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Governor, Legislature, withdraw your swords!
The Roundhouse in Santa Fe (Photo by Peter St. Cyr)
Governor, Legislature, withdraw your swords! You’re fighting the wrong battle. The battle isn’t against each other, it’s against other states.
Today, there are multiple combat lines being incised between a number of fiscal, economic and ideological forces. Of all the various combatants, the U.S. states are emerging on the frontlines of the fight. And some of their tactics are encouragingly following free-market principles. Let’s pick up the story with some recently published data.
The corporate income tax rate drives revenue overall
It’s no secret that U.S. states in general are facing large budget deficits, and a dozen or so in particular are in dire straits. State tax revenue has fallen dramatically since the real estate bust and subsequent recession. Although the National Bureau of Economic Research, the official arbiter of recession dating, declared the nation’s downturn had ended in June 2009, the rest of the country knows better.
Let’s look at the three tax revenue sources: corporate income tax (CIT), personal income tax (PIT), and the sales tax (GRT).
Of the three revenue sources, CIT is the one to watch and will determine the path of PIT and GRT growth. A sustained fall in corporate taxes remitted to the state signals company profits are falling or remain negative. Declining or non-existing company profits do not encourage hiring – and absent rising employment, both PIT and GRT revenue stagnate.
Yes, PIT and GRT revenue have shown signs of life for 2010 through September. However, whether this rise was due to income tax rebates and other one-time stimulus schemes or organic growth in employment and wages is hard to determine. Time will tell. The fact remains, the unemployment rate is proving harder to lower than the decibel level on Fox News.
State vs. state: Let the battle begin
Thomas Molitor
Recent events suggest that a battle for tax revenue has commenced – pitting high-tax states against low-tax states.
In January, Illinois, faced with a gaping $13 billion hole in its budget, $8 billion in unpaid bills, and addicted to its corrupt spending ways, raised its personal income tax rate 66 percent and the corporate tax rate 46 percent.
The reaction from neighboring Wisconsin Governor Scott Walker was immediate. “Escape to Wisconsin,” said Walker, borrowing from an old state tourism board campaign slogan, and urged Illinois businesses to move to his state.
Wisconsin’s Walker was not alone. Indiana Governor Mitch Daniels, Michigan’s Rick Snyder, and even Chris Christie in faraway New Jersey have been promoting their states as a haven for businesses that want to flee the tax-and-spend culture.
This rivalrous trend is not limited to the big three tax revenue targets – PIT, CIT, and GRT – with some states getting very creative. The latest twist on beggar-thy-tax-neighbor targets cigarettes in the hope of drawing smokers from other states to buy in their state and increase revenue.
This is the age-old border town strategy. States with geographically small footprints and/or those with large towns on or near their borders will entice neighboring state residents to make the short drive and save on sales, use or excise taxes.
My prediction: At some point, states will begin reducing their tax on gasoline to draw motorists from across the border.
Inter-state tax competition
Tax competition is here and it is real, not merely conjecture based on anecdotal evidence.
If you want to increase your tax take, lower your tax rate. As counter-intuitive as that sounds, it’s true. Free-market competition has entered the tax sector.
Unfortunately, New Mexico has a higher corporate tax rate than any of its neighboring states – Texas, Arizona, Colorado, Utah – according to The Tax Foundation figures.
The recently concluded legislative session did absolutely zero to address this inter-state competitive tax competition.
The border town strategy is turning today’s state lines into tomorrow’s revenue battle lines. The New Mexico taxpayer will be the ultimate winner if the Legislature and the governor stop competing against each other and start competing against other states for revenue and jobs.
Molitor is a regular columnist for this site. You can reach him at tgmolitor@comcast.net.
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Mr. Molitor:
That only works in the short term; the 2005 CBO paper shows a long-term decrease in funds. This is to say nothing of your usual decision to ignore such petty things as employment rates and living wages.
In recent American history three presidents, Republicans Ronald Reagan and George W. Bush—and Democrat icon John Fitzgerald Kennedy—all lowered taxes in response to economic recessions. In all three cases, more money flowed into federal coffers than expected, and all three recessions ended.
