Wednesday, February 3, 2016

Fred Thompson: Tax Mavens Talk About Disappearing State Corporate-Income-Tax Revenues; Oregon Did Something About It

 Fred Thompson checks in with the second of his two-part post.  The first one appeared last week.

In 2010, under Measure 67, Oregon adopted a minimum-tax scheme whereby C-corporations are taxed on profits (income) or on turnover (gross revenue), whichever tax liability is greater.

Measure 67 set the alternative minimum turnover tax rate at approximately .1 percent (to a maximum of $100 thousand). Measure 67 also increased Oregon’s marginal corporate-tax rate on Oregon taxable income (profits earned in Oregon) over $10 million from 6.6 percent to 7.6 percent and increased the minimum tax on pass-through businesses to $150.
Economists don’t like turnover taxes. The Diamond-Mirrlees production-efficiency theorem is hostile to taxes on intermediate inputs, a predisposition I appreciate and generally embrace. However, Diamond-Mirrlees presumes the absence of widespread tax avoidance/evasion, an assumption that is clearly violated so far as state corporate income taxes are concerned. In contrast, turnover taxes are hard to avoid and relatively cheap to enforce, much more so on both counts than state corporate-income taxes. Consequently, I found it fairly easy to support Measure 67’s alternative minimum turnover tax, as an effective complement to the corporate income tax, and would not rule out further incremental increases in the turnover tax rate. Massive SCIT avoidance/evasion provides ample justification for alternative minimum turnover taxes.

But there’s more: Oregonians pay high taxes, partly because we face fairly high tax rates, but a lot of the taxes that we pay are actually paid to other states (and to jurisdictions in other states). On a per-capita basis, Oregon is one of the nation’s leading net tax exporters. Consequently, Oregon’s per capita state and local tax collections are actually below the average of the US as a whole. It’s only when one adds in fees paid to state and local governments that Oregon’s collections come up to the US average. 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. Minimum alternative turnover taxes tend, thereby, to reduce tax exports.

Moreover, it looks the minimum turnover taxes work the way they are supposed to: under Measure 67, business tax revenues (the sum of alternative minimum turnover tax and CIT revenues) increased from 1.9 percent of total state cash inflows in the decade prior to its passage to 2.3 percent today. Interestingly, most Oregonians, even those who pay attention to state fiscal policy matters, are unaware of the apparent success of this experiment.

Nevertheless, there are a variety of proposals to increase or extend Oregon’s turnover tax. The group, A Better Oregon, is seeking to put an initiative on the ballot that would leave its structure pretty much unchanged, but increase the marginal tax rate on the Oregon sales of C-corps in excess of $25 million from .1 percent to 2.5 percent, or 25 times (2500 percent!).  That’s a huge increase, so much so that, if enacted, the turnover tax might no longer represent a supplement to the corporate income tax, but would very likely behave more like a sales tax (averaging about 4 percent on roughly half of all goods and services sold in Oregon) than an income tax (i.e., a higher portion of it would be shifted to final consumers rather than stick with shareholders).  It would also probably have the effect of shifting even more business activities from C-corps to pass-through entities, encourage vertical integration, and advantage high mark-up businesses relative to their high-turnover counterparts – in other words, do all the bad things Diamond-Mirrlees warned us against. It is hard to say how much damage to Oregon’s economy these things would do. It could be a lot; it could just as easily be minimal. But whether the damage would be a lot or only a little, I seriously doubt that it would strengthen Oregon’s economy. Personally, I’d prefer it if experiments like this were performed in some other laboratory of democracy.

The Oregon Legislative Revenue Office recently assessed the consequences of adopting a comprehensive turnover tax (called a commercial activity tax or CAT) that would apply to nearly all business transactions and not just to the sales of large C-corps, as under the status quo. Its analysis considered an array of rates from .4 percent to .65 percent of sales and various uses of CAT revenue, most notably, repealing Oregon’s corporate income tax, increasing the standard deduction on Oregon’s personal income taxes, and creating a property-tax exemption for owner-occupied, primary residences. The revenue office assumed that the CAT would behave pretty much like a consumption tax (albeit on gross rather than final output). If so, relative to repeal of the corporate income tax, it should reduce the progressivity of Oregon’s state and local tax system and, thereby, reduce its short-term volatility somewhat, as well as its long-term growth rate; relative to increasing the standard deduction or creating a homestead exemption, its effects should pretty much be a wash. Seems like a lot of back and forth for not much practical payoff, which is an extremely informative insight (although oddly, it’s not the finding that has gotten the most attention).

Me? I’d like to increase the PIT standard exemption, but otherwise my tastes run to the incremental: increasing the alternative minimum turnover tax rate (to .4 or .5 percent) and, maybe, since I am a fan of tax harmonization, finding a way to extend it to all businesses, partnerships included, with revenues exceeding $500 thousand (as in the proposals assessed by the LRO, but retaining the offset provision for C-corps and creating one for other businesses) and, perhaps, not so incrementally, to all non-governmental corporations and some special-service districts as well (which is consistent with the logic of tax harmonization).