Tax Analysts Blog

Is There One ‘Right’ Apportionment Formula?

Posted on Nov 6, 2013

On November 1 Tax Analysts sponsored a conference addressing the Multistate Tax Commission’s rewrite of Article IV of the Multistate Tax Compact, which incorporates, nearly verbatim, the Uniform Division of Income for Tax Purposes Act (UDITPA). This is a topic of interest to state and local tax practitioners because many states incorporate, in whole or in part, Article IV in their tax statutes.

A host of interesting issues were raised by the panelists, who included Shirley K. Sicilian, general counsel for the MTC; Prentiss Willson, of counsel at Sutherland Asbill & Brennan LLP; Richard Pomp, Alva P. Loiselle Professor of Law at the University of Connecticut; and Arthur R. Rosen, partner at McDermott Will & Emery. The discussion was lively and informative. The panelists provided historical background on the MTC and UDITPA, as well as their thoughts on how Article IV should be updated to better reflect current economic realities.

UDITPA was developed back in 1957 by the Uniform Law Commission to address an exceedingly complex feature of state corporate taxation: the division of the tax base among the states in which a taxpayer does business. To best accomplish that task, UDITPA provides a model formula for apportioning a multistate corporation’s tax base. It’s not a perfect solution (there isn’t one), but formulary apportionment provides a rough approximation of how a corporation’s tax base should be divided.

The project to rewrite Article IV is a major undertaking. But will it promote uniformity? Let's look at apportionment formulas. The MTC has the unenviable task of promoting uniformity among states, while at the same time states are competing against each other for economic supremacy. It is this competition that has led states in the direction of single-sales-factor apportionment. Single-sales-factor apportionment benefits those businesses that have significant property and payroll in the state. The argument is that if a business is given a choice between a state with a three-factor apportionment formula and one with single-sales-factor apportionment, businesses would choose to locate additional capital in the latter. Yet single sales factor is not a panacea, and there is a lack of data to establish that a move to it results in additional revenue for a state.

The MTC acknowledged the increased focus on the sales factor in its recommendation for an apportionment formula in the rewrite of Article IV. The proposed amendment would simply recommend (not require) a formula that double weights the sales factor.

It seems that by making a recommendation only, the MTC is conceding that uniformity cannot be achieved in this area. I suppose it was the path the MTC had to take. The MTC would be hard-pressed to think it could stop states from adopting a single-sales-factor apportionment formula when state politicians tie single-sales-factor apportionment to economic development. The suggestion of a double-weighted sales factor is a compromise. But is it the right compromise? Why not just recommend a single-sales-factor apportionment formula?

While states may be moving in the direction of single-sales-factor apportionment, I am pleased the MTC didn't jump on the bandwagon. Although some studies make a correlation between a positive economic benefit for states and placing more weight on the sales factor, other policy experts have argued that single-sales-factor apportionment distorts the basic tax principle that a company's tax burden should correlate to its use of benefits from the taxing state. That is, if a large corporation is located in a single-sales-factor jurisdiction and exports 100 percent of its sales out of that taxing jurisdiction, its apportionment fraction would be zero, even though it uses a significant amount of state benefits. By placing weight on property, payroll, and sales, three-factor apportionment recognizes that states provide a variety of services to businesses and their employees, as well as provide a market in which that business can sell its products.

The rise of single-sales-factor apportionment is interesting. It could almost be a case in which one state adopted it on the grounds that it would create jobs and increase investment in the state. Then other states followed suit, not because single-sales-factor apportionment produced more accurate results, but because it was perceived as making a state's tax laws more competitive or business friendly. But while single-sales-factor apportionment may benefit some businesses, it is far from being universally beneficial for taxpayers. In the end, if state officials are truly concerned with making their state more attractive to businesses, perhaps they should consider retaining -- or returning to -- the three-factor apportionment method and focus on a less burdensome corporate tax system overall.

Read Comments (1)

emsig beobachterNov 6, 2013

Although it is probably not the best apportionment formula, the single sales
factor does have one economic benefit -- the corporate income tax would not
influence where a business chooses to produce its products. That is, the single
sales factor would be locationally neutral -- a positive attribute for any tax.
Furthermore, the corporate income tax is not necessarily a good tax to compare
the burdens of the taxation on the business to the benefits received. No
general tax can do that, especially a tax whose ultimate incidence is not well
known. For example, consider two businesses that are essentially similar
differing only in their measured profits. The profitable business writes a
check to the government while the less profitable business will write a check
for a lesser amount. Thus, each firm pays differing amounts but receives
essentially the same benefits of government services. In addition, we have no
idea if the amounts of the checks written to the government come anywhere near
covering the cost to the government of providing these services; or,
conversely, the checks written by these firms are far greater than the benefits
of the government services received. In your example of a large firm located in
a single sales factor state with little or no sales in its home state the
benefits of government services would best be measured by property taxes,
excise taxes, or even use taxes on the products and services the firm
purchases, although this latter tax creates pyramiding problems.

The trend toward adoption of the single sales factor by the states may be
viewed as an investment decision made by state and/or local policy makers. That
is, policy makers may be willing, rightly or wrongly, to give up some corporate
income tax revenue for more jobs and investment. In this calculus, if giving up
some corporate income tax revenue results in more jobs and investment, that
lost revenue may be made up in increased personal income taxes, property taxes,
and sales taxes. In the best of all possible worlds, the reduction in corporate
tax rates will result in such increased investment and profitability of
in-state firms that the corporate income tax revenues will eventually recover
to their old levels --the Laffer Curve effect. Remember, no politician was ever
elected on the basis of maximizing corporate income tax revenues.

As for your last point -- returning to the three factor formula and making the
corporate tax somewhat less burdensome -- I agree. I propose that the states
adopt the 150% sales factor, negative 25% payroll factor, and negative 25%
property factor and do away with all special exemptions, credits, deductions,
etc. "Throwback" and "throwout" rules will still be needed if PL 86-272 is not
repealed.

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