Tax & Budget Policy News

North Carolinamay soon join little-noticed movement to level the playing field on business taxes. A growing chorus of governors have called for an end to the elaborate shell games that some businesses play with out-of-state subsidiaries to avoid state taxes. These schemes leave in-state businesses that must pay full taxes at a competitive disadvantage. In the past two months governors in at least five states and legislative bills in at least four others, have proposed to join 18 other states that have decided to bypass tricky tax-avoidance transactions between subsidiaries by requiring affiliated firms to file taxes together and pay taxes based on their combined in-state business activity.

There are some signs that North Carolina may be next. According to an interview with the Governor Easley’s senior policy advisor for fiscal affairs, Dan Gerlach, published in Business North Carolina, the Governor’s office supports a move to combined reporting “to make sure that our tax system is fair to all corporations.”

“States have been duped by the tax shell game long enough,” said Rob Thompson, NCPIRG Advocate. “Years from now people will shake their heads that states ever tried to collect taxes the old way.”

Governors in Michigan Iowa, Massachusetts, New York, and Pennsylvania have proposed this modernization in their recent budgets. In numerical terms, this could be the year that combined reporting covers a majority of the nation’s state taxes on business. In 2004 the states with combined reporting still represented less than 29 percent of the nation’s total gross domestic product.1 If Governors Granholm, Culver, Patrick, Spitzer, and Rendell have their way, that number will double to almost 60 percent in 2008. And if the bills pending in North Carolina and three other state legislatures become law, combined reporting could cover almost two-thirds of the economy.

Over half of US states, generally those with smaller economies, still use the earlier system crafted in an era when few companies operated across state lines. California was the first state in 1937 to prevent multi-state companies from avoiding taxes through accounting maneuvers that shift profits to out-of-state subsidiaries.

Now, the trickle of states adopting this tax modernization may have reached a tipping point. In the last two years Texas, Vermont, and Ohio adopted combined reporting in their business taxes. The Texas rule begins in 2008. In addition to the five governors already this year, legislation has also been filed for combined reporting in MarylandNew MexicoNorth Carolina, and West Virginia.

Governors and legislators are acting now because of four factors:

• When multi-state businesses fail to pay their taxes, regular households and companies without high-priced accountants end up picking up the tab.

• Public opinion has shifted post-Enron and WorldCom. In addition to these infamous meltdowns related to tax avoidance, last month, a much-discussed expose in the Wall Street Journal described how North Carolina and 13 other states are suing Wal-Mart for avoiding taxes by sending profits to a tax-free real-estate trust owned by itself and its top brass. North Carolina is suing that retailer for approximately $33 million in unpaid taxes, interest, and penalties.

• State economies better prosper when companies succeed based on efficiency and innovation, rather than their ability to avoid taxes.

• State attempts to prohibit individual tax dodges instead of creating combined reporting have failed to keep up with private tax lawyers’ ability to invent new loopholes. States have learned that more systematic approaches are necessary because they are outgunned by a growing industry of high-priced tax consultants.

“Combined reporting will help companies that pay their taxes but compete against multi-state companies that do not,” says Thompson. “This tax reform does away with a thousand tax loopholes at once. As North Carolina and other states catch on, fewer companies will waste their time on sham transactions and subsidiaries. This is a big step toward fairer state taxes and fairer competition among business.”

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States using combined reporting for corporate income taxes in 2004 were as follows with percent of GDP listed: Alaska (0.3), Arizona (1.7), California (13.1), Colorado (1.7), Hawaii (0.4), Idaho (0.4), Illinois (4.5), Kansas (0.9), Maine (0.4), Minnesota (1.9), Montana (0.2), North Dakota (0.2), Nebraska (0.6), New Hampshire (0.4), Oregon (1.2), and Utah (0.7), and Vermont (0.2). Ohio, Texas, and Vermont, with 3.6 percent, 8.0 percent, and 0.2 percent of national GDP respectively, issued combined reporting laws in the last two years. Data is from the U.S. Bureau of Economic Analysis measures of 2005 gross domestic product by state calculated as a percentage of the entire state-based gross domestic product, including Washington DC and four states with no corporate income tax. Raw data available at http://www.bea.gov/bea/newsrelarchive/2006/gsp1006.htm table 3A.

U.S. PIRG, the Federation of State PIRGs (Public Interest Research Groups), is a network of state-based, non-partisan public interest advocacy organizations with a national advocacy office in Washington, D.C. We uncover threats to public health and well-being and fight to end them, using the time-tested tools of investigative research, media exposes, grassroots organizing, advocacy and litigation. U.S. PIRG’s mission is to deliver persistent, result-oriented activism that protects public health and the environment, encourages a fair, sustainable economy, and fosters responsive, democratic government. For more information, see www.uspirg.org