May 9, 2008
Revenue Estimate for Combined Reporting in Tenn.
Based on our internal analysis, the Food & Business Tax Fairness Act (SB3158/HB3182) will result in a net increase of revenue to the state of between $24 million and $160 million. The cost of the food tax reduction is estimated to be $90 million, while the revenue recovered from closing corporate tax loopholes is likely between $114 million and $250 million.
The Food & Business Tax Fairness Act (SB3158/HB3182) by Sen. Burchett & Rep. Fitzhugh will change the way businesses report their taxes by adopting combined reporting rules based on the model statute from the Multistate Tax Commission.
A wide array of tax loopholes, particularly those tax avoidance strategies that hinge on the ability of corporations to shift their profits back-and-forth among various subsidiaries, are closed in the process of changing to combined reporting. That's because combined reporting views the parent company and all its related subsidiaries as a single tax filer.
Unfortunately, TFT has been unable to get defensible data from the Department of Revenue (DOR) in regards to how much revenue this reform will generate. Absent any meaningful DOR data, the following analysis should give us a reasonable sense of what Tennessee could expect to recover from enacting this simple reform.
Currently, 21 states, representing over half the US economy, already use combined reporting for their business income taxes. In Tennessee, the business income tax is referred to as an excise tax. Despite it’s name, it is a tax on corporate income levied at 6.5% of net earnings.
In the last five years, several states have considered, or are actively considering, changing from separate reporting to combined reporting. As a result, we have the revenue estimates of those states to serve as a guide.
The first challenge is to remove the states whose estimates do not sufficiently compare with Tennessee's due to unique and differing circumstances.
The two states whose corporate tax situations differ significantly from Tennessee's are Connecticut and New York. Both of these states had already taken aggressive and successful action, prior to considering combined reporting, to close certain corporate tax loopholes. As a result, their estimates were notably lower than the norm.
The remaining nine states, and their estimates, provide the best apples-to-apples comparison to the situation in Tennessee. Many of the large corporations that we know are using the loopholes are operating in both Tennessee and these remaining states. More importantly, Tennessee, like the remaining nine states at the time of their estimates, is still vulnerable to the most common tax avoidance strategies addressed through combined reporting, such as Passive Investment Corporations, Captive REITs, and transfer pricing.
The estimated increase in corporate tax collections of these remaining nine states range from 11% (Wisconsin) to 24% (Pennsylvania). The average (non-weighted) of these nine estimates is 16.7%. However, there is much evidence that the Pennsylvania study, which is at the top of the range with 24%, is the most accurate and credible since it is based on a thorough examination of existing corporate tax returns. In fact, the Pennsylvania revenue estimate won a national award from the Multistate Tax Commission for its thoroughness.
According to the 2008-2009 Tennessee State Budget, page 173, excise collections are expected to be $1.15 billion in fiscal year 2008-2009 (While this number has been revised downward to slightly more than $1 billion since the publication of this budget, precise estimates are not currently available).
However, there is one known adjustment to this number that would likely need to be accounted for. Currently, financial institutions already report under combined reporting rules in Tennessee. According to the Tenn. Department of Revenue, financial institutions account for approximately 10% of business excise tax collections.
There is some evidence that the combined reporting statute from the Multistate Tax Commission used in the Food & Business Tax Fairness Act is stronger than the existing combined reporting statute used for financial institutions in Tennessee. Nonetheless, to be conservative in the estimate, we assume that only the remaining 90% of excise tax collections, or $1.04 billion, would realize the gain from changing to combined reporting.
Applying the 11% to 24% range to the $1.04 billion in excise tax collections from non-financial institutions yields a revenue gain of between $114 million and $250 million. While the average of this range (16.7%) yields a revenue gain of $174 million, as noted before, there is significant evidence that the Pennsylvania estimate is the most accurate. Using that as a basis would put the projected revenue gain at $250 million.
The Food & Business Tax Fairness Act will also reduce the state food tax from 5.5% to 4.5%. The cost of this reduction is $90 million. As a result, the net effect of the revenue recovered from adoption of combined reporting and the revenue loss from reducing the food tax is a revenue gain of between $24 million and $160 million.
Flawed Fiscal Note
The Fiscal Review Committee, the body of the General Assembly that generates the official revenue estimates for various proposals under consideration by state Legislators, has relied entirely upon the Department of Revenue in estimating the potential revenue gain from adoption of combined reporting in Tennessee. With faulty data from the Department of Revenue, Fiscal Review has issued a weak and indefensible fiscal note or revenue estimate for the Food and Business Tax Fairness Act.
The fiscal note begins by acknowledging that the revenue gain from adoption of combined reporting is likely between 10% and 20%. This is clearly a rounded estimate that downplays the potential revenue gain for the state. Nonetheless, this 10% to 20% range would yield a gain of $115 million to $230 million based on estimated excise tax collections. It’s worth note that this range mirrors our own internal estimates.
Far more troubling and inexcusable is the second part of the fiscal note. It states that due to "multiple unknown factors," the potential revenue gain may be significantly less. With no more justification than that, they conclude that the revenue gain from adoption of combined reporting is "reasonably estimated to exceed $20,000,000 per year." That is, due to "multiple unknown factors," they discounted 80% to 90% of the potential revenue gain.
TFT concedes that there may in fact be some reason unknown to us that combined reporting raises less in Tennessee than in the other states we have looked at, but to date, we have not heard any such reason from the Department of Revenue or Fiscal Review. "Multiple unknown factors" is simply not a reasonable explanation.
TFT is working with Legislators to ensure that the Department of Revenue and the Fiscal Review Committee provide an accurate and justifiable estimate of the potential revenue gain from this comprehensive and common sense plan.