In 2003, President Bush lowered income, capital gains and dividend tax rates. As a result of the Bush tax cuts, the amount of revenue flowing into the federal Treasury over the next four years surged by over 40%, or $743 billion. To illustrate how the tax cuts boosted the economy, GDP grew at an annual rate of just 1.7% in the six quarters before the 2003 tax cuts. In the six quarters following the tax cuts, the growth rate was a robust 4.1%. While some of that growth was naturally occurring, the sudden and dramatic turnaround in the economy began at the exact moment those pro-growth policies were enacted.
Take, for example, the recent situation in Japan. The Japanese Central Bank responds by flooding the market with Yen to stimulate aggregate demand, while keep its interest rates at zero. The earthquake/tsunami/nuclear triple whammy is a massive contractive event. Do you really want to increase the money supply when the output has just contracted and will remain so for years to come.
The Japanese Central Bank should do the exact opposite. It should raise interest rates to stimulate saving and attract foreign capital investment and use that money to invest in the supply-side productive capacity. The U.S. should follow the same policy.
nmattorney:
I agree that you should read the article Mr. Molitor so generously provided; I would especially recommend
this section, which succinctly explains why the theory doesn’t actually work.@nmattorney
To answer your question about about lower taxes generate higher tax revenue, see here.
Combined reporting is a hot-button tax issue for multistate corporations.
Want to get a bunch of tax experts all riled up? Just mention the phrase “combined reporting.”
It has to do with the method that a corporation uses to report its income for tax purposes.
It may sound dull. But it’s a hot-button issue right now, especially in cash-strapped states faced with big budget deficits.
It may not get a lot of attention in the media. But mark my words: it’ll be debated in New Mexico for years to come.
Here, in a nutshell, is what it’s all about.
New Mexico doesn’t require corporations to file tax reports to the state on a “separate company” basis. So, broadly speaking, a corporation that has an operation in every state pays tax to New Mexico based only on the company’s operation in New Mexico
Fair enough.
The problem is that some multistate corporations deliberately shift income out of states that have comparatively high corporate income taxes, such as New Mexico, into states that have comparatively low corporate income taxes, or none at all, such as Nevada. So when such companies report their financial results to a higher-tax state, they pay little in corporate income tax to that state.
It’s been said that businesses considering locating here would consider it a detriment if New Mexico required combined reporting.
It’s also been said that combined reporting would make tax reporting more complicated for businesses, which would also be viewed by business as a disadvantage.
Some states, as you say, have found that if combined reporting were required, some businesses would pay more in tax, others less, but it is hard to make an accurate prediction.
I am of the mind that if combined reporting becomes a requirement here in New Mexico that it would have to be linked to a reduction in the state’s corporate income tax rate — to as low as 4 percent (from the current 7.5 percent).
Overall, more than 20 states nationwide require it. One can make the argument that not having the requirement makes New Mexico more competitive to attracting corporations.
But yes, as you say, there are “some questions on whom it would affect.”
Also, just to add an additional complexity to the debate and demonstrate how silly the “tax avoiders” and “business hater” memes are:
The notion that NM businesses are somehow disadvantaged by the current tax structure isn’t so simple. A large number of local businesses are in fact “pass through” entities, meaning that they aren’t subject to the corporate tax rate, but actually the lower personal income tax rate. So on the one hand, NM businesses that elect one of these types of entities arguably have an advantage when it comes to taxes, and yet we’re not calling for them to be put on equal footing with corporate entities. I wouldn’t really venture an opinion on that other than that there are reasons to provide for the current forms of pass through entities for reasons completely unrelated to taxes. I just find the simplicity of the current arguments infuriating.
Also, Thomas, I note that you state that: “If you want to increase your tax take, lower your tax rate. As counter-intuitive as that sounds, it’s true. ”
Can you provide a single bit of empirical evidence for this? Because at least on the federal level, this sort of voodoo economics has demonstrably never worked, nor am I aware of evidence of it on a state level. I’m guessing this was more of a statement based on political persuasion than anything else.
