The Bloomberg BNA Tax Management Weekly State Tax Report filters through current state developments and analyzes those critical to multistate tax planning.
By Bloomberg BNA Corespondents Tripp Baltz, Christopher Brown, William H. Carlile, Laura Mahoney, and Yereth Rosen
Following the 2012 elections, a single party, either Democrat or Republican, fully controls both the executive and legislative branches of 35 state governments--23 are controlled by Republicans and 12 by Democrats.
For business taxpayers this means volatility. “If you look at results of elections, we have an all-time low in terms of the number of state legislatures that have split control,” according to Joseph Crosby, senior vice president and principal of MultiState Associates.
In “almost every state either the Republicans control both chambers or the Democrats control both chambers, and when you take that one step further to include the governor's office, you have a high water mark in the past 60 or 70 years of full party control, essentially a parliamentary system, where one party--either Democratic or Republican--controls all the levers of government,” he said.
As a result, real reform will at least be considered. The ideas will differ in the Democrat-controlled states versus the Republican-controlled states, but for business taxpayers, that can lead to a lot of discussion of significant changes to the tax system. According to Crosby, even if those changes prove positive in the long run, overall they could have significant negative impact on specific types of businesses or specific industries.
Tax reform should gain ground in states with full party control. In 2010, the elections were a tidal wave of Republican control. In some of those states, for example, in Kansas, there were massive changes to the tax system overall, including business taxes. When looking at the results of the 2012 elections and the states involved, Crosby predicted there should be significant activity in North Carolina, which is now in full Republican control, and significant activity in Ohio from the Republican side.
On the Democratic side, in states like California where the Democrats now have a supermajority in both legislative chambers, tax increases can be passed without Republican votes. California's nonconformity with the Internal Revenue Code could pose a simple example. Currently, California conforms with the federal code effective Jan. 1, 2005, because legislation trying to bring that conformity up to date just has not been valid under California's current two-thirds voting requirement, said Steve Wlodychak, a principal with Ernst & Young LLP in Washington, D.C.
Since 1978, California's Proposition 13 has required that increases in state taxes be adopted by not less than two-thirds of the members elected to each house of the Legislature. Proposition 26, enacted in 2010, changed the two-thirds legislative vote for taxes to include “any change in state statute which results in any taxpayer paying a higher tax.”
Whether the state's new supermajority heralds a challenge to these ballot measures or simply makes their implementation less onerous remains to be seen. But Wlodychak noted that supermajorities are ephemeral. “They don't last very long,” he said.
Minnesota also has full Democratic control now, and those Democrats have been talking for years about changes that they would like to make to certain provisions that affect foreign operating companies. For their part, fully Democratic Massachusetts and Connecticut may look at tax incentive reforms.
States that fall into either one of these camps, Republican or Democrat, should see significant tax reform proposals.
Crosby's prediction that single-party control will lead to volatility for business taxpayers has already been borne out. In recent weeks, many governors and legislative leaders in Republican-controlled states have proposed dramatic restructuring of their tax systems. The dominant theme in these states, Crosby notes, is the shift from income to consumption (sales) taxes.
Republican proposals to completely eliminate income taxes have been advanced in Louisiana, Nebraska, and North Carolina. Republican governors have also proposed lowering corporate income or personal income tax rates (New Mexico and Ohio, respectively), shifting transportation funding from fuel taxes to sales taxes (Virginia), eliminating personal property taxes (Idaho), and simplifying local sales tax administration (Arizona).
In his State of the State address, Kansas Gov. Sam Brownback (R) has proposed further reductions in state income tax rates. His Jan. 15 proposal came just weeks after a tax cut passed in the 2012 legislative session took effect, lowering income taxes for all taxpayers.
“The Kansas tax code is overly complicated, picks too many winners and losers, and attempts too much social engineering,” Brownback said.
Under the governor's plan, the state's bottom rate would continue to drop, from 3 percent in tax year 2013 to 2.5 percent in 2014, and then to 1.9 percent in 2015. The current top rate of 4.9 percent would drop under the plan to 3.5 percent in 2017.
Kansas faces a budget shortfall of approximately $300 million, which the Legislature will need to address. The governor's plan proposes eliminating the deduction for home mortgage interest and other itemized deductions, as well as all subtraction modifications, except for taxable Social Security benefits and armed forces recruitment income.
All state revenues above a 4 percent growth path would be used in lowering income tax rates more quickly.
Louisiana Gov. Bobby Jindal (R) announced Jan. 10 that he will propose legislation to eliminate all personal and corporate income taxes. The revenue loss is expected to be offset by a sales tax increase. The current state sales tax is 4 percent.
