Fred Thompson: Why Are State Corporate Income Taxes Disappearing?

Fred Thompson checks in with the first of a two-part post.  I'll post the second one next week.

They are.

https://plot.ly/~governing/692.embed

But why? The easiest explanation to discard is that, in a race to the bottom, states have reduced corporate income-tax (SCIT) rates. They haven’t. Marginal SCIT rates have been more or less constant for more than 30 years.

Me? I attribute the decline in SCIT to increased tax avoidance/evasion. Tax avoidance/evasion isn’t a new enterprise, but its direction and focus changed dramatically after 1980 and it has been growing in size and sophistication ever since. The simple fact is that it is ridiculously easy for multi-state businesses to shelter profits from SCITs, reporting them where state corporate income-tax rates are low (in states like Nevada or Washington) and avoiding them in high-tax states (like Pennsylvania or Iowa). These days, this can be done with a couple of mouse clicks (and some accounting and legal legerdemain). Unfortunately, it’s hard to fix tax avoidance/evasion mechanisms or even say which ones matter most at the state level. Multi-state businesses are not required to publicly report the income taxes they pay in each state, just the total.

However, we know the nation’s output-weighted average state corporate tax rate is about 7 percent, while the average state corporate income-tax rate paid by profitable Fortune 500 C-corps is less than half that, which is a lot of avoidance, if not evasion.

Many of our colleagues deny that the massive decline in the weight of state SCIT revenue (which is itself unquestioned) is due to increased tax avoidance/evasion. They note that enactment of the pass-through provision in 1986 and its subsequent expansions have fundamentally transformed the business landscape in America, leading to a decline in C-corporations relative to pass-through businesses.

Under the U.S. tax code the profits (income) of publically held or C-corps are taxed twice, first through corporate income taxes and then again through personal income taxes on dividends and capital gains. Other businesses – individually, family, or employee owned – are all eligible for pass-through status, meaning that their income passes directly to their owners’ personal income tax returns, as are most partnerships (these businesses are not necessarily small; there are nearly 1,000 of them in Oregon with over 100 employees).  As a result, the owners (shareholders) of C corps tend to pay higher tax rates on their businesses’ profits than do the owners of other businesses. That is generally also true at the state level. It is almost certainly the case in Oregon.

Consequently, pass-through businesses now account for more than 50 percent of all business income in the U.S., triple what it was in 1986. In fact, there are only about 3,500 large publicly traded companies in the U.S., down from more than 5,000 in the mid-80s. This goes a long way to explaining the relative decline in the importance of the federal corporate income tax vis á vis personal income tax receipts.

However, if that were the whole story, the decline in the relative importance of state corporate income-tax revenues would have been proportionate to the relative decline in the federal corporate income tax. Instead, it has fallen nearly twice as fast. Or, perhaps, more clearly, since 1990 total federal corporate tax revenues have grown about as fast as C-corp profits; total state corporate tax revenues have grown only half as fast. As a consequence, state corporate income-taxes now account for less than 2 percent of annual state revenues nationwide, down from 2.7 percent in the decade of the 1990s and 3.5 percent in the 1980s. In Oregon, the proportional decline has been less dramatic, from 1.8 percent of total state revenue, to 1.9 percent, and now 1.4 percent, according to Governing Magazine.

The decline in the relative contribution of Oregon’s CIT is proportionally less than in most states, especially places like Connecticut, Louisiana, Michigan or Ohio, where real corporate income revenues actually declined by more than 50 percent after 1990, but it still looks to be significant (although, in reality, probably not, since GM evidently excluded revenue from turnover taxes from its figure – see my next post).

Others of our colleagues are more conspiratorially minded. They tend to hold to an older view of corporate income taxes, which posits that the incidence of the tax is entirely shifted to other, less mobile, factors of production (labor and real property). Consequently, it follows that states should not tax corporate income, that, to avoid adverse effects on investment, output, and employment, it would be better to tax labor/land directly. While this view cannot be entirely ruled out as a theoretical matter, it’s wholly inconsistent with the best empirical evidence. For that reason, most tax economists now reject it.

Nevertheless, it might be noted, that, under this view, state elected officials choose to tax corporate income only because they are forced to by popular sentiment ("I pay taxes, but big companies get away Scot free?"). Bizarrely, some of those who hold this view assume a level of rationality on the part of state tax authorities that beggars all belief: they adopt high statutory tax rates to appease the public, but consciously mitigate their effects through special tax breaks. Hence, one observes persistent high state corporate income tax rates along with diminished collections.

However, as the Governing Magazine. article clearly shows, the scale of SCIT tax breaks is nowhere close to accounting for the relative decline in SCIT revenues. If nothing else, that should put paid to this particular conspiracy theory.

If I am right, tax avoidance/evasion is at the heart of the problem of the mystery of declining SCIT revenue, what can be done about it? I offer one answer in my next post.

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No, I don't know why the blog's background has suddenly turned to light gray and, no, I do not know how to fix it.  Maybe it is a sign that it is time for an overhaul...


Update!  Okay, so now there is the Earth.  Upgrade complete.  Like a whole new site...

