Sweeping Federal Tax Plans Seen Having Big Impact on States

By Tripp Baltz

Sweeping amendments proposed to the federal tax code will result in far-reaching changes for state corporate income tax systems, and states should prepare themselves for a shift to a destination-based, cash-flow federal corporate tax regime, practitioners said.

“This is a gigantic issue for the states,” Karl Frieden, vice president and general counsel of the Council On State Taxation, said. “This is the most significant change to the corporate income tax since 1913.” In that year, Congress passed the U.S. Revenue Act of 1913, re-establishing the federal income tax after ratification of the Sixteenth Amendment.

Frieden was joined by other panelists at the National Conference of State Legislatures’ Executive Committee Task Force on State and Local Taxation meeting Jan. 14 in Scottsdale, Ariz. The panel and other sessions during the meeting addressed the impact on states of the federal tax plan soon to be introduced in Congress.

Destination-Based

Perhaps the most significant tax policy change in the plan advanced by House Republicans is the effective repeal of the current 35 percent corporate income tax and its replacement with a “border-adjustable, destination-based cash-flow tax at 20 percent for corporations and 25 percent for unincorporated businesses, Kyle Pomerleau, director of federal projects at the Tax Foundation, said, speaking before the panel got started.

“It essentially makes the tax destination-based,” he said. The “border-adjustable” aspect means imports would be taxed and exports would be exempt, he said. By eliminating taxes on returns to investments and by treating debt and equity equally, the new regime will have “far fewer distortions” than the current corporate income tax system, he said.

Pomerleau gave brief descriptions of the House Republican plan and the plan proposed by President-elect Trump, which calls for significant reductions in income taxes and corporate taxes, and the repeal of the estate tax. According to a Tax Foundation analysis, Trump’s plan would reduce federal revenue by as much as $6 billion and the House Majority’s plan by about $2.4 billion, Pomerleau said.

‘Grow the Economy.’

“Both plans result in lower federal revenue, but would result in growing the economy in the long run,” he said. “Both plans cut marginal rates on work, saving and investment, which tends to grow the economy.”

They will also have “distributional impacts,” Pomerleau said. “Both plans reduce the progressivity of the tax code.”

The changes ultimately will boost revenue for states, which is the “best news” as many states are facing budget crunches and challenges in their attempts to require out-of-state sellers to collect and remit sales and use taxes, Frieden said.

Others were not so sure.

‘No Predictability.’

The proposed changes will have “totally different impacts on each of the states, and there’s no predictability about those impacts,” said Minnesota state Sen. Ann Rest (DFL). ‘We’re not talking about fake money. We have to have balanced budgets. What if you don’t have a business tax?”

“If you think it’s a good idea for the federal budget, how are we to make appropriate adjustments and evaluations before we know how it’s going to affect our budgets?” she said.

Part of what creates a “net revenue gainer” is a simultaneous lowering of rates with a broadening of the base, which seems to be happening with both the House Republican and Trump plans “for the corporate piece,” said Michael Mazerov, senior fellow at the Center on Budget and Policy Priorities. “It’s not happening for the personal income piece.”

‘Major Struggle.’

If there is a substantial broadening of the base on the corporate side, but not on the individual income side, he said, it could be a “net revenue loser for years” in the states. “Plus, it will be a major struggle for states to conform” to the federal changes.

States aren’t going to be in lockstep in terms of conforming with the changes, said panelist Greg Turner of Turner Law in Sacramento. But the federal plans “could provoke reform at the state level,” he said. “You could use it to take a look at your tax code, and this could drive investment within the United States.” States could examine tax policies such as the tangible personal property, he said. “It could provide you with an opportunity to create a more competitive tax structure for your state.”

When considering a destination-based regime, the states “are already ahead of the feds,” Frieden said. Many states have been moving in recent years toward a market-based, single-sales factor apportionment formula for determining business income taxes, he said.

With the destination basis in federal tax code, the changes “might force states into a more uniform approach based on the destination model,” Turner said.

To contact the reporter on this story: Tripp Baltz in Denver at abaltz@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

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