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November 26, 2007
State Corporate Tax Leakage: $14.5 Billion in 2006
by Martin A. Sullivan

Full Text Published by Tax Analysts®



Author's note: The idea for this article occurred while I was reading Ernst & Young's 37-page "confidential" proposal to Wal-Mart to lower that company's state taxes. That document, written in 2002, came to light as one of many revealed during proceedings in a court in North Carolina, where the state is challenging Wal-Mart's aggressive use of real estate investment trusts to reduce corporate taxes. In the document, the nation's third-largest accounting firm offered a menu of options for the nation's largest retailer to reduce its state tax burden. The price tag for E&Y's proposed services was $2.5 million. Wal-Mart is now in court trying to suppress disclosure of the documents.

* * * * *

News Analysis

State corporate taxes are leaky buckets. Estimates presented here show that from 1999 through 2006, they were 22 percent less efficient than the already porous federal corporate tax. That 22 percent shortfall translates into a revenue loss of $14.5 billion for state governments in 2006.

In this article, "leakiness" or "revenue inefficiency" of state corporate taxes refers to the presence of exclusions, deductions, and credits and of planning opportunities beyond those available in the federal corporate tax system. That revenue inefficiency reduces state tax receipts below what a federal tax structure would generate using state tax rates. If states plugged those leaks so that their tax bases were as broad, and tax avoidance opportunities as few, as exist at the federal level, they could significantly reduce their corporate tax rates without any loss of revenue.

This article also presents evidence that suggests the leakiness of state corporate taxes compared with the federal corporate tax has grown in the recent past. In particular, comparisons of estimated shortfalls before and after the 2001 recession indicate a substantial increase in the leakiness of state corporate taxes vis-à-vis the federal tax.

The article concludes by proposing a reform of state corporate taxes that would maintain present revenue, greatly reduce the compliance burden on business, eliminate the administrative costs on state governments, allow rate reductions in most states, and promote economic growth.


Estimates


Figure 1 (next page) shows state corporate tax revenue as a percentage of U.S. gross domestic product and as a percentage of total state revenue. That long-term decline is commonly attributable to three factors: (1) increased leakiness of the federal corporate tax (the usual starting point for the calculation of state liabilities); (2) more generous state tax rules; and (3) more tax planning by corporations. The method used here removes the first factor and part of the second — that is, tax rate changes — from consideration. That allows us to measure state corporate tax leakage due solely to tax laws that are more generous and planning opportunities that are more numerous than available under federal law.

State corporate tax leakage is calculated in four steps:

    • (1) Compute an implied federal corporate tax base by dividing calendar year corporate tax receipts by the top federal corporate rate of 35 percent. So, for example, for 2006, when U.S. federal corporate tax receipts were $372 billion, the implied federal corporate tax base was $1.06 trillion.
    • (2) Apportion the tax base among the states on the basis of state GDP as measured by the Bureau of Economic Analysis of the U.S. Commerce Department. The validity of that apportionment depends on a similarity in distribution of profits across states to the distribution of GDP. So, in 2006, for example, Alabama accounted for 1.2 percent of national GDP. In our calculations, we assume it has a 1.2 percent share, or $12.96 billion of the total implied federal corporate tax base.
    • (3) Multiply the top state corporate tax rate by the implied state corporate tax base to arrive at potential corporate tax revenue — that is, what state revenue would be without any leakages vis-à-vis the federal tax. For Alabama, with a top corporate rate in 2006 of 6.5 percent, broad-based corporate tax revenue is $844 million.
    • (4) Subtract broad-based corporate tax revenue (computed in (3)) from actual calendar year corporate tax receipts as recorded by the U.S. Census Bureau. For Alabama in 2006, that shortfall is $285 million ($844 million from above less actual receipts of $559 million).

Calculations are presented for 43 states. Four states — Nevada, Washington, Wyoming, and South Dakota — have no corporate tax. Also excluded were Texas, whose new corporate tax came into effect in 2005; Michigan, whose single business tax is more like a value added tax than a corporate tax (and therefore really is not comparable to the federal corporate tax); and New Hampshire, whose business profits tax applies to all business entities — including partnerships and limited liability companies — regardless of whether they are subject to federal corporate tax. The District of Columbia was also excluded because of the difficulty in obtaining corporate tax receipts data on a calendar year basis.

Figure 1. State Corporate Income Tax Receipts,
1980-2006



Sources: Tax Foundation, Facts & Figures on Government Finance, 38th Ed., Mar. 2005, Table E7. "State Revenues by Source, Selected Fiscal Years 1902 — 2002," available at http://www.taxfoundation.org/files/fb4775d47715d7ae438e64286cddfbde.pdf); U.S. GDP data from the Bureau of Economic Analysis of the U.S. Department of Commerce, available at http://www.bea.gov.

For the years 1999 through 2006, Table 1 lists top state corporate tax rates. Table 2 (p. 604) shows actual calendar year tax receipts. Table 3 (p. 606) shows estimated potential revenue (as described in point (3) above). Table 4 (p. 608) shows the excesses (positive numbers) and shortfalls (negative numbers) of actual revenue over potential revenue (as described in point (4) above).

That's a lot of numbers. Here's the executive summary: The 4-to-1 majority of negatives compared with positives in all those little rectangles in Table 4 indicates that in most states and that in most years state corporate taxes are leaking.

To facilitate comparison across states, Table 5 (p. 610) adds for each state the eight-year totals of actual receipts (from Table 2), potential receipts (from Table 3), and the difference between the two (from Table 4). From a total of 43 states, only 4 — Alaska, West Virginia, Mississippi, and California — had corporate tax systems that outperformed the federal corporate tax during the 1999-2006 period. In 13 states, revenue shortfalls were between 0 and 25 percent of potential. In 19 states, revenue shortfalls were between 25 and 50 percent of potential. And in seven states, they were greater than 50 percent of potential. Iowa — with a 12 percent corporate rate, the highest in the nation — had the least revenue-efficient corporate tax.

