Archive - Budget and Taxes

Statement of Michael Mazerov, Senior Policy Analyst

Center on Budget and Policy Priorities, Washington, DC

Before the

Ways and Means Committee, Maryland House of Delegates

on

House Bill 11, Single Sales Factor Apportionment for Manufacturing Corporations

Tuesday, February 6, 2001

Madam Chairman, members of the committee, I appreciate the opportunity to present testimony on House Bill 11 this morning. I am Michael Mazerov, a policy analyst with the State Fiscal Project of the Center on Budget and Policy Priorities in Washington. The Center is a non-profit, non-partisan institute that conducts research on a wide range of federal and state budget priority and tax policy issues, with a particular focus on those affecting people with low incomes. The State Fiscal Project at the Center works closely with a network of state groups involved in similar issues, including the Maryland Budget and Tax Policy Institute. I have been working on multistate corporate tax issues for over 10 years, first as Director of Policy Research at the Multistate Tax Commission, and currently as a policy analyst at the Center. I also happen to be a resident of Silver Spring with two children in Montgomery County public schools, and so I have a strong personal interest in issues that affect the fiscal and economic health of our state.

At his confirmation hearing three weeks ago, former Alcoa CEO, and now Treasury Secretary Paul O'Neill was asked what corporate tax incentives he believed would be most likely to stimulate increased business investment in the U.S. economy. He replied:

I never made an investment decision based on the tax code. . . . [I]f you are giving money away, I will take it. If you want to give me inducements for something I am going to do anyway, I will take it. But good business people do not do things because of inducements. . .

Secretary O'Neill's candid statement summarizes quite well the main point I hope to leave you with this morning: many Maryland corporations will gladly accept the tax windfall that House Bill 11 would confer upon them. However, enactment of a single sales factor apportionment formula for manufacturers is highly unlikely to affect to any significant extent how many jobs they decide to create in Maryland or how much investment they place in our state.

H.B. 11 proposes to change the so-called corporate income tax "apportionment formula" applicable to manufacturers doing business in Maryland from the standard property-payroll-sales formula to one based on in-state sales alone. The reason manufacturers are seeking this legislation is no mystery: for any corporation producing goods in Maryland but selling them primarily to customers outside the state, the switch to a sales-only formula tends to reduce the amount of the corporation's nationwide profit assigned to the state for corporate tax purposes. This is likely to provide a substantial, back-door corporate income tax cut to thousands of corporations. Moreover, assuming that the states in which the Maryland manufacturer is selling its wares do not also adopt a sales-only formula, the portion of the corporation's profit that is no longer taxed by Maryland becomes what state tax officials call "nowhere income" -- profit that is not taxed by any state. Maryland's granting of sales-only apportionment could be a particularly lucrative tax break to corporations with substantial sales in other states but not subject to corporate income tax in those states because of restrictions imposed by federal law. For example, a manufacturer with all of its property and payroll in Maryland but only four percent of its sales here already has 48 percent of its profit not subject to tax by any state if it is not taxable outside Maryland. (Maryland taxes the other 52 percent.) If Maryland switches to a single sales factor formula, that corporation will have just 4 percent of its nationwide profit subject to tax in Maryland, and the other 96 percent will not be taxed by any state.

Of course, H.B. 11 is not being promoted solely as a mechanism for providing corporate tax relief; if it were, it would probably not be getting serious consideration. Like most proposals to tinker with state taxation of businesses, adopting a single sales factor formula for manufacturers is asserted to be a potent incentive for economic development.

An overwhelming body of economic research concludes that interstate differences in state and local tax burdens on businesses do not significantly affect where they decide to locate or invest. State and local taxes are a very small share of business costs, and interstate differences in much more significant cost items for businesses - such as wages, energy, and transportation - simply overwhelm state and local taxes as a determinant of location. But even assuming for the sake of argument that state and local tax levels might affect the location decisions of some businesses, there are many reasons to believe that switching to a sales-only formula is likely to be almost as ineffective and - especially- as cost-ineffective an economic development tax incentive as one could imagine.

I noted a moment ago that a single sales factor formula provides a tax cut to any corporation that produces goods in Maryland but exports a relatively large share of them to other states. It is well known, however, that out-of-state corporations doing most of their production elsewhere but selling a relatively large share in Maryland will be hit with tax increases. These tax increases render the single sales factor formula a double-edged sword that could just as easily lead to net job losses in Maryland as to net job gains.

Adoption of a single sales factor formula could actually be counter-productive to job creation in Maryland for two reasons. First, corporations that suffer tax increases because they have relatively small amounts of property and payroll in Maryland but larger shares of their sales in the state could remove facilities and jobs to eliminate their taxability entirely. A little known federal law, Public Law 86-272, would permit such corporations to keep salespeople in Maryland to maintain their local market yet remain exempt from Maryland's corporate tax.

