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Don’t ‘Reform’ the Corporate Tax -- Repeal It April 8, 2010 If you’re not an accountant or tax attorney, you probably can’t define “combined reporting.” But the obscure term reveals a lot about Connecticut’s neverending budget crisis. Forty-five states impose a corporate tax. When large firms compute their annual obligations, they must determine which portions of their incomes are attributable to which states. It’s a cumbersome and costly process. To reduce their taxes as much as legally possible, corporations get creative. One tactic is the creation of a passive investment company (PIC) located in a low- or no-tax state. Delaware is a haven for avoidance strategies, because it does not tax intangible assets. Profits earned beyond the First State’s borders can be offset by the “cost” of patent and trademark “fees” imposed by a Delaware-based subsidiary formed solely for sheltering. Revenucrats fume over the billions of dollars allegedly “lost” to state treasuries through PICs and other dodges, so they’ve devised a solution: combined reporting. It requires a corporation to disclose the income of its entire “business group,” out-of-state affiliates included, before tabulating its tax obligation. In other words, no more transferring your earnings to friendlier corporate-tax ecosystems. Figure out how much your enterprise -- your whole enterprise -- made last year before ascertaining the part affected by our state’s tax. The far-left Center on Budget and Policy Priorities happily reports that “a growing number of states” are moving toward combined reporting. Connecticut is one of them. Earlier this month, the legislature’s Finance, Revenue and Bonding Committee voted 40-15 to adopt the method. Passage in the Connecticut General Assembly appears certain. Big Business isn’t happy. The Connecticut Business & Industry Association claims combined reporting “discourages investment,” boosts paperwork expenses, and may not generate additional revenue. The Insurance Association of Connecticut is also a foe, arguing that it “would add unnecessary complexities and administrative costs to the tax system and result in increased levels of litigation due to compliance uncertainties.” An Electric Boat lobbyist testified that the “reform” is a particularly unsound notion “at a time when the business climate is eroding nationwide and companies are looking for states where the cost of doing business is not prohibitive.” All true, but the “special interests” fighting combined reporting are missing the larger issue. They should switch from defense to offense, and push for elimination of the corporate tax. A 2006 analysis by the Legislative Program Review and Investigations Committee found that Connecticut’s corporate levy “is not a simple tax.” While its rate, 7.5 percent, is flat, “it is subject to many exemptions, variations on the apportionment formula depending on the business area, and the use of credits after the tax liability is calculated.” The tax is a focus of pols’ incessant meddling. Breaks for politically correct -- and politically juiced -- industries abound. Surcharges are regularly imposed when the state budget dips into the red. Do Connecticut’s coffers benefit from all this bother? Not really. The legislature’s 2006 investigation concluded that the “tax is fairly unpredictable and quite volatile.” One thing is clear: It’s producing a dwindling amount of revenue. In the mid-1990s, the tax’s annual yield, adjusted for inflation, topped $1 billion. In the current fiscal year, it is predicted to generate $721.6 million -- a figure that will cover a mere 3.9 percent of state expenditures. Avoidance and political gamesmanship account for much of the corporate tax’s growing irrelevance. But a third factor is probably the most significant. Profit-seeking ventures are changing the way they are organized. “C corporations” are on the wane, while flow-through entities hit by the personal-income tax -- e.g., S corporations, limited liability companies, and partnerships -- expand. According to the Urban Institute/Brookings Institution Tax Policy Center: “Excluding sole proprietorships, 75 percent of businesses were organized as flow-through enterprises in 2004, up from 60 percent in 1994; during that same period flow-through enterprises increased their share of business receipts from 23 percent to 33 percent.” Connecticut still has large employers, such as United Technologies, Pitney Bowes, Xerox, Northeast Utilities, and Aetna. (At least for now.) They are subject to the corporate tax, and many will face a hike under combined reporting. But small businesses are grabbing a larger chunk of the state’s economy. In that light, combined reporting appears to be an attempt to seize a larger slice of a rapidly shrinking pie. It’s nothing more than the latest scheme to ignore Connecticut’s core fiscal problem: structural overspending. Businesses don’t pay taxes. Individuals do. That’s why the corporate tax is textbook feel-good policy. It shouldn’t be “reformed.” It should be repealed. D. Dowd Muska is a writer, commentator and lecturer. His website is www.dowdmuska.com. # # # # #
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