Leveling the playing field

The more small-business owners understand how big businesses compete unfairly and do not contribute their fair share of state taxes, the more pressure can build for real reform.

Small business owners get it: They follow the rules, but preferential treatment for giant companies puts them at a disadvantage.

Case in point: Lora Fraracci, who had an excellent guest opinion in today’s Cedar Rapids Gazette about practices big companies use to avoid paying U.S. taxes. The problem is not exclusively an issue with the lax U.S. tax code. It is a big problem at the state level as well.

Ms. Fraracci runs a residential and commercial cleaning business. As she noted:

“As a small-business owner in Des Moines, I play by the rules and pay my taxes to support our American economy. I create jobs that will continue to support our local economy. When the playing field is so uneven it makes it hard to realize this dream.”

The issue has been receiving some national attention, but many may not realize the prevalence of this problem and its extension to state taxes. While Ms. Fraracci and other small businesses, or Iowa focused businesses, follow the rules, large companies they may serve can find a way to either (1) avoid the rules, or (2) block stronger rules.

The Iowa Fiscal Partnership has written about these issues for some time, and the reports are on our website.

The biggest Iowa breaks come in two ways: tax loopholes and tax credits.

Tax loopholes have been estimated to cost the state between $60 million and $100 million a year. Loosely written law is an invitation to big companies’ lawyers and accountants to find ways to lower their firms’ taxes. Multistate firms can shift profits to tax-haven states and avoid taxes they otherwise would be paying in Iowa. That creates the uneven playing field Ms. Fraracci sees.

Iowa could fix this by adopting something called “combined reporting,” which the business lobby has fought tooth and nail when proposed in the past by Governors Tom Vilsack and Chet Culver. Many states — including almost all our neighbors (Illinois, Wisconsin, Minnesota, Kansas and Nebraska) — already do this. See our 2007 report, which remains relevant because Iowa has refused to act.

Tax credits are particularly costly, rarely reviewed with any sense that they will be reformed. This is illustrated best with the Research Activities Credit, which provides a refundable credit to big companies to do something they are likely to anyway: research to keep their businesses relevant and competitive.

In 2013, that credit cost $53 million, with $36 million of that going to companies that paid no state income tax in Iowa. The default position must be that this is wasted money, because it is never reviewed in the regular budget process the way other spending is examined every year — on schools, law enforcement, worker protection and environmental quality. In Iowa, spending on tax credits is spending on autopilot.

Read here about Iowa’s accountability gap on tax-credit spending.

Looking ahead, as a new legislative session approaches and we hear repeatedly that things are tight, keep these points in mind to better understand the real fiscal picture facing Iowa. The more small-business owners understand this, the more likely pressure can build for real reform.

Owen-2013-57  Posted by Mike Owen, Executive Director, Iowa Policy Project

Hyperbole Alert: The drumbeat to cut corporate taxes in Iowa

Want to talk reform? Then recognize the real problems — we receive less in corporate tax than we used to, and don’t collect a lot because of the swiss-cheese nature of our tax code.

Mike Owen
Mike Owen

TWELVE PERCENT!

The figure practically screams at you, even when it’s not in all caps, when the conversation comes to corporate tax rates in Iowa.

Here’s the thing: It’s not a real number. Not really.

That is what is known as Iowa’s “top marginal rate” on corporate income tax. And it’s not a real number because it simply does not — cannot — reflect what a business pays on all its profits. Yet that is the implication when people (especially politicians) or corporations complain about it.

A top Iowa columnist, Todd Dorman of the Cedar Rapids Gazette, this week discussed the political battles over Iowa’s latest gigantic subsidies to Egyptian fertilizer company Orascom. In his piece he expressed a note of concern about the hyperbole in those battles. Then, he turned the discussion to Governor Branstad’s desire for cuts in corporate income taxes.