Adding together all 43 states, the bottom line of Table 5 shows that total state corporate revenue of $244.9 billion was $67.4 billion less than the potential revenue of $313.3 billion. That's an average shortfall of 21.6 percent. If the 21.6 percent figure is applied to broad-based revenue of $67.1 billion in 2006, the estimated state corporate revenue shortfall for that year is $14.5 billion.


Variation Over Time


There is considerable variation in the relationship between actual and potential state corporate revenue over the 1999-2006 period. That is illustrated in figures 2 and 3. In general, a useful way of thinking about data patterns over time is to distinguish cyclical movements from longer-term trends. Here we'll talk about business cycle movements first and then the trend.

             Table 1. State Corporate Income Tax Rates, 1999-2006
                      (percentage, end of calendar year)

 _____________________________________________________________________________
                 
1999    2000    2001    2002    2003    2004    2005    2006
 _____________________________________________________________________________
  1  Alabama     5.00%   5.00%   5.00%   5.00%   6.50%   6.50%   6.50%   6.50%

  2  Alaska      9.40%   9.40%   9.40%   9.40%   9.40%   9.40%   9.40%   9.40%

  3  Arizona     8.00%   7.97%   6.97%   6.97%   6.97%   6.97%   6.97%   6.97%

  4  Arkansas    6.50%   6.50%   6.50%   6.50%   6.50%   6.50%   6.50%   6.50%

  5  California  8.84%   8.84%   8.84%   8.84%   8.84%   8.84%   8.84%   8.84%

  6  Colorado    4.75%   4.63%   4.63%   4.63%   4.63%   4.63%   4.63%   4.63%

  7  Connecti-
     cut         8.50%   7.50%   7.50%   7.50%   7.50%   7.50%   7.50%   7.50%

  8  Delaware    8.70%   8.70%   8.70%   8.70%   8.70%   8.70%   8.70%   8.70%

  9  Florida     5.50%   5.50%   5.50%   5.50%   5.50%   5.50%   5.50%   5.50%

 10  Georgia     6.00%   6.00%   6.00%   6.00%   6.00%   6.00%   6.00%   6.00%

 11  Hawaii      6.40%   6.40%   6.40%   6.40%   6.40%   6.40%   6.40%   6.40%

 12  Idaho       8.00%   8.00%   7.60%   7.60%   7.60%   7.60%   7.60%   7.60%

 13  Illinois    7.30%   7.30%   7.30%   7.30%   7.30%   7.30%   7.30%   7.30%

 14  Indiana     7.90%   7.90%   7.90%   7.90%   8.50%   8.50%   8.50%   8.50%

 15  Iowa       12.00%  12.00%  12.00%  12.00%  12.00%  12.00%  12.00%  12.00%

 16  Kansas      7.35%   7.35%   7.35%   7.35%   7.35%   7.35%   7.35%   7.35%

 17  Kentucky    8.25%   8.25%   8.25%   8.25%   8.25%   8.25%   7.00%   7.00%

 18  Louisiana   8.00%   8.00%   8.00%   8.00%   8.00%   8.00%   8.00%   8.00%

 19  Maine       8.93%   8.93%   8.93%   8.93%   8.93%   8.93%   8.93%   8.93%

 20  Maryland    7.00%   7.00%   7.00%   7.00%   7.00%   7.00%   7.00%   7.00%

 21  Mass.       9.50%   9.50%   9.50%   9.50%   9.50%   9.50%   9.50%   9.50%

 22  Minnesota   9.80%   9.80%   9.80%   9.80%   9.80%   9.80%   9.80%   9.80%

 23  Missis-
     sippi       5.00%   5.00%   5.00%   5.00%   5.00%   5.00%   5.00%   5.00%

 24  Missouri    6.25%   6.25%   6.25%   6.25%   6.25%   6.25%   6.25%   6.25%

 25  Montana     6.75%   6.75%   6.75%   6.75%   6.75%   6.75%   6.75%   6.75%

 26  Nebraska    7.81%   7.81%   7.81%   7.81%   7.81%   7.81%   7.81%   7.81%

 27  New
     Jersey      9.00%   9.00%   9.00%   9.00%   9.00%   9.00%   9.00%   9.00%

 28  New
     Mexico      7.60%   7.60%   7.60%   7.60%   7.60%   7.60%   7.60%   7.60%

 29  New York    9.00%   8.00%   7.50%   7.50%   7.50%   7.50%   7.50%   7.50%

 30  N.
     Carolina    7.00%   6.90%   6.90%   6.90%   6.90%   6.90%   6.90%   6.90%

 31  N. Dakota  10.50%  10.50%  10.50%  10.50%  10.50%   7.00%   7.00%   7.00%

 32  Ohio        8.50%   8.50%   8.50%   8.50%   8.50%   8.50%   6.80%   5.10%

 33  Oklahoma    6.00%   6.00%   6.00%   6.00%   6.00%   6.00%   6.00%   6.00%

 34  Oregon      6.60%   6.60%   6.60%   6.60%   6.60%   6.60%   6.60%   6.60%

 35  Pennsyl-
     vania       9.99%   9.99%   9.99%   9.99%   9.99%   9.99%   9.99%   9.99%

 36  Rhode
     Island      9.00%   9.00%   9.00%   9.00%   9.00%   9.00%   9.00%   9.00%

 37  S.
     Carolina    5.00%   5.00%   5.00%   5.00%   5.00%   5.00%   5.00%   5.00%

 38  Tennessee   6.00%   6.00%   6.00%   6.00%   6.50%   6.50%   6.50%   6.50%

 39  Utah        5.00%   5.00%   5.00%   5.00%   5.00%   5.00%   5.00%   5.00%

 40  Vermont     9.75%   9.75%   9.75%   9.75%   9.75%   9.75%   9.75%   8.90%

 41  Virginia    6.00%   6.00%   6.00%   6.00%   6.00%   6.00%   6.00%   6.00%

 42  W.
     Virginia    9.00%   9.00%   9.00%   9.00%   9.00%   9.00%   9.00%   9.00%

 43  Wisconsin   7.90%   7.90%   7.90%   7.90%   7.90%   7.90%   7.90%   7.90%

     
