Corporate Taxes and Equity in New Jersey
The New Jersey Fair Tax Campaign
by
Kenneth Peres, Ph.D.
May 8, 2002
New Jersey Citizen Action • 400 Main Street – Floor 2, Hackensack NJ 07601 • 201-488-2804
Corporate Taxes and Equity in New Jersey
The New Jersey Fair Tax Campaign
by
Kenneth Peres, Ph.D.
May 8, 2002
New Jersey Citizen Action • 400 Main Street – Floor 2, Hackensack NJ 07601 • 201-488-2804
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What Some of the Experts Say About New Jersey’s Corporate Business Tax
– David Brunori, State Tax Expert and Contributing Editor to State Tax Notes, in "The Politics of State Taxation," April 17, 2002
The state corporate income tax has been riddled with exemptions to the point where it borders on the irrelevant… It is hard to argue that corporations are paying their fair share. Yet corporations use public services. Indeed they arguably use public services more than individuals do. No real corporation (as opposed to a tax shelter holding company) could survive without the transportation system, public safety services, and court protection provided by state governments. It is not unreasonable to ask those who benefit from state services to pay their share of the costs.
– Former State Treasurer Roland Machold, quoted in Trenton Times, "Business Breaks Add Up," by Michael Jennings, February 17, 2002
It’s really unfair. The small companies and mom-and-pop operations aren’t able to play the complicated game we’ve created. Money is fungible. If you operate in several states, you can assign different types of income to your operations in states that don’t tax it or tax it at low rates."
Corporations Rely on a Significant Number of Public Services Provided by the State Government
Required For Corporations
Public Sector Investments
State Budget
Creating and Maintaining a Skilled Workforce
Education K thru 12th grade: $7.7 billion
Higher Education: $1.8 billion
Training, etc. Dept of Labor: $ .09 billion
$9.6 billion
Maintaining a Healthy Labor Force & Citizenry
$1 billion
Providing a Decent Transportation System
$1.3 billion
Maintaining The Legal System & Protection of Property
$1.86 billion
Maintaining a Clean & Healthful Environment
$219 million
Investments in Democracy
Aid to Municipalities: $1.7 billion
Legislature, Chief Executive: $76 million
$1.8 billion
Total
$15.8 billion
Source: New Jersey State Budget Fiscal Year 2002-2003
Who Will Pay for These Public Investments?
Source: State of New Jersey Fiscal Year 2002–2003 Budget
(if corporate reforms are not passed)
Notes: Transfers and fees include Tobacco settlement bonds, state lottery, Medicaid uncompensated care, other miscellaneous revenue. Other taxes include motor fuels, motor vehicle fees, transfer inheritance, cigarette and other taxes.
Revenue from the Corporate Business Tax Decreased Despite Increases in Gross State Product, Profits and Inflation
In Fiscal Year 1982, the Corporate Business Tax generated almost $838 million in revenue. For Fiscal Year 2003, the CBT is expected to generate $820 million — a loss of $18 million. This is much less than could be expected since Gross State Product increased by 219% and profits at a national level increased by 289%.
Corporate Business Tax: 1982 actual; 2003 projection if corporate tax reforms are not enacted Sources: US Bureau of Economic Analysis; NJ State Budgets; Economy.Com; NJ Council of Economic Advisers
*Profits: Actual change in national profits from Fiscal Years 1982 to 2001 the latest year for which figures are available. National profits were utilized because there is no publicly available data on profits of corporations operating in New Jersey.
(1982-2003)
Source: New Jersey State Budgets, FY 1984 and FY 2003
The Corporate Share of State Revenue Has Decreased Significantly
In 1982, the Corporate Business Tax (CBT) generated $838 million and accounted for 15.1% of total state revenue. The CBT will account for an estimated $820 million or just 3.6% of state revenue in 2003 if Governor McGreevey’s tax reform proposals are not adopted. The CBT will account for an estimated $1.85 billion or 7.8% of state revenue if the Governor’s reform proposals are adopted.
(1982-2003)
Source: New Jersey State Budgets, various years; all actual results except for 2003 estimates contained in the FY 2003 Budget
The Share of State Revenue from the Gross Income Tax Has Increased Significantly
In 1982, the Gross Income Tax generated $1.26 billion that accounted for 22.7% of total state revenue. The Income Tax will account for an estimated $7.7 billion or 32.8% of state revenue in 2003.
