Archive - Budget and Taxes

"Single Sales Factor:" Economic Development or Another Corporate Giveaway?

How would you like to pay income tax on just half of your income? Or even less? How about a 90 percent or greater cut in your income taxes? That's the situation that some Maryland manufacturers would like for their businesses. Proposals offered in the Maryland General Assembly's 2001 Legislative Session would change the formula that determines how much of a manufacturer's profits are taxed in Maryland.

The vast majority of states-all but 7 of the 46 states that tax corporations-determine how much of a corporation's income is taxable based on a formula that considers how much of a corporation's property, payroll and sales occur within that state. This relative uniformity in state corporate income tax formulae has been in place for more than 40 years. Absent a shared formula, one can imagine a case where each state would want to tax 100 percent of a corporation's profits, even if only a share of those profits were generated within that particular state.

However, manufacturing firms in selected states-including Maryland-are seeking changes in corporate tax policies. Instead of basing the calculation of corporate income taxes on three factors-the percentage each of property, payroll, and sales within a state-corporate income taxes would be apportioned based on only one factor-the percentage of a corporation's sales that occur within a state. Such a change would result in a large tax cut for any manufacturing firm that sells most of its goods out of state (conversely, it would increase taxes for manufacturers who produce goods in other states but sell some or all of their goods in Maryland).

By targeting tax formula changes in some but not all states, manufacturers create something called "nowhere income"-income that is not taxed anywhere.

This is how it works (caution: the following paragraph contains seventh-grade algebra). Presently, most states apportion corporate income in the following way:

percentage of property in a state + percentage of payroll + two times the percentage of sales, all added together and divided by four.

If a company has 100 percent of its property and payroll in Maryland, but two percent of sales in Maryland, then 51 percent (100 plus 100 plus four = 204, divided by 4 equals 51) of corporate income is attributed to Maryland and taxed here. If Maryland changes the formula such that corporate income attributed to Maryland is based only on the percentage of sales in the state, then only two percent of corporate income is taxed on Maryland. The corporation will have secured a 96 percent reduction in its Maryland corporate income taxes.

If at the same time other states continue to use the formula that includes property and payroll, then the amount of corporate income attributed to other states is equal to 49 percent (0 percent of property plus zero percent of payroll plus two times the 98 percent of sales equals 196, divided by four equals 49). All together, instead paying tax based on 100 percent of income (51 percent in Maryland plus 49 percent in other states), the company now only pays on 51 percent of income-two percent in Maryland, plus 49 percent in other states.

Proponents of the tax change argue that it would stimulate economic development within a state. Opponents argue that other approaches would be more effective if economic development is the goal, because companies do not need to add one new job to get the tax break. In fact, the major corporations who succeeded in getting the tax change adopted in Massachusetts and Illinois subsequently laid off thousands of workers. Corporate tax watchdog Greg LeRoy of the Washington DC-based Good Jobs First says that the tax change "is perhaps the most costly-but poorly understood-way in which corporate tax cuts in the name of economic development are eroding state revenues and shifting the tax burden onto families and small businesses."

As noted our Maryland Policy Report, Maryland is already a very low-tax state for manufacturing firms. Our location on the east coast with easy access to rail, interstate, and sea transportation to major population centers is also an asset to manufacturing firms. While it is possible that a single sales factor formula for corporate income taxes could slightly increase overall state tax revenues, changing the formula in Maryland could upset the balance in interstate cooperation in establishing tax formulas on multi-state corporations that have been in place since the 1950s. -MBTPI