The Difficulty of Getting Serious about State Corporate Tax Reform

Table of ContentsI. Introduction 327II. The Four Components of a Uniform System 328III. Unilateral, Multilateral, and Federal Action 330A. Unilateral Action 331B. Multilateral Action 334C. Federal Action 335IV. The Willis Committee Report 335V. The Politics of Uniformity 337A. Multilateral Action 337B. Federal Action 338C. Political Stalemate? 339I. IntroductionIn his Note, Beyond BATSA: Getting Serious About Corporate Tax Reform,1 Quinn Ryan examines several common defects of state corporate income taxes that, in isolation or in combination, create distortions, inequities, and complexity, and argues for federal legislation that would substantially reduce the problems he describes. I will expand a bit on Ryan's analysis, review some history, and argue that neither multilateral state action nor federal legislation - especially legislation that would not make matters worse - is likely to occur.II. The Four Components of a Uniform SystemAn ideal system of state corporate income taxes would exhibit uniformity in four important respects: the definition of the potential taxpayer (or of the corporate group whose economic activities are considered in determining tax liability); standards for jurisdiction to tax, hereinafter "nexus"; the definition of income that is potentially subject to tax; and the method used to divide taxable income among the states.2 Uniformity of rates would not be required, should not be imposed, and, as in Ryan's Note, is not considered further.3The "system" of state corporate income taxes actually found in the United States fails on all four counts,4 although there is a fair amount of uniformity across states in the definition of income5 - an issue that will, for that reason, not be considered further here. State assertion of nexus is restricted by federal statutory law (Public Law 86-272) under certain circumstances, but not others, and whether a federal constitutional restriction on the assertion of nexus in the sales and use tax area is applicable for income tax purposes is a matter of continuing controversy in state courts.6 Although a model law, the Uniform Division of Income for Tax Purposes Act7 (UDITPA), has been in existence for over fifty years, it deals with only one of the four areas where uniformity would be desirable, not all income tax states have adopted it or patterned their laws after it, and, despite UDITPA's endorsement of an apportionment formula that accords equal weight to the taxpayer's payroll, property, and sales, there is substantial variation in the weights that the states actually apply, with an increasing number giving sales double or greater weight - or even sole weight, presumably for economic development reasons.8In his note, Ryan has emphasized the lack of a clear nexus standard and the need for a uniform definition of income and a uniform method of dividing income, describing the inequities, economic inefficiencies, and complexity that result from the current defective system.9 He argues that the federal government should enact legislation that would allow a state to assert nexus over any corporation that has an economic presence in the state, rather than the legislation pushed by the business community,10 which would further limit state assertion of nexus for income tax purposes by extending the physical-presence test found in the sales and use tax area to income taxation. …