It is in that discussion where the hyperbole typically has been the strongest in Iowa. We are often told — as Dorman noted — that Iowa’s top corporate income tax rate is the nation’s highest. Note the emphasis added on “top.” More on that in a moment. Dorman also noted, accurately, that Iowa “has four brackets and a tangle of special interest credits.”

Because of the latter, any serious concern for our corporate friends should evaporate. Because they’re really being taken care of quite nicely, thank you, by their friends in the General Assembly and the Governor’s Office.

Now, about that “top rate.” It applies only to Iowa-taxable corporate profits above $250,000. Iowa doesn’t tax any profits from sales outside the state, so the rate doesn’t apply at all there, which for many businesses is a significant share of profits. For all taxable profits below $250,000, rates are lower — 6 percent on the first $25,000, 8 percent on the next $75,000 and 10 percent on the next $150,000.

Before these rates kick in, the business gets to deduct half its federal income tax from taxable income, and may have other deductions or ways to shelter income from state tax.

Then, after the rates are computed and the taxes determined, the tax credits enter the picture — and state revenues exit. The state just expanded the potential for those credits by $50 million, raising the cap on a select group of credits. In the case of the Research Activities Credit, these credits not only erase all tax liability, but offer state checks for the remaining amount of the credit. Through that program in 2012, Iowa paid out almost $33 million to 130 firms that paid no income tax, because those companies had more credits than tax liability.

And you can bet the corporate execs and their accountants fully understand all these nooks and crannies in our tax code. But if you want to give them a free million or so, they’ll take it. They are smart folks, and they have proven themselves to be more skilled negotiators than Iowa’s economic development moguls.

Want to talk reform? Then recognize the real problems — that we receive less in corporate tax than we used to, and that a lot of corporate tax is not collected because of the swiss-cheese nature of our tax code. That gives us all something to talk about.

Just be ready for the hyperbole from those who don’t want to change that part of our system.

Posted by Mike Owen, Executive Director


For more information about Iowa business taxes, see these Iowa Fiscal Partnership reports:
— “Reducing Iowa Commercial Property Taxes,” by Heather Milway and Peter Fisher, April 24, 2013.
— “Amid Plans to Relax Limits, Business Tax Credits Grow,” by Heather Gibney, April 16, 2013.
— “Corporate Taxes and State Economic Growth,” by Peter Fisher, revised April 2013.
— “A $40 Million Budget Hole: Persistent and Growing,” IFP backgrounder, February 25, 2013.
— “Tax Credit Reform Glass Half-Full? Maybe Some Moisture,” IFP backgrounder, revised March 23, 2010.
— “Single Factor to Consider,” IFP backgrounder, April 2, 2008.

Will outrage translate into policy?

The long and short of it: Iowa does not have to sit by while big companies drain the state’s coffers and push the bill to other taxpayers, both smaller business competitors and working families. And neither does the United States.

Mike Owen
Mike Owen

Oh, the outrage.

Apple Inc., is (gasp!) working the federal tax code to its advantage, exploiting loopholes in the code to legally avoid paying taxes. OK, but we’ve heard it all before.

Many are expressing outrage — not an unreasonable reaction. Senator Carl Levin of Michigan is leading hearings in Washington about the issue, noting, “Our purpose with these hearings is to shine a light on practices that have allowed U.S.-based multinational corporations to amass an estimated $1.9 trillion in profits in offshore tax havens, shielded from U.S. taxes.” He went on:

A recent study found that 30 of the largest U.S. multinationals, with more than $160 billion in profits, paid nothing in federal income taxes over a recent three year period. Zero. These corporations use multiple offshore loopholes that give them significant control over how much U.S. income they will report and how much tax, if any, they will pay.

Senator Levin is indeed shining a light on a serious issue, but you can already see the excuses coming.

As a New York Times story notes:

While Apple’s strategy is unusual in its scope and effectiveness, it underscores how riddled with loopholes the American corporate tax code has become, critics say. At the same time, it shows how difficult it will be for Washington to overhaul the tax system.

