Evaluation of Virginia s Corporate Income Tax System National Legislative Program Evaluation Society Taxation Panel September 19, 2011
Study Mandate House Joint Resolution 681 (2009) to study Virginia s corporate income tax system Compare Virginia s system to that of similar states Consider method used to attribute income of service and intangible assets providers to Virginia Examine growth and relocations of Virginia corporations during past 20 years 2
Impetus Behind Study Corporate income tax system as a whole tweaked but not reviewed in several decades System perceived as potentially creating disincentives for businesses to expand or locate in Virginia Service sector reporting inequities compared to other sectors and other states Some support for eliminating the corporate income tax 3
Key Features of VA CIT Only paid by certain C-corporations (71,000), but most other businesses (700,000+) pay individual income or other tax 6% rate > $800 million annually in past 5 years Accounts for < 6% of all Virginia taxes Highest amount paid by Multistate corporations (87%) Manufacturers (26%) 4
How Approached Evaluating the CIT Tax System Identified major components of the CIT system that affect revenue (tax rate, apportionment method, tax credits, etc.) Compared against other states CIT systems to identify unwanted disparities Evaluated based on impact on economic development to ensure competitiveness relative to other states Assessed relative to principles of effective tax systems to find practices that might undermine simplicity, equitability, and/or adequacy of revenue Presented options to address major shortcomings identified and trade-offs of changes 5
Key Findings VA CIT largely consistent with other states CIT generally has limited impact on economic development, but can differentiate comparable states Several targeted changes could be made to improve its alignment with tax principles and address stakeholder concerns, especially the use of market-based sourcing Major restructuring options exist but may not be warranted 6
Finding Virginia s corporate income tax system is largely consistent with that of other states, with a few exceptions Helpful Resource: 2010 Multistate Corporate Tax Guide 7
VA CIT Generally Consistent With Other States 42 other states and DC tax corporate income 6% rate lower than most states Taxes similar group of corporations Includes similar sources of income Calculates income earned in State similarly New methodologies emerging Provides tax credits for certain desirable actions Credits in competitor states often more generous 8
Finding Virginia s corporate income tax system appears to have limited impact on economic development efforts, but gains importance in later stages of location/expansion decisions Helpful Resource: National Establishment Time Series database 1989-2009 (Walls and Associates) 9
VA CIT Generally Similar to or More Favorable Than Other States Stable, relatively simple according to corporate staff Compares favorably to other states in several areas Low tax rate, foreign income deduction, single sales factor Ranks well in national surveys CIT represents only 5% of VA total business tax burden Labor, infrastructure, and construction costs deemed more important than taxes in location decisions 10
VA Gained More Jobs Than Lost From Relocations During Past 2 Decades Net Job Relocations to VA Net Job Relocations Out of VA District of Columbia 26,460 Illinois -3,529 New York 12,522 Texas -2,671 California 5,195 Florida -2,288 Maryland 4,657 North Carolina -1,136 Pennsylvania 4,170 Georgia -1,021 New Jersey 3,301 All Other States 13,980 All Other States -6,576 Total Jobs Gained 70,285 Total Jobs Lost -17,221 Total Jobs Gained by VA From Relocations 53,064 11
CIT Considered More Closely Once States Deemed Viable Business Locations Critical business requirements must be in place before locations are considered CIT cannot compensate for other deficiencies Unique or unfavorable CIT can disqualify states CIT system can help differentiate otherwise comparable states 12
Finding Some targeted changes could be made to Virginia s corporate income tax system in order to improve its alignment with other states and principles of effective taxation. In particular, Virginia providers of services and intangible assets may be taxed inequitably relative to producers of tangible goods and out-of-state corporations 13
Cost of Performance Used to Attribute Sales of Services/Intangibles to VA Attributes all sales to state where greatest share of corporate activity performed, not consumer location Share of Corporate Activity % Sales Sourced to VA Higher in VA 100% Higher in Other States 0% Trend emerging toward market-based sourcing Attributes sales similarly to tangible goods, based on location received 14
Example of Service Provider Being Taxed on More Than 100% of Income in Multiple States Illustration % Property in State % Payroll in State % Sales in State % Income Taxed by Actual Sourced State Virginia (COP) 55% 55% 70% 100% 78% Maryland (Market- Based Sourcing) 45% 45% 30% 30% 37% Total 100% 100% 100% 130% 115% 15
Example of Service Provider Facing Higher Tax Liability Than Tangible Good Producer Tangible Good Producer Proportion in VA Service Provider Property 55% 55% Payroll 55% 55% Sales (Actual) 70% 70% Sales (Sourced) 70% 100% Income Attributed to Virginia 63% 78% Income attributed to Virginia under market-based sourcing would be 63% 16
Option: Adopt Market-Based Sourcing & End Protections for Out-of-State Corporations Significant increased tax revenue from out-of-state corporations Lower taxes for service / intangible providers with high Virginia presence Consistent rules with tangible goods No disincentive to expand in Virginia 17
Finding A major restructuring of Virginia s corporate income tax system does not appear necessary to be in line with other states system and principles of effective tax policy, or to successfully compete for economic development against other states Eliminating Virginia s CIT could increase employment and gross state product, but economic gains likely to be modest relative to foregone tax revenue 18
Major CIT System Restructuring May Not Be Warranted VA highly consistent with other states Disproportionate response to narrowly focused concerns raised by tax professionals and corporate representatives Carries significant financial risk Could disrupt system stability 19
Best Case Dynamic Forecast - Eliminating CIT Could Create Growth, But at High Cost Virginia Indicator Cumulative Impact Years 1-5 % Change from Status Quo Employment 12,785 0.27% Economic output (GSP) $4.1 B 0.24% State Revenue CIT Revenue (Static) Other Revenue (Dynamic) ($3.3B) ($3.5B) $0.2B (1.9%) (100%) 0.12% State Expenditures $0.1B 0.08% Best case scenario: 100% of tax reduction used to reduce corporate cost of capital, 100% of tax reduction remains in Virginia, and 0% of tax reduction is funded through budget reductions or tax increases. Based on REMI model conducted by UVa Weldon Cooper Center GSP = gross state product 20
More Realistic Dynamic Forecast - Eliminating CIT Could Negatively Affect Economy Overall Virginia Indicator Cumulative Impact Years 1-5 % Change from Status Quo Employment (15,431) (0.32%) Economic output (GSP) ($4.0B) (0.24%) State Revenue CIT Revenue (Static) Other Revenue (Dynamic) ($3.8B) ($3.5B) ($0.3B) (2.2%) (100%) (0.16%) State Expenditures ($2.7B) (0.03%) More realistic scenario: 25% of tax reduction used to reduce corporate cost of capital/75% spent on durable goods, 25% of tax reduction remains in Virginia/75% is used in other states, and 75% of tax reduction is funded by budget reductions/25% by surplus funds. Based on REMI model conducted by UVa Weldon Cooper Center GSP = gross state product 21
VA Results Similar to Dynamic Modeling in Other States REMI dynamic modeling indicates that < 10% of foregone CIT revenue may be recouped over first 5 years 9% in VA 10% average in other states Range from 2% in New Mexico to 18% in California Dynamic modeling regarded as best analytical tool for evaluating effects of tax policy changes 22
Where to Find This Report Review of Virginia s Corporate Income Tax System Complete briefing package http://jlarc.state.va.us/meetings/november10/citbrf.pdf Report http://jlarc.state.va.us/reports/rpt408.pdf 23