Business Tax Breaks | Investing in the Future

Investing in the Future

Reducing Special Tax Breaks for Businesses

Generating State Revenues by Reducing
Special Tax Breaks for Businesses

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While income taxes collected from corporations represent a fairly modest share of most state's total revenue collections,1 they nevertheless are an important part of the whole. Moreover, it is possible for states to increase their corporate collections by tens of millions or even hundreds of millions of dollars annually by making small changes to their tax laws. Each of the options we present below reduces or eliminates special tax breaks provided to businesses.

Tax breaks are special rules, intentionally created, that allow a taxpayer to reduce the taxes otherwise owed.  While a multitude of tax breaks are available both for individuals and for corporations, in this section we focus only on states' corporate tax policy. 

As part of their effort to spur economic development, state governments throughout the country collectively provide businesses with billions of dollars in tax breaks each year.2 Not only is it unclear how effective most of this "tax code spending"3 is at generating additional, high-quality jobs,4 but in many cases, states have only a very rough idea how much revenue they are losing to these tax breaks.5 Moreover, the revenue lost to these tax breaks translates into a reduction in the state resources that otherwise would be available for the many public investments that actually are known to help state economies grow over the long term – investments, for example, in education and transportation infrastructure.6 Given the very large sums of state revenue forgone annually to business tax breaks and the questionable value many of these tax breaks provide to state economic development, there is ample reason to consider reducing or eliminating some of them and reinvesting these tax dollars in proven public goods. 

Notably, these increased public investments provide direct benefits to businesses. The underlying rationale for requiring businesses to pay any state tax is that the successful operation of these businesses – the ability to make and sell a given product for a profit – depends in part on the infrastructure and services supplied through state government. These include roads and highways, police and fire protection, courts and legal structures, and the presence of an educated and healthy workforce.  State corporate taxes help to pay for all of these; corporate tax breaks, by contrast, leave these essential services underfunded.

Virtually all of the special tax breaks that we discuss below are ones used overwhelmingly by large, multi-state corporations. Reducing the cost or eliminating altogether these special tax breaks consequently raises new revenue primarily from large, profitable corporations. In the process, it also can help level the playing field for smaller, in-state businesses.

Not insignificantly, as we discuss options for increasing the amount of tax that states are collecting from profitable corporations, it is worth noting that corporate taxes have declined markedly over the last several decades as a share of total state tax revenues. In 1979, for the US as a whole, corporations paid 10.2 percent of all tax revenues collected by states.7 By 1989 the share had dropped to 8.8 percent, by 2000 it had fallen to 6.3 percent, and by 2011 it had fallen to 5.3 percent.8 Further rounds of rate cuts and the creation of new loopholes and tax breaks for corporations in the early 2000s exacerbated the loss of corporate income tax revenue at the state level during the last decade.9 State corporate income taxes likewise have declined as a share of Gross State Product and as a share of corporate profits.10 A major contributor to this decline is the increasingly sophisticated and aggressive use of tax breaks by corporations to reduce their state (and federal) taxes.11

Reducing or eliminating tax breaks is a simple approach that states can use to reverse the decline in their corporate tax collections and ensure that more resources will be available for essential public investments.

In this section, we examine four ways to reduce or eliminate a number of particularly costly special tax breaks for businesses:

  • Eliminate the Film Tax Credit
  • Eliminate the Single Sales Factor Apportionment Formula
  • Decouple from the Domestic Production Deduction
  • Eliminate or Cap Sales Tax "Vendor Discount"

METHODS OF IMPLEMENTATION

Eliminate the Film Tax Credit

State "film tax credits", which subsidize the instate costs of producing a film, have become a very common feature of state tax codes. As of 2010, 43 states were offering some kind of film tax credit, at a nationwide cost to the states of some $1.5 billion annually.12 Numerous analyses, however, by state departments of revenue, legislative research departments, economists, and public policy think tanks from across the political spectrum have reached a common conclusion: in most cases, these tax credit programs are expensive; they do not "pay for themselves" through enhanced income tax collections from the jobs they create; much of the benefit accrues to non-state residents (including movie stars and investors); and they produce little in the way of lasting state economic development.13

Depending on the specifics of each state's program and the amount of film production that occurs within a given state, individual states lose from several million to hundreds of millions of dollars annually through their film tax credit. With the growing realization among state legislators that these state programs represent a poor use of limited state tax dollars, an increasing number of states either are eliminating or suspending their programs, though some states instead are choosing to expand their programs.14 Eliminating film tax credit programs can be a way to generate substantial additional revenue for essential public investments.