Average     7.66%   7.61%   7.56%   7.56%   7.62%   7.54%   7.47%   7.41%
 _____________________________________________________________________________
 
Source: Tax Foundation, "State Corporate Income Tax Rates,
 1999-2006," Jan. 26, 2007, available at
 http://www.taxfoundation.org/files/statecorpincometaxrates-20070125.xls.
 Shaded cells indicate change from prior year. Ohio's corporate tax began a
 five-year phaseout in 2005.

           
Table 2. State Corporate Income Tax Receipts, 1999-2006
                     (millions of dollars, calendar years)

 _____________________________________________________________________________
                 
1999    2000    2001    2002    2003    2004    2005    2006
 _____________________________________________________________________________
  1  Alabama      $233    $243    $202    $323    $242    $292    $397    $559

  2  Alaska       $212    $438    $400    $269    $207    $340    $589    $822

  3  Arizona      $545    $523    $541    $346    $389    $526    $702    $890

  4  Arkansas     $212    $237    $202    $177    $177    $182    $277    $369

  5  Cali-
     fornia     $5,459  $6,639  $6,899  $5,333  $6,804  $6,926  $8,670 $10,316

  6  Colorado     $301    $335    $340    $205    $200    $240    $316    $458

  7  Connecti-
     cut          $475    $427    $388    $149    $345    $380    $575    $635

  8  Delaware     $233    $240    $159    $252    $208    $218    $249    $296

  9  Florida    $1,267  $1,183  $1,591  $1,219  $1,227  $1,441  $1,785  $2,406

 10  Georgia      $793    $712    $691    $568    $484    $495    $712    $891

 11  Hawaii        $52     $75     $60     $53     $31     $58    $124    $148

 12  Idaho         $96    $126    $142     $77     $93    $104    $141    $198

 13  Illinois   $2,104  $2,261  $2,217  $1,384  $1,293  $1,279  $2,183  $2,400

 14  Indiana      $990    $925    $825    $709    $729    $645    $825  $1,044

 15  Iowa         $235    $215    $167     $88    $140     $90    $186    $285

 16  Kansas       $254    $272    $237    $122    $125    $167    $248    $381

 17  Kentucky     $312    $306    $361    $302    $370    $382    $479  $1,002

 18  Louisiana    $286    $222    $293    $264    $199    $237    $352    $506

 19  Maine        $147    $150     $96     $77     $91    $112    $136    $188

 20  Maryland     $405    $431    $501    $359    $379    $570    $807    $847

 21  Massachu-
     setts      $1,250  $1,306  $1,212    $812  $1,185  $1,301  $1,333  $1,859

 22  Minnesota    $779    $803    $732    $534    $597    $637    $934  $1,072

 23  Missis-
     sippi        $230    $228    $211    $196    $289    $244    $283    $317

 24  Missouri     $277    $265    $236    $300    $206    $224    $218    $344

 25  Montana       $90    $100    $104     $68     $44     $68     $98    $154

 26  Nebraska     $135    $140    $138    $108    $112    $167    $198    $262

 27  New
     Jersey     $1,334  $1,347  $1,301  $1,101  $2,397  $1,897  $2,225  $2,508

 28  New
     Mexico       $164    $159    $191    $124    $102    $138    $242    $377

 29  New York   $2,888  $2,772  $3,199  $2,258  $2,089  $2,045  $2,785  $4,018

 30  North
     Carolina     $921  $1,197    $724    $668    $898    $837  $1,272  $1,308

 31  North
     Dakota        $94     $78     $63     $50     $56     $50     $76    $120

 32  Ohio         $752    $631    $663    $761    $795  $1,061  $1,327  $1,102

 33  Oklahoma     $187    $194    $167    $174    $104    $133    $169    $231

 34  Oregon       $324    $407    $323    $196    $226    $320    $365    $438

 35  Pennsyl-
     vania      $1,538  $1,697  $1,389  $1,198  $1,189  $1,678  $1,703  $2,117

 36  Rhode
     Island        $66     $75     $78     $28     $67     $69    $113    $170

 37  South
     Carolina     $257    $227    $192    $160    $174    $197    $247    $297

 38  Tennessee    $571    $614    $673    $503    $613    $695    $806    $928

 39  Utah         $180    $174    $163    $111    $148    $145    $189    $348

 40  Vermont       $50     $44     $45     $37     $42     $62     $69     $86

 41  Virginia     $414    $566    $364    $309    $328    $422    $606    $863

 42  West
     Virginia     $263    $218    $214    $220    $182    $182    $463    $533

 43  Wisconsin    $671    $578    $495    $445    $527    $682    $783    $808

     
Total     $28,045 $29,782 $29,192 $22,640 $26,101 $27,933 $36,258 $44,902
 _____________________________________________________________________________
 
Source: U.S. Census Bureau, "Federal, State, and Local
 Governments — State Government Tax Collections," available at
 http://www.census.gov/govs/www/statetax.html.