Second, for corporations with significant sales in Maryland but not subject to corporate income tax here, the adoption of a single sales factor formula could actually be an incentive for them to write Maryland off as a location for future job-creating investment. Consider a Pennsylvania manufacturer that is seeking a location for a new R & D lab that will employ a number of well-paid scientists and engineers. Assume this company has a substantial share of its sales in Maryland, but no facilities or employees in the state that provide Maryland with the authority to subject it to a corporate income tax. Assume the lab would represent a small share of the manufacturer's nationwide property and payroll. In this case, a single sales factor formula would cause the Maryland tax liability arising from the company's decision to locate the facility in Maryland to be higher than it would have been had the state retained the current three factor formula. In other words, Maryland's adoption of a sales-only formula would be a disincentive rather than an incentive for this company to chose Maryland as a location for the R & D facility. If someone wants to argue that a single sales factor formula could reduce the tax liability of certain corporations enough to lead them to increase their Maryland employment and investment, they have to acknowledge that the formula inherently creates countervailing incentives. There are absolutely no theoretical reasons to believe that any positive investment incentives would not be neutralized or even outweighed by the incentives created by the formula for some corporations to eliminate existing Maryland jobs or to avoid Maryland as a location for new investment.

If the inherently cross-cutting incentives created by the single sales factor formula raise doubts about its effectiveness as an economic development stimulant, even greater questions may be raised about its cost-effectiveness. With any tax incentive there is always the issue of the extent to which it merely provides a windfall to corporations for taking actions they would have without the incentive. But at least to get an investment tax credit a corporation must make an investment. The single sales factor formula provides an automatic, open-ended, no-strings-attached tax cut to corporations producing in a state but selling the output largely outside the state. They do not need to create a single new job or invest even one more dollar in the state adopting the formula to collect the tax cut. Indeed, as Massachusetts and Illinois have discovered, corporations can actually be laying off employees and still obtain tax savings from the sales-only formula. Massachusetts enacted the single sales factor formula in response to demands by Raytheon Corporation; Raytheon has since reduced its Massachusetts workforce by at least 3,000 people. Overall, Massachusetts has lost 15,200 manufacturing jobs since it began phasing in the single sales factor formula in 1995. Motorola was one of the principal supporters and beneficiaries of the sales-only formula in Illinois, yet two weeks ago it announced plans to eliminate 2,500 jobs by closing its only remaining U.S. cell phone plant, which is located in that state. Yet because Motorola is headquartered in Illinois, it will continue to reap tax savings from the sales-only formula in that state despite the plant closure. Illinois has lost 18,700 manufacturing jobs since it began phasing in the sales-only formula two years ago - reversing a six year trend. Recall again the words of Treasury Secretary O'Neill: corporate executives are only too happy to pocket tax savings from corporate tax incentives, but if they are doing their jobs these incentives will not affect investment or disinvestment decisions dictated by the fundamental economics of their businesses.

I would like to make one final point that bears on the question of the cost-effectiveness of the single sales factor formula as an economic incentive. The fiscal note on this legislation to my knowledge has not yet been issued, however, press reports have indicated that the bill is likely to be scored as essentially revenue-neutral. That is theoretically possible, although I would point out that every other state that has recently studied the fiscal impact of adopting a sales-only formula has concluded that it is a net revenue loser. Even if H.B. 11 is judged to be revenue-neutral using a short-term, static analysis, however, that is unlikely to be the case over the long term. The inherent weakness of Maryland's so-called "separate entity" method of taxing multistate corporations that are structured as a parent and subsidiaries makes it very easy for the corporations that are hit with tax increases by the sales-only formula to restructure their operations to nullify those tax increases. Members of this committee may be aware of recent litigation in which the Comptroller's office tried and failed to stop the use of so-called Delaware Holding Companies to siphon taxable profits out of Maryland. Suffice it to say that any corporation that is hit with a tax increase by the switch to a single sales factor formula has that much more incentive to attempt to counteract the tax increase by setting up a Delaware Holding Company or engaging in other kinds of strategies for reducing the amount of its profit taxable in Maryland. As I've already mentioned, some corporations might even choose to remove facilities and jobs from the state to eliminate their taxability. To the extent that these activities occur, the long-run cost of adopting a sales-only formula could be much greater than zero.

In sum, there are good reasons to expect that Maryland's adoption of a single sales factor formula for manufacturers will be more costly than the state is forecasting yet have little effect on the state's desirability as a manufacturing location. The states that have adopted the sales-only formula so far appear to have little to show for it in the way of job creation or new investment. Public officials can maintain the existing formula secure in the knowledge that doing so will not harm Maryland's economic competitiveness. Rather than damaging our state's fiscal health with a potentially costly tax cut, the state can retain the revenue to preserve and enhance our state's excellent education and transportation systems. This will contribute more to a healthy state economy than tax cuts for a limited group of corporations ever could.

For more information on Maryland's business tax environment, see our report Maryland is a Low-Tax State for Manufacturers

Download the bill language and fiscal note for HB 11 and the identical SB 701