In Iowa alone, as we showed many years ago, this also happens with some big, multistate companies, which use gimmicks to get out of paying state corporate income tax. Instead of shifting profits to phantom companies in Ireland to avoid U.S. tax, these companies shift Iowa profits to shell companies in Delaware, where they go untaxed by either Delaware or Iowa. And it could be fixed, but Iowa lawmakers simply have chosen not to. Not acting, after all, is the easiest course.

Tell lawmakers privately about what’s happening and if it’s new to them, they express outrage. Wait a few weeks, and for many the outrage is gone. Frequently, the view changes to either (1) it’s something we need to accept so companies won’t move away, or (2) the issue is just too big to address.

Of course both arguments are what big business lobbyists want everyone to believe. And both are wrong.

The business lobby has obscured the fact that there would be no reason under Iowa tax law for these companies to move away if the state were to pass legislation to plug loopholes — and lawmakers certainly can do so, with a device called “combined reporting.” Read about it here.

The long and short of it: Iowa does not have to sit by while big companies drain the state’s coffers and push the bill to other taxpayers, both smaller business competitors and working families. And neither does the United States.

Posted by Mike Owen, Assistant Director

Small businesses understand competitive realities, role of government

There are lessons in the nationwide survey: Folks in small business understand that not all business tax breaks treat businesses equitably, or help the economy.

Mike Owen
Mike Owen

Political talk pandering to small businesses is commonplace, and often involves inaccurate assumptions about positions on taxes and the role of government. Thus, they are not only frequent, but frequently wrong.

A survey released today by the Small Business Majority (SBM) www.smallbusinessmajority.org — a nonpartisan small-business advocacy group — found wide acknowledgement of the need for more equitable, sustainable fiscal choices in Washington. As noted by SBM:

Contrary to popular belief, nationwide scientific opinion polling conducted earlier this month found that the majority of small business owners—more of whom identify as Republican than Democrat (47%-35%)—believe that raising taxes on the wealthiest 2% is the right thing to do in light of our budget crisis. What’s more, 40% strongly believe this.

The polling also found the majority of entrepreneurs see a productive role for government in helping small businesses achieve success. Nearly 6 in 10 agree government can play an effective role in helping small businesses thrive.

These are interesting results but they should not be terribly surprising.

Folks in small business know:

  • Budgets have two sides — spending and revenue.
  • Small businesses benefit when employees and consumers are educated, safe, healthy and financially secure.
  • Small businesses can compete when the playing field is level for all businesses; it’s hard to compete with bigger competitors who are getting special breaks from the referee — government.

And there are lessons in this for state policy makers as well.

Tax breaks geared to multistate corporate giants that can shift profits to other nations or states do not benefit small businesses, or all businesses equitably, and do not always help the economy. It is clear that people running small businesses understand this.

Iowa can make the playing field better, and restore squandered revenue, by plugging tax loopholes that are costing the state $60 million to $100 million a year. Several states already do this, including four of the six states that border Iowa: Illinois (home of Deere & Co.), Wisconsin, Minnesota and Nebraska. But Iowa lawmakers have refused to defy the big corporate lobbyists that have stood in the way of this important reform, known as “combined reporting.”

You can learn more about that and other inequitable, unaccountable tax breaks in Iowa at the Iowa Fiscal Partnership website, www.iowafiscal.org.

Posted by Mike Owen, Assistant Director

The Tax Foundation’s indefensible mish-mash

What the “State Business Tax Climate Index” offers is, at its core, an indefensible mish-mash of “Stuff the Tax Foundation Doesn’t Like,” which should be the title.

Peter Fisher
Peter Fisher

The Tax Foundation’s 2012 State Business Tax Climate Index is out, and not much has changed — including the political talk about it.

What this annual release offers is, at its core, an indefensible mish-mash of “Stuff the Tax Foundation Doesn’t Like,” which should be the title. Instead, the group slaps the term “State Business Tax Climate Index” on it, adds its slick logo and pretends the whole thing has meaning. For an ideological message, it may, but for decisions on business locations and expansions, not so much.