Eliminate the Single Sales Factor Apportionment Formula

Another common and expensive tax break provided by states to businesses involves changes in the "apportionment formula" that states use to calculate (or "apportion") the share of each corporation's nationwide profits that the state will tax. The standard apportionment formula gauges the share of a corporation's total nationwide property, payroll and sales that occur within a given state's borders, applying an equal weight to each of these three "factors."15 If half of a company's property, employees and sales occur in state Z, than state Z will collect tax on half of the company's nationwide taxable profits.

Implicit in this formula structure is the recognition that state-provided services help to support the day-to-day operations of businesses, and that the corporate taxes a state collects should correspond in some meaningful way to this level of state support. One company may have very little in-state property and few employees but sell a great deal of products into a given state, while another company may have large factories with many employees but sell virtually none of its products in-state. Both of these companies rely on the infrastructure and services supplied through state government - such as roads and highways, police and fire protection, courts and legal structures, and the presence of an educated and healthy workforce – though they do so in different ways.  Under an apportionment formula that weights the property, payroll, and sales factors equally, each of these companies will contribute tax dollars to support these essential government services in rough proportion to its use of those services. Additionally, other states will be in a position to tax just that portion of these companies' profits that correspond roughly to the companies' use of public services in these other states. 

Many states, however, do not use an equally weighted apportionment formula, instead opting to weight the sales factor more heavily. The argument for doing so is two-fold:  1) that by reducing or eliminating the weight placed on the property and payroll factors, businesses are encouraged to expand factories and jobs in-state, and 2) that the state is able to "export" more of its corporate tax costs onto "outside businesses", businesses headquartered elsewhere but which nevertheless sell a significant amount of product into the state.

Not only, however, does this unequal weighting make the overall corporate tax structure unfair - favoring some types of businesses over others16 - but by doing so, creates disincentives for some businesses to establish or maintain property and payroll in a given state.17 Most importantly, in most cases, overweighting the sales factor reduces a state's net corporate tax collections and often by more than is projected when the change is being enacted.18

As of 2012, of the 45 states with a corporate income tax, only eight continue to apply an equal weight to all three factors in their apportionment formula (these states include AK, DE, HI, KS, MT, NM, ND and OK).19 The rest double, triple, quadruple or still further overweight the sales factor. Sixteen states rely exclusively on the sales factor, employing what is termed a "Single Sales Factor" (SSF) formula (SSF states include CO, GA, IL, IN, IA, LA, ME, MD, MI, MS, MO, NE, NY, OR, PA and WI).20

SSF states may provide this preferential formula to all corporations or instead may limit the use of the SSF formula to specific industries. While companies (with existing in-state operations) in many industries likely would gain a substantial tax advantage were they permitted to use a SSF apportionment formula, often this advantage is provided only to those industries with the most political influence within the state. Not coincidentally, this influence also commonly corresponds to those industries that have large amounts of property holdings and/or many employees in the state.21 If these particularly influential industries make a large majority of their sales to out-of-state customers - as do most manufacturers, for example – they in particular will stand to benefit from a SSF apportionment formula.22 These influential industries therefore have an especially strong incentive to seek the preferential tax treatment that SSF provides them. Not surprisingly, the manufacturing industry has been a strong - and often times successful – proponent for the adoption of SSF apportionment for manufacturers in states across the nation.23

Depending on the particulars of each state, use of an SSF formula typically results in an annual revenue loss of between 1 percent and 17 percent of a state's total corporate tax collections.24 For some states this translates into a revenue loss of several million dollars a year, while, in other cases, states are losing amounts from $100 million to $200 million per year.25 Returning to an apportionment formula that places equal weight on each of the three factors (property, payroll and sales) can increase corporate tax revenue collections, providing additional resources for investments in education, infrastructure and other essential public services.

Decouple from the Domestic Production Deduction

The domestic production deduction or QPAI is a tax break given to companies on the portion of their income they earn from a variety of "qualified activities." Income generated through these specified activities can be partially deducted, for tax purposes, from a corporation's total income.26 This lowers the corporation's "taxable income" total, thus reducing the amount of income tax owed by the corporation.

