Tax Analysts Blog

Just Do It

Posted on Dec 19, 2012

The recent fight between Nike and Oregon was well-document in the press. Nike was looking to expand and said it was prepared to expand in Oregon if state lawmakers would guarantee that the state’s tax rules wouldn’t change following the investment. In other words, Nike wanted Oregon to agree that it would be locked in to single-sales-factor apportionment. Of course, Oregon agreed.

Oregon Gov. John Kitzhaber (D) set forth a proposal, the Economic Impact Investment Act (LC 1), that would give the governor the authority to enter into qualifying contracts (which would extend from five to 40 years) with any company that commits to creating a minimum of 500 jobs or making $150 million in investment over five years.

Oregon should have resisted the impulse to “just do it,” and here’s why:

States that impose a corporate income tax must determine how to apportion the income of multistate businesses among the states in which they do business. States have some latitude regarding apportionment, provided state tax on corporate income is limited to the portion of a multistate business's net income that is "fairly attributable" to the business's activity in the taxing state.

Many states with a corporate income tax chose to adopt the three-factor formula for apportionment included in the Uniform Division of Income for Tax Purposes Act (UDITPA). With three-factor apportionment, the three factors -- property, payroll, and sales -- are computed as ratios of the taxpayer's presence in the state over the taxpayer's presence everywhere. Under the standard UDITPA approach, the ratios are given equal weight and are used to calculate the taxpayer's apportionment percentage, which is multiplied by its total apportionable income to arrive at the portion that is subject to tax in a particular jurisdiction.

Although that method once enjoyed nearly universal application, and was referred to by the Court in Container Corp. of America v. Franchise Tax Board, 463 U.S. 159 (1983), as a "benchmark against which other apportionment formulas are judged," in recent years, the three-factor apportionment method has undergone significant modifications in many adopting states. In some states, the sales factor is given additional weight. For example, some states double weight the sales factor for all taxpayers or for taxpayers with specific qualifications. In other states, a single-sales-factor method is used. Under that method, the sales factor is the only factor considered when determining the tax base.

Single-sales-factor apportionment can benefit some taxpayers, while it can burden others. Nonetheless, a number of states have switched from a three-factor formula to a single-sales-factor formula to encourage job creation and investment within its borders. Unfortunately, there is little empirical evidence to prove a connection between the adoption of single-sales-factor apportionment and increased in-state jobs or investment.

In Oregon, Nike is good example of a taxpayer that benefits from a single-sales-factor apportionment method because it has significant property and payroll in Oregon (which is not factored into its apportionment formula) and most of its goods are sold outside the state (resulting in a low sales factor). In the end, Nike benefits greatly from single-sales-factor apportionment.

Although many states are moving toward an apportionment formula that more heavily weights the sales factor, Oregon should not lock itself into any tax policy, particularly now. States face real fiscal challenges in the near future and need to have the ability to make comprehensive tax reform.

It is also a dangerous precedent in the world of tax incentives and states should resist incentives whenever possible. They simply do not represent good tax policy.

If it makes economic sense (aside and apart from any tax incentives) for Nike to expand in Oregon, the company will likely do so, regardless of what Oregon promises. Fortunately or unfortunately, companies are driven by economic realities, not tax consequences.

By cow-towing to Nike, Oregon is setting itself up to have other corporations wanting to take advantage of the same deal. Other states, driven by the constant need to attract and retain high-wage jobs, could also feel compelled to offer similar deals to large in-state employers. And, in the end, the race to the bottom will be perpetuated with a new breed of state tax incentives.

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