Time to fix Utah’s punitive corporate income tax

Following the recent signing of SB223 – the $220 million omnibus tax cut package – there was broad media coverage of the individual income tax cut which makes up $109 million of the cut and $80 million in sales tax cuts. These were viewed as tax cuts “for the people.” But perhaps the most important parts of the bill for “people” and families were labeled as tax cuts for businesses: The $5 million mining equipment sales tax exemption, the $14.5 million research and development tax credit, and the $3 million renewable energy tax credit.

These business tax cuts – although meager in amount compared to the tax cuts on “people” – are designed to make Utah more attractive for capital investment and therefore more attractive for higher paying jobs to support Utah families. Governor Huntsman understands this and pointed out in his remarks at the signing of SB223 that capital is a coward, and consequently, it is incumbent on policymakers in Utah to make Utah safe for capital investment.

I was invited to make brief remarks at the signing so I continued on the Governor’s theme and suggested that Utah’s next big tax cut should be fulfillment of the Governor’s campaign pledge to fix Utah’s corporate income tax.

In recent years, states have been slowly reducing corporate income taxes to remain competitive in a global economy. States have been doing this not by reducing corporate income tax rates but rather by increasing the sales factor weighting in corporate income tax apportionment formulas. Governor Huntsman’s campaign literature called for the complete repeal of the corporate income tax, but on further examination, this could create more problems than it solves.

Why shouldn’t Utah repeal the state corporate income tax entirely?
Complete repeal of the Utah corporate income tax presents two problems. First, the fiscal impact would be huge. In FY2006, Utah’s corporate income tax generated $380 million (the amount generated each year varies dramatically depending on the state of the economy). Increasing the sales factor weighting would impact revenues by about $30 to $50 million per year.

Second, complete repeal of the state corporate income tax would allow local governments to begin collecting property taxes on intangible property such as patents, trademarks, and goodwill. The Utah state constitution prevents the taxation of intangible property as long as corporate income tax is imposed (” If any intangible property is taxed under the property tax, the income from that property may not also be taxed.” — Utah Constitution, Article XIII, section 2, part (6))

For example, let’s assume a company has a market value based on its stock price of $1 billion and tangible real and personal property of $100 million. Currently, local governments can impose property taxes on $100 million. If the state corporate income tax were repealed without changing the state constitution, then local governments would impose property taxes on $1 billion.

What is apportionment of corporate income?
Apportionment of corporate income is an important issue for multi-state companies. Many decades ago, states agreed to use an evenly weighted three-factor apportionment formula based on a corporation’s sales, property, and wages. Each factor was given a 33.3% weighting. This was intended to prevent overtaxation of a corporation’s profits. For example, without apportionment, a company doing business in twenty states would have to pay 100% state corporate income tax if each state imposed a 5% corporate income tax rate.

Using the evenly weighted three factor formula, the corporation’s income would be apportioned to each state where it did business. The following hypothetical example illustrates how this works

Percent of sales in
Other states: 99%
Utah : 1%

Percent of wages in
Other states: 1%
Utah 99%

Percent of property in
Other states: 1%
Utah : 99%

Apportionment in
Other states = (99% + 1% + 1%) / 3 = 33.7%
Utah = (1% + 99% + 99%) / 3 = 66.3%

Why increase sales factor weighting?
States have been increasing the sales factor weighting from the usual 33.3% in order to incentivize and encourage investment by high wage, export-oriented companies that have the option of locating in any state (or country for that matter). A semiconductor manufacturer, for example, pays high wages, brings money into the state by exporting products to other states, and can locate anywhere.

By increasing the sales factor to 100%, a company that employs Utahns and invests in Utah but exports all or most of its product to other states, would pay zero or little Utah corporate income tax (assuming the throwback rule were eliminated, which is a topic for another time). Companies that produce and employ in other states but sell their products in Utah would not benefit from this change.

Using the above hypothetical example, the Utah-based exporter’s apportionment to Utah would be 1% instead of 66.3%.

Utah recently enacted an electable double-weighted (50%) sales apportionment formula. Only eight states still use an evenly weighted formula for all corporations. Twelve states use or soon will be using a single sales factor (100% weighting) in addition to three states (Nevada, South Dakota, and Wyoming) that do not impose corporate income taxes at all.

Accomplishing the enactment of an electable single sales factor should be done in the 2008 session of the Utah Legislature. It may require a phase-in over a few years rather than an immediate jump from the 50% sales factor weighting currently allowed, but however it is done, there should be no delay in passing the law to make Utah more competitive.