Figure 2. Actual Tax Receipts Compared to
Potential Using Federal Tax Base, 1999-2006




Source: Tables 2 and 3.

The figures show that the decline in profits associated with the 2001 recession causes a larger proportional decline in federal than in state corporate taxes. While the total shortfall over the eight-year period is 21.6 percent, the shortfall is close to zero from 2001 through 2003. Those data tell us that state corporate tax revenue is more resilient to downturns than federal corporate tax revenue. A possible explanation is the decoupling by many states of their tax systems from the large business tax cuts — most notably, bonus depreciation — enacted by Congress in the early 2000s.

During a recession, short-term business cycle effects swamp long-term trend effects the way a cougar temporarily disturbs the direction of a migrating herd. To get an indication of the long-term trend of the leakiness of state tax systems, we look at the earliest and latest years of the 1999-2006 period before and after the recession. Table 6 (p. 611) compares estimated shortfalls for the two-year periods of 1999-2000 and 2005-2006. From the total of 43 states, 33 had increasingly leaky tax systems. Only 10 improved. For the 43 states, combined revenue inefficiency increased from 22.9 percent during 1999-2000 to 33 percent during 2005-2006: State corporate revenue shortfalls as a percentage of potential revenue are larger now than they were before the recession.


Another View of Variation Over Time


Figure 4 (p. 609) shows the simple ratio of state corporate tax receipts to federal corporate tax receipts from 1940 through 2006. The main difference between the data presented in figures 2 and 3 and those presented in Figure 4 is that in the latter, the effects of tax rate changes are not removed. The same cyclical movement as occurred during the 2001 recession also occurred during the 1982 recession — the ratio of state to federal corporate tax receipts spikes during the downturn. Also, the downward trend described above appears to be part of a longer-term trend that began around 1980. The ratio of state to federal corporate tax receipts has declined from over 20 percent in 1980 and 1981 to 13.4 percent in 2006.

Reform

The data presented here show that state corporate taxes have become increasingly leaky and that significant shortfalls are not the result of state tax rate cuts or of leakiness in the federal tax. That leaves tax relief from state tax laws more generous than tax relief from federal laws and tax planning beyond that used at the federal level as the explanation of our estimated $14.5 billion shortfall in 2006. Without a detailed examination of state tax structures, however, it is not possible to separate the shortfalls due to legislative largesse from the shortfalls due to tax planning.

     Table 3. Estimated Potential State Corporate Tax Revenue, 1999-2006
                    (millions of dollars, calendar years)

 ___________________________________________________________________________
                       
1999    2000    2001    2002    2003    2004    2005
 ___________________________________________________________________________
  1  Alabama            $323    $359    $256    $213    $315    $472    $674

  2  Alaska             $132    $159    $108     $94    $109    $167    $254

  3  Arizona            $686    $791    $497    $413    $473    $693  $1,013

  4  Arkansas           $246    $272    $193    $162    $183    $272    $387

  5  California       $6,024  $7,122  $4,956  $4,081  $4,633  $6,864  $9,784

  6  Colorado           $428    $498    $355    $290    $323    $471    $680

  7  Connecticut        $737    $753    $533    $429    $475    $707    $994

  8  Delaware           $198    $226    $166    $136    $157    $234    $338

  9  Florida          $1,405  $1,623  $1,179    $990  $1,146  $1,711  $2,511

 10  Georgia            $960  $1,092    $774    $634    $711  $1,038  $1,472

 11  Hawaii             $143    $161    $115     $96    $111    $167    $240

 12  Idaho              $151    $175    $117     $96    $108    $166    $239

 13  Illinois         $1,870  $2,121  $1,499  $1,225  $1,388  $1,999  $2,777

 14  Indiana            $847    $961    $665    $558    $682  $1,000  $1,376

 15  Iowa               $596    $677    $475    $402    $457    $686    $967

 16  Kansas             $334    $381    $274    $227    $256    $373    $530

 17  Kentucky           $540    $578    $409    $343    $384    $557    $664

 18  Louisiana          $573    $659    $461    $370    $437    $667    $988

 19  Maine              $172    $199    $143    $119    $134    $197    $275

 20  Maryland           $692    $790    $581    $492    $556    $822  $1,172

 21  Massachusetts    $1,385  $1,635  $1,148    $930  $1,040  $1,506  $2,082

 22  Minnesota          $978  $1,135    $803    $670    $760  $1,118  $1,553

 23  Mississippi        $182    $201    $142    $117    $135    $196    $273

 24  Missouri           $610    $691    $491    $405    $455    $656    $920

 25  Montana             $80     $90     $65     $55     $64     $96    $138

 26  Nebraska           $241    $271    $193    $161    $188    $272    $386

 27  New Jersey       $1,700  $1,942  $1,408  $1,155  $1,305  $1,887  $2,636

 28  New Mexico         $215    $241    $168    $137    $163    $249    $363

 29  New York         $3,794  $3,891  $2,613  $2,122  $2,376  $3,490  $4,937

 30  North Carolina   $1,061  $1,182    $849    $704    $787  $1,148  $1,657

 31  North Dakota       $102    $117     $84     $72     $85     $81    $120

 32  Ohio             $1,769  $1,979  $1,373  $1,141  $1,274  $1,849  $2,059

 33  Oklahoma           $288    $337    $244    $201    $231    $342    $499

 34  Oregon             $397    $464    $315    $266    $299    $457    $641

 35  Pennsylvania     $2,169  $2,436  $1,751  $1,456  $1,640  $2,377  $3,326

 36  Rhode Island       $160    $189    $136    $114    $132    $195    $269

 37  South Carolina     $314    $352    $253    $209    $238    $339    $480

 38  Tennessee          $588    $657    $467    $396    $485    $714  $1,001

 39  Utah               $184    $211    $151    $125    $141    $208    $303

 40  Vermont             $94    $109     $79     $66     $75    $110    $154

 41  Virginia           $840    $979    $716    $590    $676  $1,001  $1,441

 42  West Virginia      $214    $234    $168    $140    $156    $230    $327

 43  Wisconsin          $771    $869    $619    $513    $577    $843  $1,174

     
Total           $35,194 $39,811 $27,995 $23,116 $26,320 $38,626 $54,072
 ___________________________________________________________________________
 
