Tax Analysts Blog

States Should Cede Some Taxing Power to the Feds

Posted on Jun 30, 2014

Economists of all political stripes will tell you that of all our taxes, the corporation tax is the biggest drag on economic growth. Unfortunately for the economy, it is not going away anytime soon. Taxing the profits of big corporations appeals to voters. And now, with the rise of anti-corporate populism in the Tea Party, even Republicans will be reluctant to cut corporate taxes. On top of all that, cash-strapped governments have become highly dependent on revenue from the corporate tax. According to the latest projections, the federal government expects that the corporate tax, which raised $274 billion in 2013, will generate $502 billion of revenue in 2016.

As bad as the federal corporate tax is, state corporate taxes are worse. Added together, these taxes on average raise only about 20 percent of the revenue the federal government gets from the its corporate tax. (See the figure below.) But the costs of compliance to businesses and costs of administration to state governments are enormous. While for most states, the federal corporate tax return is the starting point for calculating state tax, each has its own forms, tax breaks, definitions, and method of auditing and enforcing its corporate tax.

Many Republican governors have talked about getting rid of their states' corporate taxes. But those efforts have largely gone nowhere. For example, during her 2010 campaign, South Carolina Gov. Nikki Haley(R) said she wanted to repeal her state's corporate tax. That state's rate was 5 percent then and has remained 5 percent.

Given that states' corporate taxes are here to stay, we should consider making them as painless and low-cost to businesses as possible. One way to do that is for Congress to exercise its authority under the commerce clause of the Constitution and require states to entirely piggyback their corporate taxes on the federal system. Under that approach, each state would be allocated a share of a corporation's national profits and then it could tax them at any rate it wished -- or not at all. The federal government would do all the collection. One form. One tax administration. One set of rules. The same amount of revenue for each state. Note that this approach could increase tax competition among the states because a business could simply compare tax rates.

That approach has been battle-tested in the real world. In Canada, 11 of 13 provinces and territories allow the federal government to collect and administer their corporate income taxes. When Ontario agreed to join this group in 2006, its government estimated that the benefit would be a $100 million reduction in corporations’ annual compliance costs.

The enormous roadblock to any sensible system like this is the selfish refusal of states to agree to give up any portion of their taxing power. For Congress to act, there must be some acquiescence from the states and some support from businesses. But there is no indication that this could happen -- despite all the chatter about the need to promote competitiveness and simplification through tax reform. That's too bad. In some areas of government policy -- particularly those concerning the economy--the goal of smaller government is better served by the states' ceding some power to the federal government.

Read Comments (2)

david brunoriJun 30, 2014

Marty, Great post. I think subnational business taxes are terrible. But your
idea would make the state CIT a little less painful in terms of both compliance
and administration. It is a terrific idea. Alas, the same forces that oppose
repeal of state income taxes will not like your idea much. Lots of people make
money on the system.

tong liuJul 8, 2014

Your views on corporate income taxes are mostly correct; the corporate income
tax, for many reasons, is not a good tax for the federal government or for
state governments. However, the corporate income tax, while an impediment to
economic growth, is not necessarily the biggest impediment.
In fiscal year 2013, state corporate income taxes accounted for 5.3 percent of
all state government tax revenue. Twenty years earlier, corporate income taxes
accounted for 6.8 percent of all state tax revenues. Considering the high cost
of compliance to business and administration to governments the tax can be
deemed relatively inefficient as a revenue raiser. . However, your suggestion
that the states cede some tax sovereignty to the federal government by having
the IRS apportion some part of the corporate income tax revenues to the states
according to a federally mandated formula is focused on the wrong tax. “Piggy
backing” the state individual income tax on to the federal income tax would
tremendously reduce compliance and administrative costs.
The individual income tax is much more important than corporate income tax.
According to the data from United States Bureau of the Census, for states with
both corporate and individual income taxes,, individual income tax collections
in fiscal year 2013 were more than 7 times greater than corporate income tax
collections. Of course there is a wide range around thae average – in North
Dakota, individual income tax collections were slightly more than twice the
collections of corporate income taxes. In Hawaii, individual income tax
collections were more than 19 times greater than corporate income tax receipts.
“Piggybacking” state individual income taxes onto the federal income tax would
yield extremely large reductions in both compliance and administrative costs;
and, would probably face little resistance from individual taxpayers.
Furthermore, allocating tax revenues back to the states according to historical
collections of the federal income taxes by state, which are already collected
by the IRS, should be noncontroversial.

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