax types used widely by state governments.

Nor is it true that Oregon has a “very low corporate tax rate.” Oregon’s statutory CIT rate is above the national average. Nevertheless, there is no question that CIT collections have lagged the growth in business profits over the past 40 years. That is true at the national level, it’s especially true at the state level – and it’s true in Oregon as well. But it isn’t true that once upon a time Oregon relied heavily on the CIT or that its decline has impoverished Oregon’s state government.

In Figure 8e, Oregon’s CIT is shown in light pink. The key takeaway from this figure is that Oregon’s CIT never really played a dominant role in Oregon’s tax system. Other revenue sources have always overwhelmed the CIT, both in terms of totals and even annual fluctuations. The one thing that this figure doesn’t clearly show is the decline of the CIT relative to other revenue sources. Figure 8g shows the composition of Oregon’s revenue portfolio over time. Again the CIT is depicted by the light pink and it clearly tells a story of relative decline – that, relative to Oregon’s portfolio of revenue sources, the CIT is only about half as important as it once was. Figure 8g also shows that weight of ‘other revenue’ and severance taxes in the state’s revenue system has fallen even faster.

The Oregon Center for Public Policy (OCPP) recently reported on the causes of the relative decline in Oregon’s CIT. Their analysis is entirely accurate, although puzzlingly they list the causes in reverse order of their importance. In a previous blog I attributed Oregon’s CIT base erosion to the following: 58 percent due to the U.S. tax code’s expanded pass-through provisions, 31 percent to corporate tax sheltering and planning, and 11 percent to state-specific deductions, exemptions, and credits. Ironically, IP28 directly affects C-corps, the only business class that cannot avail itself of the U.S. tax code’s pass-through provisions. It is also probably the case, although OCPP denies the possibility, that a substantial portion (1/2-2/3) of the CIT receipts lost to pass-through is recouped in terms of higher PIT receipts.

Ultimately, however, Our Oregon’s claim that Oregon’s C-corps are not paying their fair share of taxes isn’t based on state CITs or even the tax liabilities specific to C-corps. Rather their claims are based on the Anderson Economic Group’s (AEG) 2016 State Business Tax Burden Rankings report, which ranks states according to the remittances of ALL businesses to state and local governments as a percentage of their pre-tax gross operating margins – i.e., the sum of the Bureau of Economic Analysis’s gross operating surplus measure plus ALL state and local sales, excise, severance, property, corporate-income, and business-income tax payments, license fees, and unemployment-insurance premiums.

That’s a silly gauge, both from the standpoint of the numerator and the denominator. Mostly, what the AEG report says is that the state of Oregon relies heavily on the PIT, which is IMHO a feature, not a bug. Indeed, not all the items included in the AEG report are taxes; some are fees for services rendered (UI premiums), but AEG appears to arbitrarily include some charges and exclude others (most local imposts, for example; these are relevant to us because Oregon’s are the highest) in the US. More significantly, tax burdens don’t depend on who writes the checks but on who suffers the consequent loss of buying power. Some of the taxes remitted by businesses can be reasonably assumed to stick with their owners (business income and corporate income taxes, mostly; property taxes, probably); the incidence of the other taxes they remit is largely shifted forward to final consumers (sales and gross receipt taxes) or backward to employees (UI premiums) or other factor suppliers (severance taxes).

One good thing about the AEG report is that it looks beyond state government, recognizing that local taxes are part of the state system, even if they do so in what I think is a wrong-headed and haphazard manner. In a future blog, I’ll take a look at the claim made by supporters of IP28 that, as a result of Measures 5 and 50, businesses in general and C-corps in particular are ducking their fair share of Oregon property taxes.

[1] They further say that Oregon “small businesses pay 8 times the tax rate of big corporations.” Their reported source is the Department of Revenue, but I cannot substantiate this claim one-way or the other. It is clearly not the case if one looks only at the state’s CIT and business excise tax.  They also claim that “[c]orporations with more than $25 million in Oregon sales paying minimum taxes pay the equivalent of only 3 cents for every $100 in sales,” citing the same source. Again, I can neither confirm nor deny this claim, but it sounds credible, assuming that we are talking only about the state’s CIT and business excise tax.

[2] This would also appear to put paid to the claim that Oregon taxes corporations at an unusually low rate “due in large part to the fact that most corporations (72%) pay just the minimum, and those minimums are very low." In fact, Oregon’s alternative minimum tax is the exception, not the rule. This claim looks like question begging, pure and simple.