What Wedum59 is referring to is the what’s commonly called the “Big Box Store Tax”, but what it actually refers to is Unitary Combined Reporting. It actually does not relate to GRT per se. Thomas, I think the problem with your response to her lies in just saying that they create jobs. Well, great. So do local businesses. Just because they create jobs isn’t a reason to create an unequal playing field, if it is in fact unequal.
What bothers me about the discussion about Unitary Combined Reporting is simply that it’s an issue that partisans of both sides have latched on to without the slightest understanding of what it is or how it operates. Wedum, can you actually tell us how changing to Unified Combined Reporting would differ from the current structure? That’s great if you can, but of the people I’ve spoken with that speak so passionately about “getting” these tax evaders, very, very, VERY few know anything about it other than to scream that the big box stores are avoiding taxes. Or from the Right, that the Left doesn’t want jobs or hates business (as indicated by Thomas’ response).
I am not a tax attorney; I’ve looked at it enough to have a basic understanding, but what I can tell you and just a small amount of research will show you is that no one really knows what changing would do. Due to uncertainty about how gains and losses are apportioned, there’s nothing close to a unified view among economists as to how the change would affect tax revenues. There’s evidence that a change to unified combined reporting has lead to decreased tax revenues in certain states, and evidence that the change has increased tax revenues in other states. Part of the problem is that states that have changed tax structures in recent years have done so in the midst of economic changes (whether the dot-com bubble and bust or the more recent economic turmoil), so it’s almost impossible to tell what the real impact may be. Putting aside all other economic factors, it’s possible that changing to uniform combined reporting may increase or decrease revenues in a given state, given how losses are also allocated. For example, if a company in New Mexico has significant losses, it is possible that the state would get less revenue then under the current structure, whereas now some of those losses may have been attributed to an “out of state” entity and would not have decreased the in-state entities revenues. I believe that officials from NM Tax & Rev have testified to this effect in the past, for whatever that’s worth (given that T&R is interested in getting as much tax revenue as possible, I think that it is telling).
Argue for or against it, I’m not sure it really matters because no one knows what the result will be. But the issue itself demonstrates how silly our political debate is: partisans jump on an issue and scream phrases like “box box store” and “carpetbaggers” and “they create jobs”, with absolutely minimal understanding of the underlying issue.
@wenum59
Can you cite our source? Thanks.
Separately, these “carpetbaggers” create jobs by the way.
It’s my understanding that one of the ways NM loses revenue is that corporations with out-of-state headquarters do not have to pay GRT here. That’s Walmart, etc. I believe we are one of only three states that has this carpetbagger giveaway.
@nmattorney,
md is saying we are the only state that structures its sales tax as a GRT which captures taxes along the B2B supply chain. Is this because of what you say…
If so, I did not know the origin of the GRT incentive. That’s an interesting point because New Mexico ranks No.1 in federal spend on every NM tax dollar taken. 2:1 ratio. Thanks for pointing that out.
MD,
I can’t comment on how other states handle taxation of services. It’s not clear from your statement if you’re advocating dropping the GRT in favor of a sales tax, but if that’s the case, it’s an absolute non-starter.
The reason we have the GRT is in large part due to a legal fiction that allows for a back-door method of imposing a tax on the federal government and its contracts with the defense contractors at the national laboratories. A sales tax would not allow the state to collect on the contracts between the federal government and contractors.
Do away with that revenue, and you create a not insubstantial hole in the state’s budget–which would ultimately lead to higher sales tax rates, or other means of making up that income.
So if el paso has a higher sales tax rate how come nobody comes to nm to do their shopping? I have no doubt that nm could improve its tax structure, but acting like lowering taxes is some kind of panacea is foolish. Last I checked texas had a huge budget hole despite zero income taxes. A recent article in the albuquerque journal had a more reasoned discussion pointing to a few specific ways we tax businesses that make us less competitive. But that’s not the whole story, and GRT is part of the problem, by the way. In no other state does a business have to pay GRT on a service from another business. That makes it cheaper to get services from out of state.
Financing, availability of workers, quality of life and cultural issues all play a major role in new mexico’s economy.