Problems with the methodology of this “index” are outlined in my 2005 book, Grading Places, published by the Economic Policy Institute. Much of the latest Tax Foundation (TF) report reads verbatim from earlier versions.

The Tax Foundation rests on contradictory messages. First, it claims that taxes paid make a difference in business decisions or growth, selectively citing literature to back the claim, despite a preponderance of evidence that taxes matter little. Then, it produces an “index” that has little relation to what businesses actually pay. In some cases, lower taxes actually produce a worse score on the index.

Rather than measuring what businesses actually pay, TF instead focuses on selected characteristics of the tax code while ignoring significant features. Results differ wildly from a ranking based on what businesses pay in many cases. This is because of the TF emphasizes rates of tax, without considering the base to which those rates apply. This feature penalizes Iowa, which in fact is a low-tax state for business; according to Ernst & Young, only 18 states have lower overall state and local taxes on business.

In other words, if a state — like Iowa with its single-factor apportionment formula — holds down the base on which tax rates apply, the Tax Foundation ignores the impact on actual taxes paid because it doesn’t like the rate structure.

Ironically, the report penalizes states that offer tax credits, which TF views as harmful to the business climate, a defensible position because it creates an uneven playing field for competing businesses, and jeopardizes critical public services that benefit businesses and their employees. But tax credits have strong lobbies in the Legislature. When the anti-tax politicians crow about Iowa’s low ranking in this report, something tells me that is one part of it they will not mention.

Like the Tax Foundation, they will stick with anything that backs the message they want to share, rather than examine the real issue of effects on business.

Posted by Peter S. Fisher, Research Director

Is what Wal-Mart wants for Amazon also good for Wal-Mart?

“Leveling the playing field” — does Wal-Mart always want it?

Mike Owen
Mike Owen

An interesting column by Liz Peek on TheFiscalTimes.com notes Wal-Mart and other retail giants are banding together behind legislation to require Amazon.com to collect and pay state sales taxes rightfully owed on purchases made online.

OK, but why does Wal-Mart take advantage of its own wide reach to shield profits from state taxation?

As the Peek column notes:

Overall, retail sales over the Internet grew nearly 15% last year in the U.S., and totaled $165.4 billion.

Industry analysts are expecting that figure to swell to more than $188 billion this year. That presents quite a dual challenge to states unable to collect sales taxes on those purchases, and to traditional stores that are losing market share. Consequently, large retailers, and thousands of others across the country, have banded together to demand the playing field be leveled. (emphasis added)

So, Wal-Mart is demanding “the playing field be leveled.” Admirable, perhaps, but ironic, to be sure.

In an April 2007 report for the Iowa Fiscal Partnership, “Leveling the Playing Field,” Peter Fisher illustrates how Wal-Mart has gone to great trouble in tilting the field in its favor on corporate income tax. Wal-Mart created a multilayered, multistate structure to shift at least some profits where they are taxable to states where they are not. In a nutshell, Wal-Mart found a way to charge itself rent to reduce taxable profits.

All done by the book as the book has been written. But it creates an advantage for one retail giant that its small competitors who sell shoes, tires, clothes, office supplies, groceries, etc., cannot take. And Wal-Mart’s strategy is not the only one being used by large, multistate corporations to dodge tax responsibility. Many corporations do so by exploiting loopholes, the seams in tax law that companies use to defeat legislators’ intent.

Iowa could fix this — and level the playing field — with a simple solution already adopted by five neighboring states: Nebraska, Kansas, Illinois, Minnesota and Wisconsin. That solution is corporate combined reporting, supported by Iowa’s last two governors, but not once debated on the floor of the Iowa House or Senate.

When the solution not only could raise money for the state and make the playing field more fair for small businesses, this debate is long overdue.

Posted by Mike Owen, Assistant Director

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