Tuesday, May 31, 2016

Fred Thompson: Update on IP28

Fred Thompson checks in with a post on IP28. 

Monday morning (May 23) the Legislative Revenue Office released its report on Initiative Petition 28 – the proposal to levy a 2.5 percent tax on the Oregon sales of C-corporations in excess of $25 million. The LRO report is the closest thing to an authoritative, unbiased assessment of the proposal that we are likely to see. Its big takeaway is that IP28 would increase state revenue by a lot, about $6 billion in the next biennium. So, if you think that Oregon needs a lot more ($3 billion a year) of your (mostly) money for education, health, transportation, and other programs and activities, or, in the alternative, you think the grasping hand of the state is already getting too much of your hard-earned cash and dumping it down various rat-holes, that’s pretty much all you need to know.

If, however, you are concerned about the nuances of tax policy, this report should be of considerable interest, insofar as it addresses a couple of additional questions: who pays, and with what consequences for the growth and economic welfare of the state?

With respect to who pays, the main takeaway is that about 2/3s of IP28’s total tax burden, $2 billion, will be shifted forward to Oregon consumers. This is an amount equal to nearly one percent of all the goods and services produced in the state. As a point of comparison, that would be equivalent to a retail sales tax on goods of about 6 percent, although IP28’s effects would be more uneven and its incidence harder to suss out.

This is so, because the businesses that are responsible for collecting/remitting the tax account for less than 60 percent of the state’s commercial value-added, altogether about 25 percent of total state product. Consequently, one percent across the board implies an average effective burden in the taxed sector of approximately 4 percent. However, the actual burden would vary greatly across final products, with some drugs and packaged foods bearing burdens in excess of 7.5 percent, while most services and products would weigh in at less than one. Not surprisingly, the LRO punted on this issue, spreading the tax hike across the economy like peanut butter.

Who Pays for IP28 (OR Households)?

The LRO further argues that most of the remaining 1/3 of the total will be shifted out of state. Remarkably, it estimates that the U.S. Treasury will eat the lion’s share of this remainder, about $700 million, with the balance of the annual burden of IP28 split between capital providers (75-80 percent or >$200 million) and employee wages (20-25 percent, >$40 million). Like the LRO’s estimate of IP28’s dead weight loss (about $.5 billion), given their other assumptions, this estimate of the hit to federal corporate-income-tax receipts seems on the high side to me, but is entirely possible.

Which takes us to the other big takeaway from the LRO report: that the dead weight loss associated with IP28 is nearly $.5 billion per annum and is likely to increase over time, that it will cost 38 thousand private-sector jobs. This is huge – it’s about the number of jobs Oregon’s business workforce added last year. Since the LRO is working with a DGE model, this loss will be almost entirely recouped by increased government sector activities (of presumably equal or greater value?), so arguably, from the standpoint of the economy as a whole, it isn’t a big deal. Nevertheless, it seems hard to square with the notion that, while IP28 will hurt some businesses and help others, its net effect on capital suppliers will be trivial.

Many will say that the LRO report rebuts the claim of the proponents of IP28 that its burden won’t be passed along to consumers or, if passed on to consumers, since the businesses responsible for collecting/remitting the tax are all big national corporations, they will pass 99 percent of the mark-up on to customers out of state.

The second of these hypotheticals is clearly wishful thinking. In the first place, it violates two basic premises of economics: that businesses maximize free cash (after tax and interest) flows and that cross subsidization is contrary to profit maximization. Maybe these reasons are convincing only to economists, but they work fine for me. More persuasively, perhaps, this hypothetical is flatly contradicted by commonplace fact. Businesses everywhere add retail sales taxes and excises (like cigarette and gas taxes) to their prices, which vary accordingly from state to state. Where value-added taxes exist, businesses incorporate them directly into their prices, and, where jurisdictions levy different rates, as in Europe and Canada, prices reflect those differences. It is even the case that prices in Washington State vary according to their B&O Tax rates, the closest analog I know of to IP28.

