Testimony in support of eliminating the federal “domestic production deduccton”

April 05, 2013

         The Institute supports a bill that would disallow the federal domestic production deduction which is a costly tax giveaway that was never voted on by lawmakers in our state but rather carried down through the federal tax code.       

       Enacted in 2004, this allows businesses to 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, such as publishing, construction, architecture and software development.[i]

      This provision is costing the state at least $700,000 a year but we expect that number to be higher for at least two reasons.  First, the 2012 Tax Expenditures Report, which documents that Rhode Island lost close to $700,000, only accounts for the cost through the personal income tax, not the revenue lost against the corporate income tax.  We understand this will change in future reports.  Second, the rate has risen from 3 to 6 to a high of 9 percent of qualifying income in 2010, and no estimates have been made for the cost in that year.

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 in the aftermath of 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 five states and the District of Columbia are not affected by this tax expenditure or have already decoupled, allowing them to preserve much needed revenue.

[i] Mazerov, Michael and Chris Mai.  January 2013.  State can opt out of the costly and ineffective “domestic production deduction” corporate tax break.

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