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To hear some folks talk, one might think that Oregon had repealed its business taxes.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

Tuesday, April 12, 2016

Fred Thompson: Hive Mind

Hive Mind: How Your Nation’s IQ Matters So Much More than Your Own
By Garett Jones (Stanford University Press, 2016)

Individual cognitive ability scores aren’t good predictors of lifetime earnings. On average individuals with high IQ scores earn about 60 percent more than the national average. That premium is more or less constant over time and distance. But nations with the highest scores are on average “about eight times more prosperous than nations with the lowest scores” (p. 5, evidence in Chapter 2).

In Hive Mind, Garett Jones sets out to explain why higher cognitive ability scores (which he argues in Chapter 1 reflects real underlying differences in skills) are so much more important for collectivities than for individuals.

Human society is a form of collective intelligence, in which the accumulated knowledge of the past makes its members richer today, and in which the many small, daily cognitive contributions of millions of their neighbors  – in offices, in factories, in the halls of government, and elsewhere – help to make their lives better.... . Members of society all draw on that collective intelligence, they all get benefits from the hive mind they never pay for... (p. 12)
Jones doesn’t really tell where differences in cognitive abilities come from. His story is mostly about why they matter. They matter because higher because (p. 13):

1)   High scoring groups cooperate more effectively, which is the key to making collective action more productive in all kinds of enterprises, both by increasing throughput and by building capacity. (Chapter 5)
2)   High scoring groups work together better in teams, which is critical to the performance of weakest-link, precision activities – the kinds of activities that are characteristic of complex value chains. (Chapter 7)
3)   High scoring groups are more patient and forward looking. They save more and they invest more, not just in plant and equipment, but also in organizational learning and technology. (Chapter 4)
4)   High scoring groups make better citizens and sustain more effective polities. (Chapter 6)
5)   Cooperative, patient, well-informed groups encourage their members to engage in cooperative, patient, information seeking behavior. (Chapter 8)
At the same time, he insists that average cognitive ability scores are increasing and that they can be improved (Chapter 3). The reason he cannot tell us how best to do so is that there are far more plausible explanations for increases in cognitive ability than there are observations with which to test them. Consequently, his strongest conclusions have to do with the provision of basic public health and nutrition. He’s moderately hopeful for education as well, but only where students are physically present, have access to books, and teachers teach. As he notes, years of formal schooling is only weakly associated with cognitive abilities, whereas the association between measured learning and cognitive ability is quite strong. Of course, the causal arrow could go either way, but Jones plausibly suggests that, over the long term and on average, educational effort drives cognitive development.

On balance this is a notable text – perhaps, 2016’s most important economics book, both for the development specialist and the general reader.

Garett Jones is Associate Professor of Economics at the Center for Study of Public Choice, George Mason University   
 As for its weaknesses, there are arguably three, none particularly damning.

Chapter 8 emphasizes monkey see monkey do, reminding us that we humans are eager and able to copy the practices of prestigious others, to the benefit of all. However, if Jones appreciates the degree to which social segregation can short-circuit this mechanism, I missed it. This is a potentially serious omission, since it suggests a important pathway to enhancing the mechanism’s efficacy.

Second, Jones writes beautifully. For the most part this book is a model of clarity and accessibility. Regrettably his explanation of why both low skilled and high skilled workers are paid better and are also more productive in rich nations than in poor ones is especially murky (Chapter 9). As an economist, even if not a very good one, I think I understand what Jones is saying, others might not.

Third, Chapter 9, on the benefits international migration, seems tangential to the main argument of the book, not, I think, because it is, but because the transition to this topic and its development are excessively truncated. Indeed, so far as the last third of the book is concerned, this reader found himself consistently wanting more.

For example, in Chapter 7, Jones talks briefly about collective intelligence within enterprises. This is hugely important. A nation’s productivity is merely the sum of the output of its enterprises. How much does enterprise performance depend on the cooperative, patient, information-seeking behavior of its members? Jones suggests that the answer may be quite a bit. But he leaves the how sketchy. This is a pity for several reasons, not the least of which is that it may be relevant to an understanding of increased income inequality. We know that inequality has increased rapidly in recent decades, nowhere more so than in the United States.  According to Song, et al. (2015), most of this increase is due to increased differences between businesses, not to increased inequality within businesses. They claim, that over the past 30 years, wage distributions within businesses have remained virtually constant, as has the wage gap between the highest paid employees within enterprises and their average employees. It seems likely (see Bender, et al., 2016) that some enterprises systematically recruit and retain workers with higher average cognitive abilities and that workforce selection and positive pay premiums explain much of the observed differences in productivity and earnings at the enterprise level. I’d really like to see a more developed discussion of this topic.

Finally, Jones is primarily concerned about improving outcomes in less-developed nations, he has little to say about boosting cognitive abilities in developed countries, although in the special case of the US, which is rather like a mosaic comprised of myriad middle–income communities and very rich ones, his strictures regarding nutrition and public health retain considerable relevance. Nevertheless, I wish that he had paid some attention to the potential payoffs to expanding pre-kindergarten, especially for disadvantaged children, and of the relationship between quality of childcare and the development of cognitive abilities.

Overall, this is a very good book, it would be better if it were about 100 pages longer.

Song, J., Price, D.J., Guvenen, F., Bloom, N. and von Wachter, T., 2015. Firming up inequality (No. w21199). National Bureau of Economic Research.

Bender, S., Bloom, N., Card, D., Van Reenen, J. and Wolter, S., 2016. Management Practices, Workforce Selection and Productivity (No. w22101). National Bureau of Economic Research.