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August 14, 2006
The Business Activity Tax Simplification Act: A Good Standard for Multistate Business
by Chris Atkins
Article originally published in
StateTax Notes on August 14, 2006

Full Text Published by Tax Analysts®

Introduction


H.R. 1956, the Business Activity Tax Simplification Act of 2005, would prohibit states from imposing a corporate tax (based on net income, gross receipts, net worth, and so forth) on any corporation that has no physical presence (property or employees) in the state.

On July 11 the Congressional Budget Office released a revenue estimate of H.R. 1956. The CBO estimates that in the first year after the bill's passage, state tax revenue would drop by $1 billion and federal tax revenue would rise by $107 million. Some in Congress have asserted that because federal revenue is projected to rise after enactment, the bill as a whole must therefore be counted as a tax increase. But as the CBO's cost estimates reveal, taxpayers would pay lower taxes overall under H.R. 1956. In 2007 alone taxpayers would see net tax reductions of almost $900 million. Thus, H.R. 1956 should not be labeled a tax increase or opposed on that basis.

H.R. 1956 From the Taxpayer's Perspective

Currently, states can require companies to file and pay most corporate taxes just for selling products to state residents. That way of thinking about state tax liability is referred to as economic presence or nexus. A previous Tax Foundation report explained why physical presence is consistent with the benefit principle of taxation and is the more practical standard for reasonable tax enforcement.

The always contentious issue of what tax changes should count as a tax increase or a tax cut has arisen. The CBO estimates that H.R. 1956 would deplete state revenue overall but increase federal revenue. The states would lose revenue because fewer firms would be paying business activity taxes; the federal government would gain revenue because corporations would have fewer state tax payments to deduct on their federal tax return. The CBO anticipates even greater state revenue losses in subsequent years and a corresponding increase in federal revenue.

Thus, while the federal treasury would grow as a result of this bill, affected taxpayers would see overall tax reductions. Because the intent of the bill is to protect state taxpayers from unwarranted imposition of state business activity taxes, it is more logical to view the revenue impact from the taxpayer's perspective rather than the federal tax collector's.

For example, Ohio's new commercial activities tax (CAT) applies a 0.26 percent tax rate (when fully phased in) to the Ohio-based sales of a corporation, regardless of the presence of property or payroll in Ohio (see Table 1, below). Thus, a corporation with $5 million in Ohio sales has to pay the CAT even if it has no Ohio property, no Ohio-based employees, and no physical presence in Ohio.

H.R. 1956 would restrict Ohio from applying its CAT in that hypothetical situation, reducing taxes for our hypothetical corporation by $8,450 — even after it loses the federal deduction for CAT taxes paid. From the perspective of the taxpayer, that is a worthwhile change because state tax reductions would exceed federal tax increases. More importantly, the taxpayer would be required to report and pay tax in fewer states, which means less litigation, fewer accountants and attorneys on the payroll, and more money spent on investment in labor and capital instead of state tax compliance.


               

Naturally, it's disconcerting for state legislators and tax collectors to have a revenue source preempted by the federal government. State budgets must be balanced, after all. However, while complaints on that score are understandable, the estimated revenue loss is so small — roughly 0.1 percent of state revenue — that it is well within the margin of error in every state's revenue estimate, and in any case, states will have time to make any adjustments they need. Further, to the extent that states adjust to H.R. 1956 by shifting the burden of taxation back to their own resident individuals and corporations, they will enhance the transparency of their tax system.

Conclusion


H.R. 1956 would amend federal law to restrict states from imposing corporate taxes if the corporation lacks a physical presence in the state. Because companies that are physically present in a state are receiving the benefits of government services, it is appropriate to use a physical presence nexus standard for imposing corporate tax. Of course, if H.R. 1956 became law it would reduce some of the revenue that states have received from out-of-state companies. That reduction would also have the secondary effect of increasing federal revenues because those state taxes would no longer be deducted on companies' federal returns.

Lawmakers should not be concerned about the federal revenue increase, nor should it be labeled a tax increase. Any business taxpayer that pays more federal tax as a result of H.R. 1956 will have an offsetting reduction in state taxes paid. Further, business taxpayers will be able to spend less money on state tax compliance. That represents a win-win scenario for both interstate commerce and sound tax policy.

Chris Atkins is a staff attorney with the Tax Foundation, Washington.


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