Republican lawmakers in North Carolina have outlined a proposal to eliminate personal and corporate income taxes in exchange for higher sales tax on groceries, medical expenses, and other currently tax-free services.
Real estate transactions would be taxed at 1 percent, up from the current 0.2 percent rate, based on the property's value.
Current income tax rates in North Carolina are 6.9 percent for corporations and a 7.75 percent personal tax rate for the highest earners, among the highest in the region.
Gov. John Kasich's (R) State of the State speech is scheduled for mid-February. In his 2012 year-end review, the governor alluded to upcoming efforts to reduce the state's personal income tax.
But the state's fiscal situation requires that it replace $140 million in funding after the Ohio Supreme Court ruled in Beaver Excavating Co. v. Testa (Ohio, No. 2011-1536, 12/7/12), that the state commercial activity tax on gasoline cannot be used for nonhighway purposes. The state looks to fill that gap in the biennial budget the governor is preparing for fiscal years 2014-15.
With Alaska's oil production already lower than that of North Dakota, and in danger of slipping behind California, Gov. Sean Parnell (R) submitted legislation Jan. 16 that would substantially change the state's oil production tax by removing a tax-rate escalator that goes into effect with high oil prices.
The plan would also remove credits for oil company capital expenditures. “By eliminating progressivity and rebalancing capital tax credit payments, we can create a simpler 25 percent tax,” Parnell said in his State of State speech.
Parnell's bill (H.B. 72/S.B. 21) would keep the base tax rate at 25 percent of oil companies' net Alaska profits. The bill is Parnell's third legislative attempt since 2010 to rewrite the state's oil tax system, which oil companies have complained is too onerous at times of high prices. The progressive rate increases that apply when prices are high, company officials argue, reduce potential for development rewards and make investments in Alaska oil development less attractive.
In past years, Parnell's oil-tax legislation has been embraced by the Republican leadership of the House but rejected by a bipartisan coalition controlling the state Senate. However, in 2013 the Senate is under Republican leadership.
Parnell also addressed the Alaska unemployment insurance tax in his State of the State address. He said the state received an extra $20 million in insurance payments last year that were not needed because the unemployment insurance fund was solvent. “If the fund has enough money, we will cut unemployment taxes,” he said.
Arizona Gov. Jan Brewer (R) said Jan. 14 that the state's tax system is “an accountant's dream, but a business owner's nightmare.” She urged lawmakers to adopt simplification measures during her annual State of the State message.
Brewer is expected to announce her tax-simplification plan when the executive budget is released. The plan is expected to draw from recommendations of a task force she appointed in 2012.
The governor's proposal comes at a time when Arizona's economy is bouncing back from the worst economic recession since the Depression. Brewer said the state ranked fifth in the nation in job growth in 2012.
Arizona faces the expiration in May of a 1 percent temporary sales tax increase that generated an estimated $1 billion in revenues. An effort to extend the sales tax beyond the expiration date was rejected by voters in the 2012 general election, however, which now leaves lawmakers scrambling to make up the projected lost revenue.
In addition, tax breaks to business totaling almost $500 million are set to commence in 2013, furthering the drain on the state treasury. Lawmakers approved the tax breaks years ago but delayed implementation, anticipating an improved economic outlook. The two reductions in revenue have left lawmakers cautious, even with a $450 million rainy day fund set aside.
In his State of the State and Budget address Jan. 7, Idaho Gov. Butch Otter (R) outlined his intention to propose eliminating Idaho's personal property tax, a move that would cost $141 million in tax revenue but provide a boost to business.
The governor said that “personal property taxes are a significant part of how some of our counties pay for public services,” but said his preference is granting “local-option taxing authority that enables county voters to decide for themselves how to address their most pressing needs.”
South Carolina Gov. Nikki Haley (R) proposed eliminating the 6 percent individual income tax rate. South Carolina currently imposes individual income tax at graduated rates. Individuals with taxable incomes of $8,401 to $11,200 are subject to a 5 percent tax; those with taxable incomes of $11,201 to $14,000 are subject to a 6 percent tax. Haley's proposal would combine those two brackets--which would be higher than the 2012 limits after adjustment for inflation--to make both subject to the 5 percent rate.
Haley also said in her annual address that, although investment in infrastructure is needed, she would never support raising the state's motor fuels tax.
Wisconsin Gov. Scott Walker (R) used his annual State of the State address Jan. 15 to propose lower income tax rates for the middle class, asserting the change would nurture economic growth across Wisconsin.
