State corporate tax revenue trends: causes and possible solutions.

INTRODUCTION

States' ability to collect taxes on business, and particularly on interstate business activity, appears to be diminishing. This should not be a surprising outcome since economists have for many years recognized the difficulties for sub-national governments to collect taxes

on mobile activities (see Inman and Rubinfeld, 1997, for example). Much recent attention has been paid to the revenue losses that have resulted from the inability to collect taxes on Internet sales, and in particular on business-to-business transactions (see Bruce and Fox, 2000). (1) Reduction in state taxation of specific industries such as telecommunications (through lower rates, reduced property tax assessments, and so forth) has taken place as well. Focus has shifted recently to the diminishing relative importance of corporate income taxes as a state revenue source. (2) Combined, these factors represent a significant lowering of the tax burden that is initially incident on business. This paper takes just one of these, the role of corporate income taxation, and seeks to investigate the extent to which the revenues have declined and some ways to reverse the pattern.

The paper is divided into three sections. The first is a detailed examination of the trends in state corporate income tax revenues over the past three decades. The second is a description of the underlying causes of the decline in corporate tax revenues that has been underway for more than a decade. The last is a review of alternative means of slowing or ending the decline in corporate tax revenues. The paper does not seek to comprehensively address the extent to which state corporate taxes should be levied, though this is a related and interesting part of the overall business tax story.

THE DECLINE IN STATE CORPORATE TAX REVENUES

This section is a consideration of the long-term trends in the role that corporate income taxes play in state finance. In general, corporate taxation grew in importance from the 1960s through the mid-1980s and has declined since. The net effect is that the relative contribution of corporate tax revenues is currently at about the same level that it was in the early 1970s. As discussed in this section, increases in corporate tax collections through the mid-1980s were primarily attributable to legislated rate increases and new states adding the tax. Relative changes in the tax base do not appear to have been an important source of the revenue changes, except for the effects of the Economic Recovery Tax Act of 1981 (ERTA) that significantly reduced the base and the Tax Reform Act of 1986 (TRA86) that significantly broadened the base. Shrinkage of the base appears to explain the general tendency over the last decade or so for revenues to erode back to the levels prevalent in the early 1970s.