(1982-2003)
Source: New Jersey State Budgets, various years; all actual results except for 2003 estimates contained in the FY 2003 Budget
Corporations Pay A Decreasing Share of Total Income Taxes, You Pay An Increasing Share
In 1982, corporations paid 40 cents for every 60 cents paid by individuals. In 2003, corporations will pay just 10 cents for every 90 cents paid by individuals if Governor McGreevey’s tax reforms are not enacted. If the reforms are enacted, corporations will pay 19 cents for every 81 cents paid by individuals.
Source: New Jersey State Budgets, various years; all actual results except for 2003 estimates contained in the FY 2003 Budget
(1982-2003)
* Corporate Business Tax as a percentage of the combined individual income tax and corporate business tax
77% of All Corporations Paid Only The Legal Minimum Corporate Business Tax of $200
In 1999, the last year for which statistics are available — and the only year for which statistics were made public — 201,258 out of 262,341 corporations paid only the statutory $200 minimum corporate business tax. Of those minimum taxpayers, 141,811 were going concerns with economic activity, as opposed to shell corporations.
Source: State of New Jersey Fiscal Year 2003 Budget
At Least 30 of the Top 50 Corporations Pay Less Income Taxes Than You
Thirty of the top 50 corporate employers in New Jersey each pay the minimum $200 in corporate business taxes. This is less than the taxes due from the 86% of all individual taxpayers who earned more than $14,300 in taxable income.*
Sources: N.J. State Budget for Fiscal Year 2003; Division of Taxation, 2001 Form NJ-1040
*Calculated using taxable income before credits. The 86% figure is for all taxable returns and was extrapolated from 1999 income tax returns, the latest year available, as contained in the Department of the Treasury, Statistics of Income 1999 Income Tax Returns, Spring 2001.
10 of the Largest, Most Profitable Corporations Pay An Effective Tax Rate That Is Lower Than Almost All NJ Individual Income Taxpayers
Ten of the largest corporations in the state:
Source: Division of Taxation, 2001 Form NJ-1040; Office of the State Treasurer, News Release: Treasurer McCormac Testifies Before Senate Budget and Appropriations Committee, April 22, 2002
Which 30 of the Top 50 Corporate Employers Only Pay $200 A Year in NJ Taxes?
New Jersey does not regularly disclose any information about the incidence of corporate taxes. Thus, we do not know which 30 of the top 50 corporate employers pay the minimum $200 in corporate business taxes.
A&P
Lucent
Acme Market
Marriott
Ahold USA
Merck & Co.
AT&T
Merrill Lynch
Automatic Data Processing
Novartis
BASF
Park Place Entertainment
Bristol-Myers Squibb
Pathmark
Cendant
PricewaterhouseCoopers
Chubb Corporation
Prudential
Commerce Bank
PSEG
Continental Airlines
Resorts Casino
Federal Express
Roche Pharmaceuticals
Federated Department Stores
Sands Hotel
First Union
Schering-Plough
Fleet Boston
Sears
Gannett
Siemens
GM
Telcordia
Harrah’s Entertainment
Toys R Us
Home Depot
Tropicana
Horizon BC
Trump Hotel & Casino
IBM
UBS Paine Webber
JC Penney
UPS
Johnson & Johnson
Verizon
Kmart
Wakefern Food Corp.
Lockheed Martin
Wal-Mart
Source: New Jersey Business & Industry Association, New Jersey Business, May 2001
Examples of Loopholes Used By Corporations To Avoid Taxes
New Jersey’s method for calculating corporate taxes allows corporations to devise strategies to reduce the taxable profits attributed to their New Jersey operations. Corporations can transfer income made from royalties, dividends, interest and management fees from New Jersey to subsidiaries in states that do not tax such income such as Delaware, Nevada and Michigan. Corporations also can transfer expenses from subsidiaries in those tax haven states to their operations in New Jersey. The following four cases provide examples of a number of corporate tax avoidance strategies.
