A Better Way for States to Tax Business
The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.
By Richard F. Keevey
October 23, 2023
Fourty-four states have a corporate business tax (CBT) ranging from 2.5 percent in North Carolina to 9.8 percent in Minnesota. Four states have no corporate tax and two have a gross receipts tax of some sort. Most corporations pay the tax based on net income. However, the effective rate is even much lower thanks to deductions, credits and a vast array of tax incentives.
Much is written concerning the need to attract and retain businesses in state governments. A common practice is to offer tax incentives to either retain corporations that are ’thinking about’ or ’threatening’ to move to a better business climate.
There is much debate as to the effectiveness of these subsidies. To oversimplify the argument, some suggest that offering these deductions encourages corporations to settle or stay in the state and in the long run the economy here will expand, and new jobs will be brought to or retained in the state that otherwise would not happen.
Others argue that tax incentives are an ineffective tool because, among other reasons, they so often reward companies for actions they would have taken anyway. More importantly, states are losing revenue.
Furthermore, the argument is often made that corporations make decisions about locating or retaining business in a state based not just on the corporate tax climate but on our location, the highly educated workforce, desirable communities and good schools.
The corporate tax has several problems with its structure. Specifically, the taxable value of the entity is measured by net income. While net income may be conceptually appealing as a measure of economic value, in the real world of separate entity accounting, pass-through entities and extensive deductions, it does not adequately measure business activity.
Net income is hardly an objective measure. Rather it has extensive loopholes that allow the tax to be evaded or reduced for certain corporations. Two other points:
- Governors and Legislatures frequently enact legislation to lessen the impact on certain corporations. Some corporations receive these credits and deductions; others do not.
- The tax is highly inefficient to administer by the state, and likewise for corporations.
The last two points are illustrative of taxation at its worst—it is neither equitable nor easy to enforce or collect. Currently, there is an army of state government tax examiners, auditors and lawyers trying to understand how each corporation is attempting to limit its payments; and a like army of corporate financial wizards trying to understand the extensive and complicated tax code and how they can limit their liability. These resources could be used more effectively.
The CBT is a broken tax that does not meet the needs of business or the state. It should be replaced with a simpler business tax that has low costs in compliance and administration, is not dependent on corporate form and raises revenue from the broadest number of entities.
A true “franchise” tax on all business entities is best, with the activity measured not by net income but by gross profits—state receipts show less deductions for cost of goods sold and normal employment costs. No credits, no other deductions for expenses, no loopholes, just a simple computation based upon an acceptable, recognizable and logical base.
There is a wide range of fee or rate schedules that can be designed to generate as much as the current CBT generates, more or less, depending on state tax policy.
As with any proposal that dramatically changes the base for taxation, some will oppose it. It will be called unfair because it imposes a tax on all businesses regardless of profitability. The real question: is there an easier, more equitable way to tax business than our complex, unfair and highly inefficient current mix of laws? These and other arguments could go on and on, and frankly are examples of why the present system is so complicated and why we are constantly legislating deductions, credits and other loopholes for certain corporations.
The goal of tax policy should be to treat all businesses, regardless of form, fairly. The current tax policy in all states is riddled with loopholes and is easy to manipulate. A reliance on net income to measure profitability or activity, while theoretically attractive to the purist, is fatally flawed in practical application.
In my judgment the conclusion is clear: the corporate income tax is broken and should be eliminated and replaced with a simple tax on all business activity regardless of corporate form, levied on a logical and recognizable base not subject to easy manipulation.
More importantly, think what incentive it would present to businesses thinking of coming to or staying in a specific state if it eliminated the complicated corporate tax and replaced it with an equitable, understandable tax that did not require an army of high-priced staff. Unlike the CBT, this tax is simple and does not distort business decisions, does not discriminate between business types and need not impose an undue burden on any business entity. That’s truly business friendly.
Author: Richard F. Keevey is the former Budget Director for the state of New Jersey– appointed by two governors from each political party. He was also appointed by the president as the Chief Financial Officer at HUD, and as the deputy undersecretary of defense for finance. He is currently a Senior Policy Fellow at Rutgers University
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A Better Way for States to Tax Business
The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.