Walker offered no details about the proposal, but said that a full plan for substantially reducing the tax burden on middle-income earners would be folded into his 2013-15 biennial budget. “We want to continue to put more money in the hands of the hard-working taxpayers and small-business owners in our state,” he said.
“There has been less activity in Democratic-controlled states, for three reasons: there are fewer such states, most of them are 'long session’ states which lessens the urgency to release reform plans early in the year, and a couple Democratic states (California and Maryland) recently adopted significant tax increases,” according to Crosby.
“Less activity does not mean no activity, though,” Crosby said, citing as examples Colorado's governor suggesting reform of the state's Taxpayer Bill of Rights (TABOR) amendment, which restricts tax increases; Massachusetts's governor calling for substantial tax increases to fund transportation and other items; and Minnesota legislators introducing several bills to expand the corporate income tax base.
For the 2013 fiscal year, California Gov. Jerry Brown (D) proposed a $97.7 billion budget that would use voter-approved tax increases to boost spending by 5 percent and help get California through years of “great fiscal difficulty.” The new budget plan marks the first time in more than a decade the state has not faced a multibillion-dollar deficit.
Most of the governor's proposed spending increases are earmarked for education as promised under Proposition 30, the measure approved by voters in November 2012 to increase the statewide sales tax rate and personal income tax rates on top earners. The governor's plan also would boost spending on health care, transportation, and government operations.
The plan includes $60 million in savings from yet-to-be proposed regulations that would change the state's enterprise zone program, which offers tax incentives to employers operating in any of the state's 42 designated zones. The regulations will be aimed mainly at a practice called “retro-vouchering,” through which employers sometimes obtain vouchers from their local zones, and therefore become eligible for up to $30,000 in tax credits, many years after hiring employees who make them eligible for the credits.
Officials in Minnesota noted that a general fund budget gap of $1.1 billion (2.8 percent) is currently projected for the FY 2014-FY 2015 biennium, according to the National Conference of State Legislatures.
Minnesota legislators have already introduced several bills to expand the corporate income tax base, including S.F. 10, which would eliminate the foreign source royalty deduction, and H.F. 37, which would impose a throwback rule under the sales factor. S.F. 35 is a measure to impose sales tax on “digital products.”
At his State of the Commonwealth address, Massachusetts Gov. Deval Patrick (D) noted the Massachusetts Transportation Department's new report that concludes the state's transportation system needs $1 billion-plus in new annual revenue.
The governor stated that in his budget, he will propose cuts in sales tax from 6.25 percent to 4.5 percent, and dedicate all the proceeds to a public works fund to support transportation, as well as the school building fund and other public infrastructure. Sales tax proceeds would be off limits for any other purpose.
The governor will seek an increase in income tax by 1 percentage point to 6.25 percent, but will seek to double personal exemptions and eliminate a number of itemized deductions, he said. Patrick added that any changes to Massachusetts's sales, income, and business taxes will be comparable to and competitive with other states in the region and beyond.
Amidst a steady downward trend in expectations for state finances, Connecticut Gov. Dannel Malloy (D) in his Jan. 9 address noted the importance of making government an active partner in tackling the challenge of economic development, citing the state's leverage of $180 million in public funding to drive more than $2 billion in private investment.
Colorado Gov. John Hickenlooper (D) called on lawmakers Jan. 10 to support needed reforms to the state's enterprise zone tax credit program. The reforms should be “both fair to taxpayers and responsible in extending benefits to support development,” Hickenlooper said. “It's time to update the rules.”
In 2012, lawmakers approved a measure (H.B. 1241) creating a 15-member enterprise zone review task force, expected to report its findings to the Legislature in November 2013. The task force is reviewing, among other things, tax credits available within enterprise zones to assess their effectiveness in achieving the purpose of the zones and expanding economic development within them, the bill said.
The governor also referred to the TABOR restrictions tax increases and two other amendments that “create a fiscal knot” placing the state on “an unsustainable fiscal course.”
TABOR requires voter approval for tax increases and limits annual state and local government spending growth to the rate of inflation plus population change. Hickenlooper wants to “explore creative ideas on how best to reform the way our Constitution is so easily amended.”
Nebraska Gov. Dave Heineman (R) used his State of the State address Jan. 15 to call for a reduction in or elimination of the state income tax and corporate tax. Calling his proposal revenue neutral, Heineman said he would also ask the Legislature to close loopholes in the state sales tax system to offset revenue lost through elimination of the income and corporate taxes.