Sources: Author's calculations described in the text using Treasury
 data on federal corporate tax receipts found in the back issues of the
 "Monthly Treasury Statement," available at
 http://www.fms.treas.gov/mts/index.html; state GDP from the Bureau of
 Economic Analysis of the U.S. Department of Commerce, available at
 http://www.bea.gov/regional/gsp; and the state corporate tax
 rates shown in Table 1.

Figure 3. State Corporate Tax
Percentage Shortfall, 1999-2006




Source: Ratio of data presented in tables 3 and 4.

Either way, leaky tax systems like those tax systems are wasting the economy's energy. There is as much economic justification for a separate tax on corporations as there is spontaneity in a presidential debate. The federal corporate tax is bad economic policy. State corporate taxes are worse.

One option for reform is to repeal state corporate taxes. That would be a decisive first step toward improving U.S. competitiveness. Of course, that suggestion, if mentioned at all, is dismissed as naïve. The revenue lost from repealing state corporate taxes would create untenable political upheavals from Annapolis, Md., to Sacramento, Calif. Would it be too bold to suggest that it is our state governments and not reform proposals themselves that are politically immature?

A less drastic option is the replacement of the current patchwork of state corporate taxes with a single-base, multirate, uniformly apportioned system of state taxes administered by the federal government. That idea, similar to the system administered in most Canadian provinces, was first suggested to me by my colleague Joann Weiner. (For more on that topic and other insights, read her book, Company Tax Reform in the European Union: Guidance From the United States and Canada on Implementing Formulary Apportionment in the EU (Springer, November 2005).)

In Canada, the federal government collects corporate income tax for 7 of the 10 provinces and all 3 territories. The merit of that approach to subfederal corporate taxation is evidenced by the recent agreement between Ontario — Canada's most populous province — and the federal government to join the federally administered system. The Canada Revenue Agency will begin administering Ontario's corporate income tax in 2009. Ontario's business community welcomed the move. According to Len Crispino, the president of Ontario's Chamber of Commerce, the change will "result in increased savings and efficiencies for both business and government, improving the competitive position of our province" (Ontario, Ministry of Finance, "Strengthening Business Through a Simpler Tax System Act, 2006," Dec. 13, 2006, available at http://www.fin.gov.on.ca/english/media/2006/bk12-ctar.html). Ontario's Ministry of Finance claims Ontario businesses will save up to C$100 million a year in administrative costs (press release, May 31, 2007, available at http://www.rev.gov.on.ca/english/media/2007/nr05-ctar.html).

     Table 4. State Corporate Tax Leakages (-) and Excesses (+), 1999-2006
                     (millions of dollars, calendar years)

 ______________________________________________________________________________
               
1999     2000    2001    2002   2003     2004     2005     2006
 ______________________________________________________________________________
  1 Alabama     -$90    -$115    -$54    $109   -$73    -$180    -$276    -$285

