It seemed so simple in the old days. Virtually all states would determine how to tax multistate corporations by using the three factor formula. A corporation's tax liability would be based on its property, payroll, and sales in a state. And, if every state taxed corporate income and every state used the three factor formula, there would be no double taxation (a good thing) and no "nowhere" income. The three factor formula was premised on the belief that a corporation's profits were generated by the property, people, and market in a state. I think that largely made sense in an economy with lots of factories. But property was limited to plant and equipment. That does not reflect value in most modern companies-think Amazon or Google. The value of high tech firms is in their intellectual property which is something the three factor formula was never designed to reflect.

But this discussion is almost moot now. Only 9 of the 44 states imposing a corporate tax still use the traditional three factor formula and evenly weight property, payroll, and sales. Today, 20 states plus the District of Columbia use single sales factor apportionment formulas. Fifteen states use double or triple weighted sales formulas. But the trend is toward single sales. And I predict that someday soon every state still taxing corporate income will use a single sales factor apportionment formula. New Mexico and North Carolina are phasing it in. Missouri uses the three factor formula but allows corporations to elect single sales factor. Single sales factor apportionment is currently being debated in Maryland. And there has been talk in every other state about adopting it.

The trend toward single sales factor apportionment is unstoppable. It reflects policy changes that will greatly affect the taxation of businesses throughout the nation. The motivation for this trend is simply to provide fewer disincentives to businesses to invest in a state. In three factor states, a corporation that adds plant and people will see its tax burden increase. That problem does not exist in single sales factor states. That is good from an economic development policy perspective. To be sure, companies selling into a single sales factor state won't necessarily like the outcome. But if all states eventually adopt single sales factor this problem is minimized. From a political standpoint, single sales factor formulas are winners. In-state companies with property and payroll will pay less. Out of state companies may pay more. But that is a tradeoff most legislators will take.

But let's be clear. One of the rationales for taxing corporate income is that corporations use public services. They enjoy the infrastructure, the protection of the courts, and the education system. In a sense, the levy on corporate income is a benefits tax. The shift to single sales factor belies that argument. Corporations investing in property and people use more public services; their tax burdens do not increase commensurate with the value of those services. Single sales factor further disconnects the tax from any rationale for imposing it.

A Bad Tax

I wrote critically of the proposal (SB 335) in West Virginia to adopt a broad based gross receipts tax and use the revenue to repeal the income and general sales taxes. As much as I disdain the corporate income and believe lower personal income taxes are good for the economy, this trade off is terrible. A gross receipts tax is far worse from a policy perspective than taxes on income. The tax is regressive, hidden, subject to cascading, etc.

It turns out however that the tax cannot raise enough money to repeal both the income and sales taxes. In fact, a fiscal note prepared by the West Virginia Department of Revenue found that the scheme would cost the state over $200 million in lost revenue each year. The West Virginia department folks who prepared the note have talent. So the proposal is not only bad policy but a money loser.

We'll Miss the Irony

The North Dakota legislature is considering-by the time you read this will likely have passed-an economic nexus law (SB 2298). Exactly the same as neighboring South Dakota's law requires out of state sellers to collect sales tax if they have more than $100,000 of sales or 200 or more transactions in the state. No physical presence is required. I wish North Dakota passed this before South Dakota. It would have been neat to see Quill end right where it started.

Worst Idea of the Year (this week's edition)

Inexplicably, the governor of Maine who would like to eliminate the Maine Board of Tax Appeals. I hope by the time you read this, the attempt will have died. Governor Paul LePage (R) proposed eliminating the Board to save money. The Board is an independent tribunal for hearing tax appeals. Independent tax courts are essential to both the real and perceived fairness of the revenue system. Without an independent court, the appeals process is run by the very people who are saying you owe more taxes.

For years the Council on State Taxation and practitioner groups have called for the establishment of independent tax courts. It is surreal that they are now fighting to retain such courts. The board apparently costs the state less than $500,000 a year. That is a tiny price to pay to have disputes with citizens decided by an impartial judge with tax expertise.

Guidance is Good

Revenue departments in only two states do not issue private letter rulings. There is a bill in Minnesota to rectify this problem. The bill (HF 918) would require the Commissioner of Revenue to establish a private letter ruling program in 2018. Letter rulings are a good way to provide guidance to taxpayers. The more guidance a revenue department provides – the better off everyone is. More guidance leads to fewer disputes and less litigation. I think more guidance leads to more revenue. When taxpayers are told the rules-they tend to follow them rather than taking more aggressive positions. The Minnesota Department of Revenue is opposed, as all revenue departments who faced the issue have been. The department is concerned about letter rulings setting precedent and needing additional resources. I personally think the Minnesota DOR does a very good job issuing guidance. But as I said, the more guidance the better.

Trivia question: What is the other state with no letter rulings? First person to email me will receive a signed copy of my state tax policy book. You can always re-gift it.

More Maine Struggles with Good Tax Policy

I know. Good tax policy is hard. But the folks in Maine make it Herculean. There is a bill before the legislature (LD 708) that epitomizes all that is wrong with how states approach tax policy. The measure will increase the tax on pot and cigarettes – by a lot. It would then take the extra revenue and reduce the state's income tax.

Don't get me wrong. I like lowering income taxes. But Maine voters decided to impose an income tax surcharge on themselves during the last election. They didn't actually impose a tax on themselves. Rather they imposed the extra income tax (3%) on those making more than $200,000. I think that is terrible policy. But imposing a tax on a narrow set of citizens is not the appropriate response. The cigarette tax will go from an already whopping $2 a pack to $2.50. The tax on retail sales of marijuana will go from 10 to 15 percent.

Excise taxes should never be used like this. They target a minority of people. They are incredibly regressive. They are as Adam Smith said "the work of the devil." Actually I do not know if he really said that but I read it on line. The income tax surcharge was bad tax policy. The fix is worse.

Published in Thomson Reuters Tax & Accounting Blog