State Budgets: Murder by Loophole

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As President Obama and the Republican leadership continue trying to hash out a deal on raising the debt ceiling in exchange for slashing spending and closing corporate tax loopholes, the House judiciary committee is wasting no time quietly creating new tax giveaways, which could potentially leave localities scrambling for ways to pay for education and health services.

Sponsored by Rep. Bob Goodlatte (R-Va.), the Business Activity Tax Simplification Act, or BATSA, would prevent states from taxing a sizable chunk of the profits of corporations that do business within their borders, but are based out-of-state. BATSA, which the committee marked up on Thursday, would also allow corporations to “wall off” some of their profits in subsidiaries that are located in states that don’t exact an income tax.

Some context: local laws in the 44 states with a corporate income tax determine the types of activities that require a business to pay taxes. But federal law can trump state laws on tax matters, meaning that the federal government effectively enjoys veto power over state and local revenue-generating measures.

In essence, BATSA allows federal lawmakers to create corporate tax shelters that gut state and local finances. And since there’s no federal revenue lost in the process, it’s no skin off their backs.

In healthy economic times, such a law would be decidedly imprudent, as it could potentially force states and localities to choose between paying for health care services and keeping schools open. But during perilous economic times like these, it would be downright catastrophic, especially given the massive budget cuts many states are facing in 2012

In a report written when the bill was first introduced in April, CBPP found that BATSA granted corporations overly broad exemptions on their tax bills, and created a number of “safe harbors” from taxation. In real terms, who would be affected, and how?

  • A television network would not be taxable in a state even if it had affiliate stations and local cable systems there relaying its programming and regularly sent employees into the state to cover sporting events and to solicit advertising purchases from in-state corporations.
  • A bank would not be taxable within a state even if it hired independent contractors there to process mortgage loan applications and the loans were secured for homes located within the state.
  • A restaurant franchisor like Pizza Hut or Dunkin’ Donuts would not be taxable in a state no matter how many franchisees it had in the state and no matter how often its employees entered the state to solicit sales of supplies to the franchisees or to train the franchisees in company procedures.

Much to the delight of anti-tax, pro-loophole crusaders like Grover Norquist’s Americans for Tax Reform (ATR), the bill is lurching forward. After the bill’s markup on Thursday, ATR rejoiced, praising the bill for rescuing businesses from taking on their fair share of the tax burden.

Meanwhile, the nonpartisan Congressional Budget Office estimates that an older, less restrictive version of BATSA would have cost states and local governments $3 billion in revenue annually within five years of its enactment. Which means that if this bill—which enjoys broad bipartisan support in the House—continues moving forward, states will be left to foot the bill at a time when they can least afford it. 

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