  2 Alaska       $80     $279    $293    $175    $98     $172     $335     $509

  3 Arizona    -$140    -$267     $44    -$66   -$83    -$168    -$311    -$420

  4 Arkansas    -$34     -$35      $9     $15    -$6     -$90    -$110    -$114

  5 California -$565    -$483  $1,943  $1,252 $2,171      $62  -$1,114  -$2,027

  6 Colorado   -$127    -$163    -$15    -$85  -$123    -$231    -$364    -$405

  7 Connecti-
    cut        -$263    -$327   -$146   -$279  -$130    -$327    -$419    -$603

  8 Delaware     $34      $14     -$7    $116    $51     -$16     -$89    -$129

  9 Florida    -$138    -$440    $412    $229    $81    -$270    -$725    -$766

 10 Georgia    -$166    -$380    -$83    -$66  -$227    -$543    -$760    -$950

 11 Hawaii      -$90     -$86    -$55    -$43   -$80    -$108    -$116    -$154

 12 Idaho       -$55     -$49     $25    -$19   -$15     -$62     -$98    -$108

 13 Illinois    $234     $140    $718    $159   -$95    -$720    -$594  -$1,079

 14 Indiana     $143     -$37    $160    $152    $47    -$355    -$551    -$666

 15 Iowa       -$362    -$463   -$309   -$314  -$317    -$596    -$780    -$918

 16 Kansas      -$80    -$109    -$37   -$105  -$132    -$207    -$281    -$282

 17 Kentucky   -$228    -$271    -$48    -$41   -$14    -$176    -$186     $176

 18 Louisiana  -$286    -$437   -$168   -$106  -$239    -$430    -$636    -$743

 19 Maine       -$24     -$49    -$47    -$41   -$42     -$86    -$139    -$151

 20 Maryland   -$287    -$359    -$80   -$133  -$177    -$252    -$365    -$612

 21 Massachu-
    setts      -$136    -$329     $63   -$118   $145    -$205    -$749    -$733

 22 Minnesota  -$199    -$332    -$71   -$136  -$164    -$481    -$619    -$865

 23 Missis-
    sippi        $48      $27     $69     $78   $154      $48      $10     -$23

 24 Missouri   -$333    -$426   -$255   -$105  -$250    -$431    -$702    -$798

 25 Montana      $10      $10     $38     $13   -$20     -$28     -$40     -$23

 26 Nebraska   -$106    -$131    -$55    -$54   -$76    -$105    -$188    -$216

 27 New
    Jersey     -$366    -$595   -$107    -$54 $1,092      $10    -$411    -$789

 28 New
    Mexico      -$51     -$82     $22    -$13   -$61    -$110    -$120     -$89

 29 New York   -$906  -$1,120    $586    $136  -$287  -$1,446  -$2,153  -$2,178

 30 North
    Carolina   -$141      $15   -$126    -$36   $112    -$311    -$385    -$781

 31 North
    Dakota       -$9     -$38    -$20    -$22   -$29     -$32     -$44     -$29

 32 Ohio     -$1,018  -$1,349   -$709   -$380  -$480    -$788    -$732    -$799

 33 Oklahoma   -$101    -$143    -$77    -$27  -$127    -$209    -$331    -$422

 34 Oregon      -$73     -$57      $7    -$70   -$74    -$136    -$276    -$369

 35 Pennsyl-
    vania      -$631    -$739   -$362   -$257  -$451    -$699  -$1,622  -$2,004

 36 Rhode
    Island      -$94    -$115    -$58    -$86   -$65    -$125    -$156    -$162

 37 South
    Carolina    -$56    -$125    -$61    -$50   -$64    -$143    -$233    -$306

 38 Tennessee   -$16     -$43    $207    $107   $128     -$19    -$196    -$322

 39 Utah         -$4     -$38     $12    -$14     $8     -$63    -$114     -$47

 40 Vermont     -$45     -$64    -$35    -$28   -$33     -$48     -$85     -$88

 41 Virginia   -$426    -$413   -$352   -$282  -$348    -$578    -$835    -$928

 42 West
    Virginia     $50     -$16     $46     $81    $27     -$49     $136     $128

 43 Wisconsin  -$100    -$291   -$124    -$68   -$50    -$161    -$391    -$643

   
Total    -$7,148 -$10,029  $1,196   -$476  -$219 -$10,692 -$17,814 -$22,215
 ______________________________________________________________________________
 
Source: Calculations using figures shown in tables 2 and 3.

Figure 4. State Corporate Tax Receipts as a
Percentage of Federal Corporate Tax Receipts, 1946-2006




Source: Treasury and Tax Foundation data from same sources as tables 2 and 3.

Lower Rates

Under such a system, each state would choose its own rate, but everything else — the tax base itself, credits, the apportionment formula, and all aspects of administration — would be the responsibility of the federal government. To collect the same revenue as they collect under current law, states could reduce their current tax rates by more than 20 percent.

States would not have to reach multilateral agreement to implement the plan. All that is necessary is for the federal government to pass enabling legislation and empower the IRS to collect corporate tax on behalf of the states. The greater state participation would be, the greater the economic and simplification benefits would be. But states could adopt the new system at their own pace and gain its benefits independent of the actions of other states.

Because of the variation in the leakiness of each state's tax system (as shown in Table 5) the revenue-neutral amount of rate reduction would vary by state. The most dramatic change would be in Iowa, where a high rate of leakage makes possible a rate reduction from the current 12 percent level to something in the neighborhood of 3 percent.

The state-specific, revenue-neutral rates would also depend on the allocation formula chosen. Table 7 shows the revenue-neutral rates under the reform plan assuming the allocation factor chosen was proportional to state GDP.


Dynamics


The rates shown in Table 7 (p. 612) are based on static revenue estimates — that is, they do not take into account behavioral responses on the part of taxpayers.

The first type of dynamic response depends on the extent of tax planning under the reformed system. Because most of the loopholes now in popular favor would be plugged, the amount of tax planning under our proposed Canadian-style system would probably be substantially curtailed. (An analysis of Canadian interprovince corporate tax planning would go a long way in verifying or refuting this last statement.) But we cannot expect companies and their consultants to stand idly by. There would be some dynamic response that would lower the projected revenue estimates statically, and so revenue-neutral rate reductions suggested in Table 7 could be less than shown.

         Table 5. State Corporate Tax Leakages (-) and Excesses (+) for
                                1999-2006 Period

 ______________________________________________________________________________
                           
1999-2006     1999-2006                    % of
                           Actual        Potential                    Potential
 Rank                      Receipts      Receipts     Difference      Receipts

 ______________________________________________________________________________
  1   Iowa                   $1,406        $5,464        -$4,058         -74.3%

