Emerging State Business Tax Policy: More of the Same, or Fundamental Change?

Emerging State Business Tax Policy:More of the Same, or FundamentalChange?by William F. Fox, LeAnn Luna, and Matthew N. MurrayIntroductionMuch of the state tax policy discussion during thepast decade has centered on the performance ofcorporate income taxes and ways to restructurethem. Given the relatively small contribution thatcorporate taxes make to total tax receipts, it isinteresting that they receive so much attention instate capitols, industry location decisions, and themedia. State corporate income and license taxesconstituted only 6.5 percent of total state tax rev-enues in 2005 and, even combined with corporatelicense taxes, which include the value-based fran-chise taxes among others, represented only about7.6 percent of taxes.1Indeed, corporate income taxesprovide no more than 10 percent of total state andlocal business taxes.2There are several possibleexplanations, including the visibility of corporatefacilities, perceptions of corporate tax abuse, and thedifficulty of generating revenue from other sources.Though the issue of why the corporate income taxdraws so much attention may be a fascinating study,we will simply accept that states have consideredand made many changes in the corporate income taxeven if they may have found other areas with morerevenue potential.This report focuses on state responses to the weakcorporate tax collections during the 2000-2003 pe-riod as well as to the revenue performance duringthe years immediately preceding and following therecession. The report is not an attempt to argue thatthe corporate income tax is an important componentof good state tax policy. Instead, our focus is onidentifying state tactics to maintain or change thetax, determining whether those strategies are goodtax policy, and evaluating whether they are workingto achieve the basic goals of the states.The report is composed of three sections. Section1 reviews the revenue performance of corporatetaxes over the past 15 years to provide insight intowhy states may have sought new strategies. Section2 presents a brief summary of state corporate taxpolicy changes and reforms during recent years.Finally, section 3 analyzes the policy changes interms of their long-term effectiveness, across abroad set of criteria, including their capacity to helpor hinder states through economic cycles like 2001 to2003.Performance of Corporate Tax RevenueThis section provides a brief overview of corporateincome tax performance, particularly between theyears 2000 and 2003, to set the stage for why statesmay have adopted new corporate tax strategies.Corporate income and license taxes declined dra-matically during 2000 to 2003, both as a share oftotal tax revenues and in nominal terms. Statecorporate income and license taxes fell by $8.6billion between fiscal 2000 and fiscal 2002 beforeincreasing about $2.7 billion in 2003. As a result,corporate income and license taxes declined from 8.31Seehttp://www.census.gov/govs/statetax/0500usstax.html.2SeeCline et al. (2005).William F. Fox is William B. Stokely professor ofbusiness, professor of economics, and director of the Centerfor Business and Economic Research at the University ofTennessee, Knoxville. LeAnn Luna is research assistantprofessor at the center and assistant professor of accountingin the Department of Accounting and Information Man-agement. Matthew N. Murray is professor of economics andcodirector of the center.This report was presented at the conference ‘‘State andLocal Finances After the Storm: Is Smooth Sailing Ahead?’’sponsored by the Urban-Brookings Institution Tax PolicyCenter, the Kellogg School of Management and Institute ofPolicy Research at Northwestern University, and the Lin-coln Institute of Land Policy. The conference was heldMarch 30 in Washington.State Tax Notes, May 7, 2007393(C) Tax Analysts 2007. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content. percent of total state taxes in 1997 to only 5.9percent in 2002, and then came back to 6.3 percentof taxes in 2003. As noted above, corporate taxes hadrisen to 7.6 percent of total taxes by 2005 andcontinued to grow as a percent of revenues in 2006.3Corporate income taxes were affected much moreby the 2000 to 2003 slowdown than were the otherlarger taxes. For example, corporate taxes declined14.7 percent (even after the $2.7 billion revenuegrowth in 2003) while individual income taxes fellonly 6.5 percent and sales taxes rose 5.8 percentduring the three years. Corporate taxes performedmore weakly during the down cycle despite theslower growth in corporate income taxes relative toindividual income and sales taxes that occurredfrom 1992 to 2000, the window leading up to theslowdown. Thus, corporate taxes were not simplymore volatile; they have been very slow growingrelative to the other large taxes.The fall in corporate income taxes can be ex-plained by two very different underlying causes: thecyclical downturn that took place during 1990-1991and again from