Citing rankings of the Tax Foundation, a tax research group that promotes “simple, sensible tax policy,” Heineman said in his address that Nebraska currently ranks 31st in the country in the competitiveness of its business-tax climate. Among neighboring states, only Iowa, at 42nd, ranks worse, and Wyoming and South Dakota rank first and second, he said.
Nebraska's personal income tax rate, the 16th highest in the country, is particularly worthy of scrutiny, Heineman said. He added that the personal income tax rate has a great influence on businesses, 92 percent of which file their taxes as individuals rather than as corporations.
“Our goal is a better business tax climate that will create more high-paying jobs,” Heineman said.
The governor also noted that many other states exempt sources of income that are taxed in Nebraska, such as the pay of retired members of the military, which is exempt in 23 states; Social Security income, which is at least partially exempt in 43 states; and income from inheritances, which is exempt in 42 states.
In his Jan. 16 State of the State message, Nevada Gov. Brian Sandoval (R) proposed a two-year continuation of $649 million in sales and business taxes that otherwise would expire June 30. The continuation includes a 0.35 percent sales tax increase to help fund public education.
The governor also wants to expand an exemption from the state's modified business tax that would benefit an estimated 2,700 additional Nevada employers at a cost of $25 million. The Legislature, which is Democrat-controlled, will formally take up the governor's proposals when it convenes a 120-day session Feb. 4.
New Mexico Gov. Susana Martinez (R) repeated her call for a tax incentive program that reduces the corporate tax rate and changes the method the state uses to determine taxes owed by corporations engaged in multistate businesses.
The governor also called for adoption of a single sales factor, “just as 25 other states have done.” Currently, the tax obligation of a corporation is tied to its property, payroll, and sales in New Mexico.
“If a New Mexico company wants to make and sell goods to the four corners of the world, we should not punish them with our tax structure,” Martinez said.
Such a change could benefit large companies such as Intel Corp., a computer chip manufacturer that has a facility in Rio Rancho, N.M., but makes most of its sales outside the state. Corporate income taxes are estimated to account for about $340 million of the $5.9 billion the state will collect in its main budget account in the 2014 fiscal year that starts in July.
At his annual State of the State speech, Rhode Island Gov. Lincoln Chafee (I) proposed a cut in the state's corporate tax rate from 9 percent to 7 percent over a three-year period. The step-down in the corporate rate to 7 percent will put Rhode Island's tax rate below that of neighboring Massachusetts and Connecticut.
Under the governor's plan, the drop in rate to 8 percent for tax year 2014 will cost the state $8 million in lost revenue for fiscal year 2014. That loss would be partially offset by the elimination of the enterprise zone credit.
The governor also proposes $30 million in property tax relief.
In Virginia, Gov. Bob McDonnell (R) has introduced a plan that would replace the state's gas tax with an increase in sales tax, dedicated to transportation funding. The plan also would increase vehicle registration fees and assess an annual $100 charge on alternately fueled cars.
Included in the governor's plan is the state's use of $1 billion in internet sales tax revenue from legislation pending in Congress.
Proposing significant tax reform is one thing, but enacting it is another. Republican plans tend to rely on expanding the sales tax base, either by taxing currently excluded services or eliminating existing exemptions.
“Unfortunately for the reformers, most of the potential revenue from eliminating exclusions and exemptions come from categories of purchases that legislatures will balk at taxing--such as education and health care--or that they shouldn't tax--such as business inputs like manufacturing equipment,” Crosby said.
In 2012, South Carolina considered legislation to lower its sales tax rate by eliminating more than $220 million worth of exemptions from an estimated $3 billion total. In the end, the state's House passed legislation to eliminate exemptions worth about $11 million and lower the sales tax rate from 6 percent to 5.98 percent. The Senate did not take up the bill.
Using that example, Crosby noted there is little historical evidence of bold proposals being enacted, although “it is important to recognize that it has been many decades since so many states were under single party control.”
Whether these reforms represent “good” tax policy is clearly in the eye of the beholder. While moving away from income taxes and toward consumption taxes may be viewed by some as a positive step, the more liberal side of the political spectrum may have concerns about the shift in tax distribution that would result from these reforms.
For Democrat-controlled states, the balance may lie with cutting sales tax and increasing income taxes. Voters in California raised both, recently adopting measures to increase the statewide sales tax rate and personal income tax rates on top earners.
For business, the analysis may be more complicated. The percentage of sales tax revenues accounted for by business purchases may make proposals to eliminate income taxes, made revenue neutral through sales tax base expansions and rate increases, result in a massive shift of legal tax burden from individuals to businesses.
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