Kmart transferred ownership of its intellectual property to a subsidiary (KPI) created in Michigan — a state that does not tax interest and royalty income. KPI charges a royalty of 1.1% of Kmart’s net sales. From 1991-1995, KPI earned $1.25 billion in royalties — money that Kmart deducted from its income in order to reduce its taxes. In addition, the money earned on the investment of this money escaped taxation. The State of New Mexico estimated that more than $2.2 million a year flowed from Kmart’s New Mexico operations to KPI from 1992-1995. Source: Before the Hearing Officer, No. 00-04: Matter of Kmart Properties January 31, 2000
Toys R Us created a Delaware subsidiary, "Geoffrey, Inc." to act as a means to reduce the taxes of Toys R Us operations. In 1990, Geoffrey charged Toys R Us $55 million in royalties for the use of the Toys R Us name, trademarks and "merchandising skills." Toys R Us uses this particular scheme in a number of states that may or may not include New Jersey. However, it is indicative of a strategy often used by corporations. Source: Geoffrey, Inc. v. South Carolina Tax Commission, SC Supreme Court, Opinion No. 23886, July 6, 1993
Syms, as in the "educated consumer", transferred its trademarks to SYL, a specially created Delaware subsidiary. Syms then paid a large royalty to SYL for the use of the Syms name. These royalties were deductible expenses and reduced Syms taxes. The SYL corporate office consisted of an address rented from a Delaware accounting firm. A partner of that firm was SYL’s only employee serving in a part-time capacity for an annual fee of $1,200. SYL obtained royalty income of $10 million in 1987 and $12.7 million in 1991. Source: Syms Corp v. Massachusetts Commissioner of Revenue, April 10, 2002, Supreme Judicial Court
Merck provides an illustration of two tax avoidance schemes. First, beginning in 1975, Merck shifted the rights to certain intellectual property to Merck Holdings, a special subsidiary formed in Delaware. In this way, the income earned from these assets was sheltered from any state taxation since Delaware does not tax income from intangible assets. Second, since 1984 Merck transferred the stock of other subsidiaries to Merck Holdings in Delaware. This amounted to a shift of dividends, interest from business loans, gains from sales of business securities and other business income from Georgia, a state where they would be taxable, to Delaware, a state where these gains are not taxable. The State of Georgia estimated that it lost $1.138 million in tax payments from 1985-1987. Source: Merck & co. v Collins, State Revenue Commissioner; E-03677, May 12, 1994
Ingersoll-Rand Utilized A Paper Transaction To Reduce Its Taxes by Millions of Dollars
Corporations not only use domestic tax haven states to reduce taxes but also tax haven countries. Ingersoll-Rand (IR) entered a paper transaction in which it moved its incorporation from New Jersey to Bermuda. IR is not required to conduct any meetings in Bermuda and will not even have an office. All IR needs is to secure a mail drop and pay some fees. IR’s move did not result in any changes to its operations, assets, liabilities or stockholders’ equity.
By paying $27,653 a year to Bermuda, Ingersoll-Rand reduced its US income taxes by $287 million from $284.4 million or 34% of its pre tax income in 2000 to -$2.9 million or —1.19% in 2001. IR also cut its total state and local income taxes (including NJ’s portion) by $27.5 million from $18.3 million or 2.2% of pretax income to —$9.245 million or -3.8% of pretax income.
Source: Ingersoll-Rand Company Limited, 2001 Financial Report; NY Times, US Corporations Are Using Bermuda to Slash Tax Bills, David Johnston, Feb 18, 2002
Corporations Also Reduce Their Taxes By Gaining Special Interest Tax Breaks
New Jersey corporations received at least $4.36 billion over the last fifteen years from just nine tax breaks. Two special interest tax breaks enacted in the mid-1980s resulted in a $3.6 billion reduction in business taxes. Businesses also obtained another $800 million from seven special tax breaks granted between FY 1995 and FY 2002. These nine tax breaks will result in at least a $478 million loss of revenue for FY 2002 alone.
Tax Break
Net Worth Tax Eliminated
Net Operating Loss expanded
Yellow Pages Sales Tax eliminated
Double Weighting of Sales
Small Bus. Corp tax cut to 7.5%
7 added Urban Enterprise Zones
Broadcast Equipment sales exempted
Subchapter S corp. rate reduction
Tax cuts for high-tech and bio-tech
Total
Sources: State of New Jersey Budget for Fiscal Year 1989-1990; 1986 Annual Report, Division of Taxation, New Jersey Treasury Department; Office of Legislative Services.