The first hypothetical is trickier. The LRO doesn’t really show that most of the burden of IP28 will be shifted forward to final consumers; it simply assumes that, because it is a fairly broad-based tax on sales, that’s how it will behave. I sympathize: IP28 is sui generis – we have absolutely no experience with a tax exactly like IP28, from which we could extrapolate likely outcomes. None! In no other country, in no previous time. As I noted, the best analog to IP28 is probably Washington’s B&O tax; IMHO the LRO worked from the next best analog, Ohio’s gross receipts tax, owing to the availability of recent data.

The problem is that this may not be good enough. Big businesses have a lot of expertise when it comes to managing costs. They deal with cost increases like IP28’s all the time. What this means is that they find ways to avoid or mitigate costs, pass them on to others, customers or employees, or, if the business is worth it, and they cannot avoid the costs or shift them to others, eat them, but there is no guarantee that their Oregon business will be worth it, especially where low-margin, high-turnover businesses are concerned.

Nevertheless, if businesses cannot avoid the tax by means of smoke and mirrors or pass it on to their customers, as the LRO presumes, the real economic effects of IP28 will probably be bigger than predicted, and mostly negative; the revenue increase from IP28 could also be substantially smaller – i.e., more pain, less gain.

I am a cautious guy. I don’t like giant leaps into the dark, which is what IP28 is. Moreover, Oregon is already running one big policy experiment, the minimum-wage boost, which could interact with IP28 in a variety of ways, mostly adversely.  Of course, as Paul Warner, the head of the LRO, reminds us, state tax policy rarely if ever outweighs the main determinants of economic performance – the business cycle, exchange rates, productivity growth, etc. All true. So, maybe, my anxiety is misplaced. But some states – Kansas, Wisconsin, Oklahoma, Michigan – have experimented with big tax changes and managed, as a consequence, to shoot themselves in the foot.
Sen. Mark Hass

There are smart ways to boost state revenue: eliminate the PIT kicker, enact a carbon tax, broaden the weight-use-mile tax to comprehend passenger cars, adopt a real gross receipts tax (treating it as an alternative minimum tax for C-corporations) or a value-added tax, etc. This is not one of them. Besides, Oregon’s economy has performed relatively well over the past quarter century, much better on average than the rest of the U.S. Why tempt fate?

Tuesday, April 26, 2016

Fred Thompson: Where, Oh Where, Has Oregon’s Corporate Tax Gone? Where, Oh Where, Can It Be?

Fred Thompson checks in with a post on Oregon taxes. 

To hear some folks talk, one might think that Oregon had repealed its business taxes. That hasn’t happened. In 2013 Oregon’s corporate excise and income tax receipts were in excess of $600 million. Nevertheless, the growth in state personal income tax receipts has greatly outstripped the growth in business tax revenue. Arguably, even statewide property tax revenues have grown faster.

There is a mystery here. Oregon’s statutory tax rate is unchanged or even up slightly over the period. Moreover, its real state product (income) has more than doubled (2.44 times) and profit’s share (pre-tax profit/GSY) of total product, the CIT tax base, increased from about 7 to approximately 11 percent (1.57 times). Multiplying those figures together, one might expect real CIT receipts be about 3.85 times what they were in 1980. In fact, they are only about half that amount. What’s up?

To answer that question, I contrast Oregon CIT liabilities accrued in 2013, $460 million, with a set of counterfactuals constructed using 2013 BEA and DOR data, which show what CIT payments would have been in the absence of changes in the federal tax code, corporate tax avoidance, and state tax credits, exemptions, and deductions. I also estimate the gross contribution to state revenue due to the creation of the minimum alternative turnover tax put in place by Oregon’s Measure 67 and improved CIT administration as a result of the DOR’s core systems replacement.

The GAO reports that over this period, the primary change in the federal CIT code was the enactment of the pass-through provision in 1986 and its subsequent  expansion in 1994, which means that the income of individually, family, employee owned businesses, LLCs and S-corps passes directly to their owners’ personal income tax (PIT) returns, without first being taxed as corporate income. Prior to this change, ¾ of all business profits were subject to the federal CIT. Now, slightly less than half are. Because the computation of Oregon’s CIT begins with federal taxable income, this reduced Oregon’s CIT receipts (and also increased PIT and capital gains receipts). Had this change not occurred and if ¾ of all $20 billion in profits earned in Oregon in 2013 were subject to its CIT (i.e., there were no state-specific tax credits, deductions, or exemptions and no tax avoidance/evasion of the part of businesses), Oregon CIT receipts would have been about $1,095 million. In fact, only about half of the profits earned in Oregon were subject to its CIT, which implies receipts of about $730 million. In other words, expansion of the federal pass-through provision cost the state’s CIT about $365 million in receipts (and increased PIT receipts by a complementary, albeit almost certainly a smaller, amount).