By Richard F. Keevey
October 23, 2023
Fourty-four states have a corporate business tax (CBT) ranging from 2.5 percent in North Carolina to 9.8 percent in Minnesota. Four states have no corporate tax and two have a gross receipts tax of some sort. Most corporations pay the tax based on net income. However, the effective rate is even much lower thanks to deductions, credits and a vast array of tax incentives.
Much is written concerning the need to attract and retain businesses in state governments. A common practice is to offer tax incentives to either retain corporations that are ’thinking about’ or ’threatening’ to move to a better business climate.
There is much debate as to the effectiveness of these subsidies. To oversimplify the argument, some suggest that offering these deductions encourages corporations to settle or stay in the state and in the long run the economy here will expand, and new jobs will be brought to or retained in the state that otherwise would not happen.
Others argue that tax incentives are an ineffective tool because, among other reasons, they so often reward companies for actions they would have taken anyway. More importantly, states are losing revenue.
Furthermore, the argument is often made that corporations make decisions about locating or retaining business in a state based not just on the corporate tax climate but on our location, the highly educated workforce, desirable communities and good schools.
The corporate tax has several problems with its structure. Specifically, the taxable value of the entity is measured by net income. While net income may be conceptually appealing as a measure of economic value, in the real world of separate entity accounting, pass-through entities and extensive deductions, it does not adequately measure business activity.
Net income is hardly an objective measure. Rather it has extensive loopholes that allow the tax to be evaded or reduced for certain corporations. Two other points:
The last two points are illustrative of taxation at its worst—it is neither equitable nor easy to enforce or collect. Currently, there is an army of state government tax examiners, auditors and lawyers trying to understand how each corporation is attempting to limit its payments; and a like army of corporate financial wizards trying to understand the extensive and complicated tax code and how they can limit their liability. These resources could be used more effectively.
The CBT is a broken tax that does not meet the needs of business or the state. It should be replaced with a simpler business tax that has low costs in compliance and administration, is not dependent on corporate form and raises revenue from the broadest number of entities.
A true “franchise” tax on all business entities is best, with the activity measured not by net income but by gross profits—state receipts show less deductions for cost of goods sold and normal employment costs. No credits, no other deductions for expenses, no loopholes, just a simple computation based upon an acceptable, recognizable and logical base.
There is a wide range of fee or rate schedules that can be designed to generate as much as the current CBT generates, more or less, depending on state tax policy.
As with any proposal that dramatically changes the base for taxation, some will oppose it. It will be called unfair because it imposes a tax on all businesses regardless of profitability. The real question: is there an easier, more equitable way to tax business than our complex, unfair and highly inefficient current mix of laws? These and other arguments could go on and on, and frankly are examples of why the present system is so complicated and why we are constantly legislating deductions, credits and other loopholes for certain corporations.
The goal of tax policy should be to treat all businesses, regardless of form, fairly. The current tax policy in all states is riddled with loopholes and is easy to manipulate. A reliance on net income to measure profitability or activity, while theoretically attractive to the purist, is fatally flawed in practical application.
In my judgment the conclusion is clear: the corporate income tax is broken and should be eliminated and replaced with a simple tax on all business activity regardless of corporate form, levied on a logical and recognizable base not subject to easy manipulation.
More importantly, think what incentive it would present to businesses thinking of coming to or staying in a specific state if it eliminated the complicated corporate tax and replaced it with an equitable, understandable tax that did not require an army of high-priced staff. Unlike the CBT, this tax is simple and does not distort business decisions, does not discriminate between business types and need not impose an undue burden on any business entity. That’s truly business friendly.
Author: Richard F. Keevey is the former Budget Director for the state of New Jersey– appointed by two governors from each political party. He was also appointed by the president as the Chief Financial Officer at HUD, and as the deputy undersecretary of defense for finance. He is currently a Senior Policy Fellow at Rutgers University
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