Created at the federal level in 2004 (and also affecting corporate tax collections in many states), QPAI originally was intended to reduce corporate taxes for U.S. manufacturers producing goods for export to other countries. By the time the bill creating QPAI finally passed, however, its language was sufficiently vague as to allow many kinds of standard business activities – activities having little or nothing to do specifically with export manufacturing - to qualify for special tax treatment. Qualifying activities include architectural and engineering services, home and building construction, filmmaking and coffee roasting.27

As a result, the federal government now loses billions of dollars in corporate tax revenue annually to QPAI.28 Additionally, many states that "piggyback" on the federal code – levying their state corporate tax on each corporation's "taxable income" as defined under federal law – together lose hundreds of millions to QPAI annually.29 Unfortunately - given the large amount of state tax dollars forgone to QPAI - the tax break offers little value for the economic development of individual states; corporations can use the QPAI deduction to reduce their taxable income for "domestic production" activities conducted anywhere in the United States, not merely production occurring in the state(s) providing the tax break.30

A straightforward way for states to eliminate this source of corporate income tax loss is to decouple their own tax codes from the federal QPAI provision. In this way, for state tax purposes, corporations no longer would be able to reduce their taxable income using the QPAI deduction. Instead, corporations would include the income generated from these many "qualified activities" as part of their total taxable income, resulting in larger corporate tax collections for decoupled states. As the large majority of the benefits from the QPAI deduction go to very large corporations, it is primarily these large firms that would provide these additional revenues.31

As of 2011, 25 states remained coupled to the federal QPAI provision.32 These states include the following: AK, AL, AZ, CO, DE, FL, IA, ID, IL, KS, KY, LA, MI, MO, MT, NE, NJ, NM, OH, OK, PA, RI, UT,VA and VT. Individual revenue losses in these states range from several million dollars annually to upwards of $100 million a year.33 Collectively, affected states lose over $500 million annually to the QPAI deduction.34

Eliminate or Cap the Sales Tax "Vendor Discount"

Another common source of state tax revenue loss occurs through what is called the sales tax "vendor discount." In the majority of states with a sales tax, vendors actually are allowed to pocket a portion of the sales taxes they collect from their customers.35 These taxes, diverted from the state treasury to the accounts of companies collecting the tax, are meant to compensate businesses for the effort involved in collecting the sales tax from their customers and remitting those taxes to the state. Given both that 19 states with a sales tax do not compensate businesses for collecting and remitting states sales taxes, and given that the cost of performing this function has steadily declined with the computerization of business functions, it is questionable whether businesses require much or any compensation for this activity.

Currently, 26 states have some form of vendor discount program (AL, AZ, AR, CO, FL, GA, IL, IN, KY, LA, MD, MI, MS, MO, NB, NV, NY, ND, OH, OK, PA, SC, TX, UT, VA, and WI).36 Thirteen of these 26 states place a ceiling on the total dollar amount any individual vendor may withhold from the state, ranging from a few hundred dollars to several hundred thousand dollars. Depending on the state, a "vendor" may be defined as an individual retail outlet. Thus, a company with many retail locations would be able to collect many times the dollar limit established for an individual vendor.  Even with a cap in place, these thirteen states typically lose between $5 million and $25 million annually. The states that cap vendor payments include the following: AL, AZ, AR, FL, KY, MD, MI, MS, NE, NY, ND, OK and SC.

Thirteen other states (CO, GA, IL, IN, LA, MO, NV, OH, PA, TX, UT, VA and WI) do not cap the dollar amount that vendors may withhold, instead defining only the percentage of the collected sales tax that a vendor may withhold.37 The result is that in these thirteen states, vendor discount programs produce uncapped revenue losses that typically range from $30 million to $70 million annually. In a number of cases, the annual revenue loss figures are even higher.38 Collectively, the 26 states with vendor discount programs are losing over $1 billion annually in state sales tax revenue as a result of these programs.39

A reasonable approach to raising additional state revenue might include eliminating state vendor discount programs, or as a first step, creating reasonable dollar caps and applying these caps to an entire corporate entity rather to each retail outlet operated by a single corporation.

Related Reports

Center on Budget and Policy Priorities, "State Film Subsidies: Not Much Bang for Too Many Bucks", December 2010: http://www.cbpp.org/cms/index.cfm?fa=view&id=3326

Institute on Taxation and Economic Policy, "Corporate Income Tax Apportionment and The 'Single Sales Factor'", August 2012: http://www.itep.org/pdf/pb11ssf.pdf

Center on Budget and Policy Priorities, "Stat s Can Opt Out of The Costly and Ineffective 'Domestic Production Deduction' Corporate Tax Break", January 2010: http://www.cbpp.org/cms/index.cfm?fa=view&id=553

Good Jobs First, "Skimming the Sales Tax", November 2008: http://www.goodjobsfirst.org/publications/skimming-sales-tax-how-wal-mart-and-other-big-retailers-legally-keep-cut-taxes-we-pay-e

