Tuesday, March 31, 2009

Got Corporate?

The words “corporate tax” can evoke strong responses from people, particularly in a post-AIG world. While business owners may see the tax as an undue burden to evade, taxpayers often view corporate tax as a significant source of state revenue with minimal costs to individuals. Policymakers must balance these two constituent groups when proposing the addition of, or changes to, corporate taxes.

During Minnesota Governor Tim Pawlenty’s recent State of the State address, he declared that “…if Minnesota were a country, we'd have the third highest business tax rates in the world.” His proposal to address this problem? Increasing Minnesota’s competitiveness by cutting the state’s corporate franchise tax in half over the next six years.

So what is corporate tax? And more importantly – what would a drastic corporate tax break mean for the rest of us?

In technical-speak, corporate tax is a net income type tax that applies to all “C” corporations, which are defined by US statue and are the most common form of incorporation. However, tax does not apply to “S” corporations or limited liability corporations, which may account for the rise of LLCs in recent years. The tax is applied to applicable corporations’ net income through a 3-factor apportionment formula, which weighs total income against the in-state property, payroll, and sales of a corporation at a predetermined ratio. All states use an apportionment formula and most use the 3-factor formula (including Minnesota).

States in the Upper Midwest depend on corporate taxes for a similar percentage of their total tax revenue, even though the total moneys collected may vary greatly between states. For instance, both Minnesota and South Dakota collect around 6% of their total revenues from corporations, but in Minnesota the total money collected equals $1 billion whereas in South Dakota it equals approximately $76 million.
Thus even though corporate taxes may generate significant total amounts of revenue, they generally provide a small percentage of Minnesota’s overall budget. This difference creates possibilities for both sides of the debate, as pro-tax advocates cite the total amounts of revenue to be gained, while anti-tax advocates cite the small percentage of revenue provided overall

Legitimately, any corporate tax cut would require an increase in other, potentially regressive revenue sources, such as sales taxes or user fees. While these adjustments would maintain tax neutrality, they also raise questions of tax equity between high and low incomes.

Gov. Pawlenty argues that his change will spur business development and lead to job growth, yet current public sentiment leans more towards corporate restraint than independence. With a significant deficit this year, a corporate tax break will likely translate to more spending cuts or increases in the sales, user fees, and/or personal income taxes. To tax (break) or not – that is the question for Minnesota. What would you do?

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