  2   Missouri               $2,071        $5,370        -$3,299         -61.4%

  3   Rhode Island             $667        $1,528          -$861         -56.3%

  4   Louisiana              $2,360        $5,403        -$3,043         -56.3%

  5   Hawaii                   $602        $1,334          -$732         -54.9%

  6   Virginia               $3,872        $8,034        -$4,162         -51.8%

  7   Oklahoma               $1,360        $2,796        -$1,436         -51.4%

  8   Vermont                  $435          $861          -$426         -49.5%

  9   Ohio                   $7,092       $13,346        -$6,254         -46.9%

 10   Connecticut            $3,373        $5,866        -$2,493         -42.5%

 11   Nebraska               $1,260        $2,191          -$930         -42.5%

 12   Kansas                 $1,805        $3,038        -$1,233         -40.6%

 13   Colorado               $2,394        $3,908        -$1,514         -38.7%

 14   Georgia                $5,347        $8,522        -$3,175         -37.3%

 15   South Carolina         $1,751        $2,788        -$1,037         -37.2%

 16   Maine                    $998        $1,577          -$579         -36.7%

 17   Pennsylvania          $12,510       $19,276        -$6,766         -35.1%

 18   Maryland               $4,299        $6,565        -$2,265         -34.5%

 19   Minnesota              $6,088        $8,955        -$2,867         -32.0%

 20   Oregon                 $2,600        $3,647        -$1,047         -28.7%

 21   Idaho                    $977        $1,358          -$381         -28.1%

 22   Alabama                $2,491        $3,455          -$964         -27.9%

 23   North Dakota             $587          $810          -$223         -27.5%

 24   Wisconsin              $4,989        $6,817        -$1,828         -26.8%

 25   New Mexico             $1,498        $2,002          -$505         -25.2%

 26   New York              $22,054       $29,420        -$7,366         -25.0%

 27   Arizona                $4,463        $5,875        -$1,412         -24.0%

 28   Kentucky               $3,513        $4,302          -$789         -18.3%

 29   North Carolina         $7,825        $9,478        -$1,653         -17.4%

 30   Massachusetts         $10,257       $12,320        -$2,063         -16.7%

 31   Arkansas               $1,833        $2,198          -$365         -16.6%

 32   Utah                   $1,458        $1,718          -$260         -15.1%

 33   Indiana                $6,691        $7,799        -$1,108         -14.2%

 34   Florida               $12,119       $13,736        -$1,617         -11.8%

 35   New Jersey            $14,110       $15,330        -$1,220          -8.0%

 36   Illinois              $15,121       $16,358        -$1,237          -7.6%

 37   Montana                  $725          $765           -$40          -5.2%

 38   Tennessee              $5,403        $5,558          -$155          -2.8%

 39   Delaware               $1,854        $1,879           -$26          -1.4%

 40   California            $57,046       $55,808         $1,239           2.2%

 41   West Virginia          $2,276        $1,873           $403          21.5%

 42   Mississippi            $1,997        $1,587           $410          25.8%

 43   Alaska                 $3,277        $1,336         $1,941         145.3%

     
Total                $244,854      $312,250       -$67,396         -21.6%
 ______________________________________________________________________________
 
Source: Calculations using figures from tables 2, 3, and 4.

     
Table 6. State Corporate Tax Shortfalls Before and After the Recession
                     (millions of dollars, calendar years)

 ______________________________________________________________________________
                     
1999-2000 Combined         2005-2006 Combined
                   -------------------------  -------------------------
                                        %                          %      Dif-
                   Potential  Short-  Short-  Potential  Short-  Short-   fer-
                   Revenue    fall    fall    Revenue    fall    fall     ence

 ______________________________________________________________________________
  1  Alabama          $682    -$205   -30.1%    $1,517    -$561  -37.0%   -6.8%

