March 27, 2010
Ocean State missing the boat by failing to enact combined reporting and decoupling from the federal “domestic production deduction” corporate tax break
Over the past decade, Rhode Island has given up hundreds of millions of dollars in revenue through a variety of tax breaks and giveaways of questionable value to the economy. Even before the economic downturn, the state was struggling to maintain adequate funding for vital public services like education, infrastructure, and health care.
To grow our state’s economy and help families weather the economic storm, Rhode Island must keep investing in the services that people and businesses rely on. This will require state leaders to take a balanced approach to solving our financial problems, rather than relying on a cuts-only strategy that will further damage the fragile economy. That means making sure each dollar we spend is a wise, efficient investment. It also means carefully reviewing our state revenue policies. As Rhode Island faces one of the worst fiscal crises in history, we must consider not only what we spend but also what we give away.
Rhode Island’s Corporate Income Tax
The goal of the state’s corporate income tax is to ensure that Rhode Island’s companies pay their fair share towards the public services and infrastructure they use every day, like roads and bridges, police, fire and rescue, and an education system that trains current and future workers.
Rhode Island’s Business Corporations Tax raised $104.4 million in FY2009, accounting for 3.5% of the State’s General Revenues. Although Rhode Island’s statutory tax rate on corporate income is nine percent, few firms pay this amount because of the deductions, credits and exemptions allowed. In 2007, Rhode Island ranked 29th in corporate taxes collected as a share of state personal income nationally. This is a down from 26th the year before. During that year, 46,143 – or 93% – of the 49,619 Rhode Island corporate taxpayers paid the legally allowable “minimum tax” of just $500 a year.
Corporate “loopholes” allowed in minority of states, including Rhode Island
Big companies use a legal “corporate loophole” to dramatically lower their taxes by filing separate tax returns for various subsidiaries as though they weren’t part of the same business enterprise. By filing separate returns, corporations can artificially shift profits that are actually earned in Rhode Island onto the books of subsidiaries that Rhode Island cannot tax because they are located in other states. States can stop this by requiring “combined reporting,” where corporations must add together the profits of all members of the corporate family. The combined profits are then divided for tax purposes among the states in which the company does business in proportion to the level of business activity conducted in each state.
Rhode Island is among a minority of states that have left the door open for the use of aggressive interstate income-shifting schemes. Of the 45 states with corporate income taxes, 23 require combined reporting by multi-state corporations. They include the neighboring states of Massachusetts, New York, Vermont, New Hampshire, and Maine.
Combined reporting would raise revenue to help preserve vital public services
Combined reporting would raise significant amounts of revenue and help preserve education, health care, and other vital services from further spending cuts. The Division of Taxation has estimated that combined reporting would result in an additional five percent to eight percent of corporate income tax revenue.
This estimate is actually on the low side of what other states have predicted. In 2007, the Maryland General Assembly required all corporations in the state to calculate and report what they would have paid if combined reporting were in place. The state’s comptroller recently reported that if combined reporting had been in effect in 2007, corporate tax receipts would have increased by either 13 percent or 20 percent, depending upon which of two major approaches to combined reporting had been implemented. While every state’s corporate taxpayer community is different and there is no guarantee that Rhode Island would experience gains from combined reporting of this magnitude, if it did, this would mean revenue gains of $19 million to $30 million on a FY2007 Rhode Island corporate tax revenue base of $148 million.
Combined reporting won’t harm Rhode Island’s economy and could actually benefit the state’s small businesses
Opponents of combined reporting say it will harm the state’s business climate. But most businesses won’t pay higher taxes due to combined reporting. In 2008, the Rhode Island Division of Taxation estimated that of the businesses now paying taxes in Rhode Island, nearly three-quarters would not be affected by combined reporting or would see a tax decrease. Less than 30 percent would have a tax increase.
Comparisons across states indicate that combined reporting does not have an adverse impact on state competitiveness. According to the Center on Budget and Policy Priorities, between 1990 and 2007, seven of the eight states with corporate income taxes that had net gains in manufacturing employment required combined reporting (AZ, ID, KS, MT, NE, ND, and UT).
Finally, combined reporting could benefit the state’s economy by leveling the playing field between multistate and locally-owned and –operated businesses. The current system gives big companies an edge because they are more likely to be able to make use of tax shelters than are small firms that don’t have out-of-state subsidiaries, increasing their after-tax profits and thus their ability to undercut prices of smaller companies. A recent study for the federal Small Business Administration found that states that required combined reporting actually had higher rates of small business entrepreneurship than those that didn’t require it.
The Federal “Domestic Production Deduction” Corporate Tax Break
Rhode Island could be losing as much as $5 million annually due to its incorporation in the state tax code of a federal corporate tax giveaway called the “domestic production deduction.” Enacted in 2004, this allows businesses to take a deduct a portion of their profits from a wide range of “qualified production activities” that a company may be involved in, many that fall outside of traditional manufacturing.
Twenty five states, including Rhode Island, have failed to “decouple” from this provision of the federal tax code and are thus scheduled to lose significant state revenue in future years as the deduction experiences its final increase to 9 percent of qualifying income in 2010.
The deduction is not a cost-effective tool for job creation or growing the Rhode Island economy because it can be taken on activity that takes place out-of-state. Furthermore, the deduction only is immediately valuable to profitable companies, not those struggling during the downturn. The vast majority of those companies claiming the deduction are large, multi-state firms that may invest little or nothing in the state in which the deduction is being taken. The revenue forgone by adopting this tax break would have a much greater economic development “bang for the buck” if it were invested in the state’s existing economic development programs, infrastructure, or education.
According to the Center on Budget and Policy Priorities, states can easily decouple from the deduction by making modest changes to state tax laws and forms. Twenty two states have already decoupled, allowing them to preserve much needed revenue.