Massachusetts Budget and Policy Center, "Business Tax Breaks in Massachusetts", August 2012: http://www.massbudget.org/report_window.php?loc=business_tax_breaks.html

 



1. Center on Budget and Policy Priorities, “Cutting State Corporate Income Taxes Is Unlikely to Create Many Jobs”, September 2010: http://www.cbpp.org/cms/?fa=view&id=3290

2. Center on Budget and Policy Priorities, "Promoting State Budget Accountability Through tax Expenditure Reporting", May 2011: http://www.cbpp.org/files/5-11-11sfp.pdf

3. For a brief discussion of tax expenditures and "tax code spending, see the Institute on Taxation and Economic Policy report, "Tax Expenditures: Spending By Another Name", October 2011: http://www.itep.org/pdf/pb4exp.pdf

5. Center on Budget and Policy Priorities, "Promoting State Budget Accountability Through tax Expenditure Reporting", May 2011: http://www.cbpp.org/files/5-11-11sfp.pdf

7. Center on Budget and Policy Priorities, "Closing Three Common Corporate Income Tax Loopholes", May 2003: http://www.cbpp.org/cms/index.cfm?fa=view&id=1868#_edn8

8. Ibid
For 2011 figure, see US Census data: http://www2.census.gov/govs/state/11statess.xls

9. Ibid
Institute for Taxation and Economic Policy (ITEP), "The ITEP Guide to Fair State and Local Taxes", March 2011 (See Chapter 6, page 47): http://www.itep.org/state_reports/guide2011.php  
ITEP, "Corporate Tax Dodging in The Fifty States, 2008-2010", December 2011: http://www.itepnet.org/pdf/CorporateTaxDodgers50StatesReport.pdf

10. Institute for Taxation and Economic Policy (ITEP), "The ITEP Guide to Fair State and Local Taxes", March 2011 (See Chapter 6, page 47): http://www.itep.org/state_reports/guide2011.php  

11. Center on Budget and Policy Priorities, "Closing Three Common Corporate Income Tax Loopholes", May 2003: http://www.cbpp.org/cms/index.cfm?fa=view&id=1868#_edn8
Institute for Taxation and Economic Policy (ITEP), "The ITEP Guide to Fair State and Local Taxes", March 2011 (See Chapter 6, page 47): http://www.itep.org/state_reports/guide2011.php  
ITEP, "Corporate Tax Dodging in The Fifty States, 2008-2010", December 2011: http://www.itepnet.org/pdf/CorporateTaxDodgers50StatesReport.pdf

12. Center on Budget and Policy Priorities, "State Film Subsidies: Not Much Bang for Too Many Bucks", December 2010: http://www.cbpp.org/cms/index.cfm?fa=view&id=3326

13. Ibid
Federal Reserve Bank of Boston - New England Public Policy Center, "Hollywood East? Film Tax Credits in New England", October 2006: http://www.bostonfed.org/economic/neppc/briefs/2006/pb063.htm
Massachusetts Department of Revenue, "Annual Massachusetts Film Industry Tax Incentive Report", November 2011: http://www.mass.gov/dor/tax-professionals/news-and-reports/other-reports/massachusetts-film-industry-tax-incentive-report/
Tax Foundation, "Movie Production Incentives & Film Tax Credits: Blockbuster Support for Lackluster Policy", January 2010: http://taxfoundation.org/article/movie-production-incentives-film-tax-credits-blockbuster-support-lackluster-policy

15. The Uniform Division of Income for Tax Purposes Act (UDIPTA) is the system developed in the 1950s, assigning equal weights to all three factors. UDIPTA subsequently was adopted by about half the states with a corporate income tax, though many states now overweight the sales factor. If the UDIPTA system were used by all states, nationwide, the result would be that 100 percent of each corporation's taxable profits would be subject to state tax exactly once. Diverging formulas that heavily weight the sales factor increase the likelihood that profitable multi-state companies will see a sizable share of their profits go untaxed by any state.
Institute for Taxation and Economic Policy, "Corporate Income Tax Apportionment and The 'Single Sales Factor'", August 2012: http://www.itep.org/pdf/pb11ssf.pdf

16. Overweighting the sales factor is beneficial to companies, such as manufacturers and certain types of banking and investment companies that sell primarily to out-of-state customers. These types of companies typically maintain substantial property and payroll in-state, relying on publicly-provided services and infrastructure, but through overweighting of the sales factor, can pay little or no state corporate income taxes to support these public goods.