  2  Alaska           $291     $359   123.4%      $566     $844  149.2%   25.8%

  3  Arizona        $1,476    -$408   -27.6%    $2,323    -$731  -31.5%   -3.9%

  4  Arkansas         $518     -$69   -13.3%      $870    -$224  -25.7%  -12.5%

  5  California    $13,146  -$1,048    -8.0%   $22,128  -$3,142  -14.2%   -6.2%

  6  Colorado         $927    -$291   -31.4%    $1,542    -$769  -49.8%  -18.5%

  7  Connecticut    $1,491    -$589   -39.5%    $2,231  -$1,021  -45.8%   -6.2%

  8  Delaware         $424      $49    11.6%      $762    -$218  -28.6%  -40.1%

  9  Florida        $3,028    -$578   -19.1%    $5,683  -$1,492  -26.3%   -7.2%

 10  Georgia        $2,052    -$546   -26.6%    $3,313  -$1,710  -51.6%  -25.0%

 11  Hawaii           $304    -$176   -58.0%      $542    -$269  -49.7%    8.2%

 12  Idaho            $326    -$104   -31.9%      $545    -$207  -37.9%   -6.0%

 13  Illinois       $3,991     $374     9.4%    $6,257  -$1,673  -26.7%  -36.1%

 14  Indiana        $1,808     $106     5.9%    $3,086  -$1,217  -39.4%  -45.3%

 15  Iowa           $1,274    -$825   -64.7%    $2,169  -$1,698  -78.3%  -13.5%

 16  Kansas           $715    -$188   -26.4%    $1,193    -$564  -47.3%  -20.9%

 17  Kentucky       $1,118    -$500   -44.7%    $1,490     -$10   -0.7%   44.0%

 18  Louisiana      $1,231    -$723   -58.7%    $2,237  -$1,379  -61.6%   -2.9%

 19  Maine            $371     -$73   -19.7%      $614    -$290  -47.2%  -27.5%

 20  Maryland       $1,483    -$647   -43.6%    $2,631    -$977  -37.1%    6.5%

 21  Massachu-
     setts          $3,020    -$464   -15.4%    $4,674  -$1,483  -31.7%  -16.4%

 22  Minnesota      $2,113    -$531   -25.1%    $3,490  -$1,485  -42.5%  -17.4%

 23  Mississippi      $383      $74    19.4%      $614     -$13   -2.2%  -21.5%

 24  Missouri       $1,301    -$759   -58.3%    $2,062  -$1,500  -72.7%  -14.4%

 25  Montana          $170      $20    11.6%      $315     -$63  -19.9%  -31.5%

 26  Nebraska         $512    -$237   -46.3%      $864    -$404  -46.7%   -0.4%

 27  New Jersey     $3,643    -$961   -26.4%    $5,933  -$1,200  -20.2%    6.2%

 28  New Mexico       $456    -$133   -29.1%      $829    -$209  -25.3%    3.9%

 29  New York       $7,685  -$2,026   -26.4%   $11,133  -$4,330  -38.9%  -12.5%

 30  North
     Carolina       $2,243    -$126    -5.6%    $3,746  -$1,166  -31.1%  -25.5%

 31  North Dakota     $219     -$47   -21.5%      $269     -$73  -27.1%   -5.6%

 32  Ohio           $3,748  -$2,366   -63.1%    $3,961  -$1,531  -38.7%   24.5%

 33  Oklahoma         $625    -$244   -39.0%    $1,153    -$752  -65.3%  -26.3%

 34  Oregon           $862    -$130   -15.1%    $1,448    -$645  -44.5%  -29.4%

 35  Pennsylvania   $4,605  -$1,370   -29.8%    $7,447  -$3,626  -48.7%  -18.9%

 36  Rhode
     Island           $350    -$208   -59.6%      $601    -$318  -52.9%    6.7%

 37  South
     Carolina         $666    -$181   -27.2%    $1,083    -$539  -49.8%  -22.6%

 38  Tennessee      $1,244     -$59    -4.7%    $2,252    -$518  -23.0%  -18.3%

 39  Utah             $396     -$42   -10.6%      $698    -$161  -23.0%  -12.5%

 40  Vermont          $203    -$109   -53.6%      $328    -$173  -52.7%    0.9%

 41  Virginia       $1,820    -$839   -46.1%    $3,232  -$1,763  -54.5%   -8.4%

 42  West
     Virginia         $447      $34     7.5%      $732     $264   36.1%   28.5%

 43  Wisconsin      $1,640    -$391   -23.8%    $2,625  -$1,034  -39.4%  -15.6%

     
Total         $75,004 -$17,177   -22.9%  $121,189 -$40,029  -33.0%  -10.1%
 ______________________________________________________________________________
 Source: Calculations using figures from tables 2, 3, and 4.

 
Table 7. Possible Revenue-Neutral Rates With Reformed Corporate Taxes
 ______________________________________________________________________
                                                      Rate Under Reform
                      Current Rate (%)       Change          (%)

 ______________________________________________________________________
  1   Alabama               6.50%            -27.9%            4.69%

  2   Alaska                9.40%            145.3%           23.06%

  3   Arizona               6.97%            -24.0%            5.29%

  4   Arkansas              6.50%            -16.6%            5.42%

  5   California            8.84%              2.2%            9.04%

  6   Colorado              4.63%            -38.7%            2.84%

  7   Connecticut           7.50%            -42.5%            4.31%

  8   Delaware              8.70%             -1.4%            8.58%

  9   Florida               5.50%            -11.8%            4.85%

 10   Georgia               6.00%            -37.3%            3.76%

 11   Hawaii                6.40%            -54.9%            2.89%

 12   Idaho                 7.60%            -28.1%            5.47%

 13   Illinois              7.30%             -7.6%            6.75%

 14   Indiana               8.50%            -14.2%            7.29%

 15   Iowa                 12.00%            -74.3%            3.09%

 16   Kansas                7.35%            -40.6%            4.37%

 17   Kentucky              7.00%            -18.3%            5.72%

 18   Louisiana             8.00%            -56.3%            3.49%

 19   Maine                 8.93%            -36.7%            5.65%

 20   Maryland              7.00%            -34.5%            4.58%

 21   Massachusetts         9.50%            -16.7%            7.91%

 22   Minnesota             9.80%            -32.0%            6.66%

 23   Mississippi           5.00%             25.8%            6.29%

 24   Missouri              6.25%            -61.4%            2.41%

 25   Montana               6.75%             -5.2%            6.40%

 26   Nebraska              7.81%            -42.5%            4.49%

 27   New Jersey            9.00%             -8.0%            8.28%

 28   New Mexico            7.60%            -25.2%            5.68%

 29   New York              7.50%           -25.04%            5.62%

 30   North Carolina        6.90%            -17.4%            5.70%

 31   North Dakota          7.00%            -27.5%            5.07%

 32   Ohio                  5.10%            -46.9%            2.71%

 33   Oklahoma              6.00%            -51.4%            2.92%

 34   Oregon                6.60%            -28.7%            4.70%

 35   Pennsylvania          9.99%            -35.1%            6.48%

 36   Rhode Island          9.00%            -56.3%            3.93%

 37   South Carolina        5.00%            -37.2%            3.14%

 38   Tennessee             6.50%             -2.8%            6.32%

 39   Utah                  5.00%            -15.1%            4.24%

 40   Vermont               8.90%            -49.5%            4.50%

 41   Virginia              6.00%            -51.8%            2.89%

 42   West Virginia         9.00%             21.5%           10.93%

 43   Wisconsin             7.90%            -26.8%            5.78%

     
Average               7.41%                              5.68%
 _______________________________________________________________________
 
Source: Tables 1 and 5.

However, corporate rate reduction — even if it is revenue neutral — should have a positive effect on economic growth and therefore on overall revenue — both federal and state, from both corporate and noncorporate taxes. If the federal government would be willing to share projected dynamic revenue gains from the reformed taxes with the states, the revenue-neutral rate reductions in Table 7 could be larger than shown.

Those two dynamic effects are in opposite directions. The net effect is uncertain. At any rate, they should not distract us from any attempt to capture the fundamental economic benefits of reforming the state corporate taxes. Optimism about the benefits of reform is well-founded because of the dismal condition of the taxes being reformed. Lowering the rate of tax and compliance and administrative costs of one our most economically harmful taxes will improve U.S. competitiveness. It is time states stopped competing with each other and focused their attention on competing with foreign governments.

Martin A. Sullivan is a contributing editor for Tax Notes.


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