Corporations Reduce Their Taxes Through Special Tax Credits
In 1991, there were four corporate business tax credits that cost the state $1.1 million. In 1998, there were eight credits costing almost $90 million. The two largest credits are for Research & Development (R&D) and Manufacturing Equipment. The R&D Credit is equal to 10% of the R&D expenditure over a base amount plus 10% of basic research payments as determined by the Internal Revenue Code. It cost the state $390 million from 1994 — 2000. The manufacturing equipment tax credit is equal to 2% of the cost of qualified machinery up to a maximum credit of $1 million. It cost the state $112 million from 1994 — 2000.
(1989-1998)
Source: FY 2003 New Jersey Budget, figure 4
Do Corporate Tax Breaks Create Jobs? What the Experts Say
– Paul O’Neill, U.S. Secretary of the Treasury, former CEO of Alcoa, at his confirmation hearing
I never made an investment decision based on the tax code. If 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 (tax) inducements.
Most of these incentives are just shenanigans. The companies get rewarded for doing what they would have done anyway and it upsets the competitive balance putting companies that don’t get a break at a disadvantage. – Henry Coleman, Director of the Center for Government Studies at Rutgers University
If taxes were a big factor, businesses would be moving to Mississippi and Louisiana (where taxes are very low)… That’s not happening. The state business tax is 9% on the bottom line. Labor can eat up 70% of the top line. So taxes are really a small factor. Companies decide where to locate based on the quality of the workforce, the transportation and communications infrastructure and the access to markets. By those measures, New Jersey has much to offer.
Source: Trenton Times, "Business Breaks Add Up" by Michael Jennings, February 17, 2002
Do Corporate Tax Breaks Create Jobs? The New Jersey Experience
From 1987 to 2001, two tax breaks (the elimination of the net worth tax and readjusting the way corporations calculate taxable income) worth $3.08 billion primarily benefited the state’s largest corporations. The top 100 corporations in New Jersey responded by cutting more than 91,200 jobs. New Jersey essentially rewarded the top 100 corporations with tax breaks worth $33,700 for each ELIMINATED job.
(1986-2001)
Source: NJ Business and Industry Association, NJ Business Magazine, Top 100 Employers, various years; State of New Jersey Budget for Fiscal Year 1989-1990; 1986 Annual Report, Division of Taxation, New Jersey Treasury Department; Office of Legislative Services; New Jersey Department of Labor
A Five Point Program To Insure That Corporations Pay Their Fair Share of Taxes
1. Combined Reporting: The Most Comprehensive Approach To Closing Tax Loopholes
New Jersey’s Corporate Taxes Are Riddled with Loopholes. Current New Jersey law allows corporations with operations in different states to shift income from their New Jersey subsidiaries to subsidiaries in other states and to shift expenses from these other subsidiaries to New Jersey. (NOTE: For a great discussion of tax loopholes see Michael Mazerov, "Closing Three Common Corporate Income Tax Loopholes", Center on Budget & Policy Priorities, April 2002; Richard Pomp, Michael McIntyre and Paull Mines, Designing a Combined Reporting Regime for a State Corporation Income Tax: A Case Study of Louisiana, Louisiana Law Review, August 2001; and Michael Mazerov, Taxing the Profits of Multistate Corporations in Wisconsin, Center on Budget & Policy Priorities, June 1999.)
Combined Reporting: The Most Comprehensive Approach to Closing Loopholes. Sixteen states have implemented "combined reporting" which requires that all related subsidiaries of a corporation engaging in the same basic line of business are treated essentially as one taxpayer and their profits are combined for tax purposes. Combined reporting would eliminate the ability of corporations to implement such schemes as Syms, Merck, Toys R Us, and Kmart identified previously. The benefits of combined reporting include the following:
2. Institute a Throwback Rule to Eliminate Income That Is Not Taxed by Any State
The "throwback" loophole allows particular corporations not only to reduce their New Jersey tax but also to shield income from taxation by any state. Throwback sales are sales originating in New Jersey made to either the federal government or to customers located in states where the seller is not subject to tax due to the "nexus" standards defined by federal law and interpreted by the New Jersey Administrative Code.
