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To hear some folks talk, one might think that Oregon had repealed its business taxes.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.


CardKaptor said...

Hi Fred. Just some thoughts I had while reading the blog post.

It sounds to me like you believe Mike Mazerov's and your proposal would help Oregon recover a significant portion of the $200 million missing do to tax planning while at the same time your proposal (and perhaps Michael Mazerov's, though I admittedly haven't had time to read it all) only calls for for more transparency in state-by-state tax reporting.

While I understand how this would help if the $200 million was related to illegally sheltering income from the state of Oregon, I seriously doubt that a significant portion of it is (which by the way is why we should avoid calling it tax evasion). At least not $50-$100 million of it. I suspect a significant portion of the $200 million is legally shifted from Oregon in one way or the other. Accountants make a lot of money helping corporations engage in legal tax planning. So for transparency to have a significant effect, I think we would need to see changes in Oregon's tax policies as well.

For example, the OECD's BEPS Initiative has moved towards country-by-country reporting, basically the same transparency idea. However, with it they've pushed other changes to attempt to close tax loopholes.

From BEPS' website: "“Treaty shopping” generally refers to arrangements through which a person who is not a resident of one of the two States that concluded a tax treaty may attempt to obtain benefits that the treaty grants to residents of these States. These strategies are often implemented by establishing companies in States with desirable tax treaties that are often qualified as “letterboxes” “shell companies” or “conduits” because these companies exist on paper but have no or hardly any substance in reality. It can be addressed through changes to bilateral tax treaties in line with the minimum standard agreed in the context of the BEPS Project." http://www.oecd.org/ctp/beps-frequentlyaskedquestions.htm

Note that they are specifically calling for changes to the tax treaties to prevent this issue. Country-by-country reporting would make it more obvious to taxing authorities that this is happening, and thus would aid in writing tax law, but "treaty shopping" isn't illegal, so knowing it is happening wouldn't increase taxes collected.

A more concrete example from the same website: "Hybrid mismatches are cross-border arrangements that take advantage of differences in the tax treatment of financial instruments, asset transfers and entities to achieve “double non-taxation” or long term deferral outcomes which may not have been intended by either country. A common example of a hybrid financial instrument would be an instrument that is considered a debt in one country and equity in another so that a payment under the instrument is deductible when it is paid but is treated as a tax-exempt dividend in the country of receipt."

Again, while this outcome "may not have been intended," the legal structure of the debt/equity isn't tax evasion, its within the bounds of the law. So the law has to changes to have an impact on taxes collected.

As you note, moving away from the single-factor apportionment could get Oregon $74 million of the $200 million, but I think tax code changes beyond simply transparency in reporting would be needed to collect almost any of the other $200 million.

One interesting thought I had while writing this is, "would knowing they are facing increased transparency cause corporations to engage in less aggressive tax planning?" My guess is no, as its only state and federal tax authorities who would know, not the general public, but interesting to think about none the less.

Fred Thompson said...

Card: You wrote: "I seriously doubt that a significant portion of it is {related to illegally sheltering income from the state of Oregon} (which by the way is why we should avoid calling it tax evasion). At least not $50-$100 million of it. I suspect a significant portion of the $200 million is legally shifted from Oregon in one way or the other. Accountants make a lot of money helping corporations engage in legal tax planning." Maybe, but I'd like to see what's behind the base erosion. In 2010, the federal CIT tax base was $900B net, the output weighted mean statutory state CIT rate was about 6.1%, but states only collected about $3,0-$3.3B in CITes. Moreover, based on my work with the DOR, I am inclined to believe that states are pretty much stuck with accepting whatever corps tell them about factor apportionment. Reporting on a comprehensive 50 state-by-state basis, would go a long way to resolving this question. Besides, if it wouldn't matter very much, why are corps so adamantly opposed to this proposal?

Fred Thompson said...

Transparency could also be accomplished through and interstate compact, but I wouldn't hold my breath. http://www.oecd.org/tax/a-new-boost-to-transparency-in-international-tax-matters-six-new-countries-sign-agreement-enabling-automatic-sharing-of-country-by-country-reporting.htm?utm_source=Adestra&utm_medium=email&utm_content=A%20new%20boost%20to%20transparency%20in%20international%20tax%20matters%3A%206%20new%20countries%20sign%20agreement%20enabling%20au&utm_campaign=Tax%20News%20Alert%2012-05-2016&utm_term=demo