The Tricky Problem of Child Labor

On NPR this morning there was a report on an Amnesty International report on the child cobalt miners of DR Congo.  Families can dig their own mines in mineral-rich DRC.  Often, apparently, all or many members of the families take part in this household production, including children.  The report suggests that this is a bad thing, that children should not be involved in mining and should instead be in school.

On the face of it, this all makes sense.  Children are not old enough to make these decisions for themselves and society must protect them.  Mining is a difficult and dirty task, not suitable for small children.  School is where they should be.

But this ignores the fact that most parents in the world want what is best for their children and would prefer that they do not work.  But if it comes to the stark choice of having the child work or not feed the family, families are forced send their children to work.

Ironically, by calling on Apple, Samsung and Sony to ensure no children are used in the mining of the cobalt used in their products might be condemning these families to a worse fate - making these kids worse off not better.

This was the point of a seminal paper by Basu and Van in 1999, only if, by banning child labor does the overall supply of labor decrease so much that adult wages rise enough to compensate, does a ban actually improve the welfare of the children.  And if the local schools are poor - as they often are in rural parts of low-income countries - there maybe little benefit to sending children to them.

Much of my work over the last decade and a half studies the consequences of children working so I am acutely aware of the problem.  Enough to know that calls to ban child labor, though well-meaning, are often misguided.  I prefer focusing on investments in education and social safety nets to create a situation where families have enough consumption to survive and where sending kids to school is a good long-term investment.   Besides, bans are often essentially toothless without  real enforcement, something that low-income countries do not have the resources to do.  Better to focus on the incentives that cause children to work in the first place.

Fred Thompson: Kickers Redux

Fred Thompson once again keeps the blog alive with another insightful piece.

Patrick Emerson and I have written about the Kicker and its folly often here at the Oregon Economics Blog. In what is otherwise an arguably exemplary state and local tax system, Oregon’s kicker is an embarrassment, or, more correctly, the legislature’s unwillingness to deal with it is simply shameful.

As it happens the kicker isn’t entirely unique to Oregon. At least six other states – Colorado, Massachusetts, Missouri, New Hampshire, North Carolina and Oklahoma – have “triggers” that automatically impose tax cuts (i.e., give refunds, credits or a reduction in rates to taxpayers or businesses) whenever cash inflows (real or expected) exceed planned outflows. Moreover, Michigan’s Governor, Rick Snyder, recently signed a bill that will automatically roll back personal income-tax rates whenever state revenue exceeds 1.425 times the rate of inflation, although not until 2023.

All of these measures have a similar justification: the widespread belief that governments are myopically imprudent, that when times are flush they will spend like drunken sailors, thereby creating irresistible pressures to raise taxes when times are tight to maintain otherwise unsustainable current service levels. Moreover, automatic cuts are apparently politically appealing. They promise tax cuts for voters, but grant them only when there is enough cash to pay for the cut.

From this standpoint, Oregon’s kicker could be worse. It goes into effect retrospectively, when actual cash inflows exceed the budget forecast. In Oklahoma, the kicker is prospective, based on the revenue forecast itself. This year Oklahomans, like Oregonians, will get a big refund. Unfortunately, forecasts are not reality. Oklahoma’s actual revenues are insufficient to cover both its budget and the automatic tax cut. Moreover, Oklahoma has a very strict balanced-budget law. It must bring its cash outflows into line with inflows during the current year and it is prohibited from borrowing (even from itself) to do so. In this instance, the automatic trigger caused precisely the problem it was supposed to fix.

Economies are cyclical; revenues are too. That’s not necessarily a bug. The problem is stabilizing spending, but, as the Legislative Task Force on Restructuring Revenue and Governor Ted Kulongoski’s reset team recognized, the solution is straightforward: avoid myopic imprudence, i.e., grow spending at a sustainable rate, using saving and, when necessary, borrowing, to smooth out spending. Were the legislature less pusillanimous, repeal of the kicker law would allow this solution to be put into effect without a foreseeable need for borrowing (actually, given my druthers, I would base the revenue estimate on a sustainable, long-term growth rate, use the kicker – revenues in excess of the estimate – to automatically pay down state debt/build a sinking fund, and rely on borrowing whenever actual revenues dropped below the revenue estimate, but that is a slightly different story).

It might be noted that other states have found the political cojones to repeal automatic triggers. According to Governing Magazine, the trigger trend began in California, but was laid to rest during the Schwarzenegger administration. More recently, thanks to their Governor Brown, California voted Proposition 2 into law. Proposition 2 amends the California Constitution to require that the Governor make mid-term spending and revenue targets part of the state budget process, requires the state to set aside revenues each year – for 15 years – to pay down specified state liabilities, and substantially revises the rules governing the state’s rainy day fund. In other words, California’s legislature did pretty much what Oregon’s has consistently refused to do. They referred a measure aimed at making state and local spending sustainable to the citizenry. On November 4, 2014, 70 percent of the electorate voted in its favor. It is downright shocking when California exhibits greater fiscal responsibility than Oregon.