17. Institute on Taxation and Economic Policy, "Corporate Income Tax Apportionment and The 'Single Sales Factor'", August 2012: http://www.itep.org/pdf/pb11ssf.pdf

18. Center on Budget and Policy Priorities, "The SSF Formula for State Corporate Taxes", September 2005 (see section IV): http://www.cbpp.org/files/3-27-01sfp.pdf  

19. Institute on Taxation and Economic Policy, "Corporate Income Tax Apportionment and The 'Single Sales Factor'", August 2012: http://www.itep.org/pdf/pb11ssf.pdf

20. Ibid
Some states, such as Massachusetts, may employ a SSF formula when determining taxes for specific industries, while employing a different apportionment formula as part of their general corporate income tax structure. 

21. Institute on Taxation and Economic Policy, "Corporate Income Tax Apportionment and The 'Single Sales Factor'", August 2012: http://www.itep.org/pdf/pb11ssf.pdf

22. Institute on Taxation and Economic Policy, "Corporate Income Tax Apportionment and The 'Single Sales Factor'", August 2012: http://www.itep.org/pdf/pb11ssf.pdf

23. Center on Budget and Policy Priorities, "The SSF Formula for State Corporate Taxes", September 2005 (see page 7): http://www.cbpp.org/files/3-27-01sfp.pdf
Note: In states that limit use of their SSF apportionment formula to specific industries, corporations in other industries nevertheless may benefit from overweighting of the sales factor in the state's more general apportionment formula (even if the general formula does not eliminate entirely the property and payroll factors, as occurs under an SSF formula). 

24. Center on Budget and Policy Priorities, "The SSF Formula for State Corporate Taxes", September 2005: http://www.cbpp.org/files/3-27-01sfp.pdf  

25. Center on Budget and Policy Priorities, "The SSF Formula for State Corporate Taxes", September 2005: http://www.cbpp.org/files/3-27-01sfp.pdf  
Few if any states increase their own revenue by adopting an SSF formula, and undoubtedly the states as a whole lose revenue under a SSF structure, as adoption of SSF rules provides corporations with increased opportunities for generating "nowhere income." Nationwide, the adoption of SSF formulas results in a substantial net loss of combined state revenues, and this holds true whether adoption is piecemeal or universal.

26. Institute on Taxation and Economic Policy, "The 'QPAI' Corporate Tax Break", August 2011: http://www.itep.org/pdf/pb33qpai.pdf
While businesses are permitted to deduct most expenses from their profits as they calculate their taxable income, QPAI functions differently. QPAI instead defines a category of otherwise taxable income (income generated from qualifying activities”) and allows a portion of this income (9 percent) to remain entirely untaxed.  

27. Institute on Taxation and Economic Policy, "The 'QPAI' Corporate Tax Break", August 2011: http://www.itep.org/pdf/pb33qpai.pdf

28. Institute on Taxation and Economic Policy, "The 'QPAI' Corporate Tax Break", August 2011: http://www.itep.org/pdf/pb33qpai.pdf

29. Center on Budget and Policy Priorities, "States Can Opt Out of The Costly and Ineffective 'Domestic Production Deduction' Corporate Tax Break",  January 2010: http://www.cbpp.org/cms/index.cfm?fa=view&id=553

30. Institute on Taxation and Economic Policy, "The 'QPAI' Corporate Tax Break", August 2011: http://www.itep.org/pdf/pb33qpai.pdf

31. Ibid

32. Ibid
For some states, the interaction between state codes and QPAI is more complicated. See the CBPP report for additional details.

33. Ibid

34. Ibid

36. Good Jobs First, "Skimming the Sales Tax", November 2008: http://www.goodjobsfirst.org/publications/skimming-sales-tax-how-wal-mart-and-other-big-retailers-legally-keep-cut-taxes-we-pay-e
Both CO and VA have either reduced or temporarily suspended their vendor discount programs (Emaial communication with Greg Leroy of Good Jobs First, 11/13/2012).

37. Good Jobs First, "Skimming the Sales Tax", November 2008: http://www.goodjobsfirst.org/publications/skimming-sales-tax-how-wal-mart-and-other-big-retailers-legally-keep-cut-taxes-we-pay-e
In some states, the percentages may vary with the amount of sales tax collected.
Since this list was compiled in 2008, at least two states have reduced the losses they incur through their vendor discount programs. Virginia has disqualified the largest corporate beneficiaries of the program, while Colorado temporarily suspended its program. In some states, the percentages may vary with the amount of sales tax collected.

39. Ibid