They are.
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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