Other changes at the national level after 1980 couldn’t have caused decreases in Oregon’s corporate income tax revenues, because, generally speaking, they have had the effect of increasing reported corporate income. There is, nevertheless, a substantial discrepancy between Oregon’s CIT base according to the BEA’s Income and Product Accounts, approximately $10 billion, as above, and the declared tax base of $7.3 billion. Applying Oregon’s statutory CIT rate to the latter yields only $530 million, approximately $200 million less than the $730 billion that would have obtained in the absence of this gap. Moreover, it is common knowledge that this sort of CIT base erosion is widespread at the state level and increasing. Presumably, CIT base erosion is primarily due to what is euphemistically known as corporate tax sheltering and planning – what the rest of us would call tax avoidance/evasion.

Finally, there is the $70 million discrepancy between the $460 million CITes accrued in 2013 and the $530 million figure obtained by multiplying the reported CIT base by the statutory tax rate, which is due to Oregon-specific deductions, exclusions, and credits, the bulk of which ($50 million) are due to environmental and energy related tax credits enacted after 1991.

Breaking down the sources of CIT base erosion to its component parts, 58 percent is due to the U.S. tax code’s expanded pass-through provisions, 31 percent to corporate tax sheltering and planning, and 11 percent to state-specific deductions, exemptions, and credits.

What should be done? Before turning to that question, it is useful to look at what has already been accomplished. In 2010, under Measure 67, Oregon adopted a minimum-tax scheme whereby C-corporations are taxed on profits (income) or on turnover (gross receipts or sales), whichever tax liability is greater. One of the neat things about supplementary turnover taxes is that they implicitly raise the cost of jurisdiction shopping, by making it cheaper for multi-state businesses to pay the higher Oregon CIT than for them to pay turnover taxes in Oregon and pay CITs in other states, even where those CIT rates are lower. Consequently, as a result of Measure 67, Oregon business tax receipts were at least $60 million more in 2013 than they would otherwise have been and, perhaps, as much as $114 million more. Furthermore, the DOR’s core systems replacement effort, perhaps the most successful IT project in the state’s history, vastly upgraded the state’s ability to monitor business tax liabilities and to collect taxes. As a result, CIT receipts increased by an estimated $45 million in 2013 over 2012. These are noteworthy accomplishments. They deserve to be recognized.

Oregon’s Department of Revenue attributes approximately $74 million of the $200 million missing due to corporate tax sheltering and planning to single-factor apportionment. Before tax year 1991, a corporation’s income was apportioned to Oregon by a three-factor formula. The factors used in this formula were Oregon payroll relative to total payroll in all states, Oregon property relative to total property, and Oregon sales relative to total sales. These three percentages were equally weighted to determine the apportionment percentage applied to total AGI of the corporation. Since 2005, the apportionment percentage has been simply the ratio of Oregon sales to total domestic sales.

While there is plausible evidence that businesses manage these factors regardless of apportionment percentages, most tax analysts believe that sales are somewhat easier to fiddle than payroll or property. Hence, the nearly universal adoption of single factor apportionment is often cited as one of the reasons for the growing discrepancy between the BEA’s state profit totals and reported state CIT bases. However, it makes sound tax sense to apportion profits on sales rather than local employment or investment. The proper response to the problem of tax base erosion is not to throw the baby out with the bathwater, but to improve reporting, thereby making it harder for businesses to hide sales or allocate them to low or no CIT states.

Michael Mazerov of the Center on Budget and Policy Priorities has authored state CIT disclosure legislation aimed at this problem. Oregon is one of several states that have considered his proposal. My own preference would be a federal law that extended IRS Form 1120, Schedule M-3, to require state-by-state disclosure of the following information:
       the nature of the corporation’s activities;
       its sales;
       its employees;
       apportionment shares
       income tax accrued;
       credits, deductions, and exclusions; and
       income tax expense on a state-specific basis.
And to require businesses to file the expanded M-3 along with their state tax declarations. My best guess is that this would be worth $50-$100 million in additional CIT revenue to Oregon each year. However, in the absence of federal action, which seems very unlikely at this time, Oregon should promptly enact Mazerov’s proposal into law.