Under the nexus standards, a corporation must have some type of operations in a state in the form of property or employees before its income can be taxed by that state. Without nexus, a state cannot tax a corporation.
Corporations use this loophole to remove a portion of their income from any state taxation. New Jersey does not include the income attributable to sales in destination states in the calculation of the corporate tax. Neither is such income included in determining corporate taxes in the destination states where the sales are made. This is called "nowhere" income because it is not taxed anywhere.
Twenty-four states have closed this loophole by establishing a "throwback" rule. The throwback rule requires that a sale be thrown back to the state of origin if the selling corporation is not taxable in the state of the purchaser. Sales to the federal government also are thrown back because of the difficulty in determining the destination of the sales.
3. Expand the Definition of Taxable ‘Business Income’ to Encompass Corporate Profits from Irregular Transactions
New Jersey allows corporations to exclude "non-business income" from state taxation. Unfortunately, New Jersey has a very expansive definition of non-business income to include many transactions that might in any way be construed as "irregular." Thus, corporations could exclude the profit made on the sale of a corporate subsidiary that was actively managed by the parent corporation at the time of the sale. Another example is the inability of states to tax the capital gain realized when depreciated plant and equipment are sold.
The state could amend its definition of business income to read: "’Business income’ means all income that is apportionable under the Constitution of the United States."
4. Create an Effective Minimum Corporate Business Tax
The Current $200 Minimum Corporate Tax Is Ineffective. Profitable corporations should not be allowed to pay a corporate business tax of just $200 a year.
Create an Effective Corporate Minimum Tax. Governor McGreevey has indicated the general outlines of a more effective minimum tax. He would exempt small businesses and focus on out-of-state companies with significant sales in New Jersey. The corporation would calculate its tax under the current tax structure and the alternative and pay the greater of the two. The alternative tax would be calculated by applying a rate of 0.1% to 0.5% to the New Jersey share of corporate sales, payroll and property. The combined rate would not exceed 1%. However, the Governor’s proposal would cap the minimum tax at $5 million. With this reform ten of the largest corporations in the state with $2 billion in profits attributable to New Jersey would pay a total corporate business tax of $50 million instead of the current $2,000 i.e., the current $200 minimum each. However, this would still be less than the expected $177 million in corporate tax that they would have paid without the benefit of loopholes and other methods to reduce taxes.
The benefits of such an approach include the following:
5. Increase Public Information & Accountability
Tax Expenditure Reporting
While legislators and citizens have a great deal of information concerning direct expenditures on governmental programs, there is not any accurate information concerning indirect expenditures created through tax credits, exemptions, deductions, deferrals, etc. Unlike direct spending, these "tax expenditures" are open-ended, have no built in budget limits, or any annual appropriations and oversight process. In addition, there is no publicly available information concerning who receives the benefits of the tax expenditures or whether they are working as originally hoped.
Tax expenditures can be significant. For example, in FY 1999 Louisiana granted $312 million in corporate tax expenditures but collected just $286 million in corporate tax revenue. In other words, Louisiana collects just $286 million out of a potential $598 million — a 52% loss of tax revenue.
New Jersey should require an annual tax expenditure report. Thirty-seven states including New York as well as the federal government have published tax expenditure reports. For example, Texas requires a tax expenditure report that assesses the revenue impact of exemptions, discounts, exclusions, special valuations, special accounting treatments, special rates and special methods of reporting relating to all major taxes. In addition, Texas requires a report on the distribution of the tax burden by income distribution, income class and business or industry class for all major taxes.
Comprehensive Legislative Fiscal Notes
New Jersey law currently requires the preparation of an estimate of the fiscal impact of proposed legislation called a "fiscal note." This fiscal note is prepared whenever requested by the sponsor of the legislation, chairperson of the reference committee, or presiding officer of either house. The fiscal note provides revenue or cost estimates for the current year and the two succeeding years and includes the impact on local governments as well as the state.
However, New Jersey’s fiscal notes are too limited. First, fiscal notes should be prepared for every bill that entails a potential fiscal effect. After all, legislators should be given information about the fiscal effects of the bills on which they are voting. The New Jersey State & Local Expenditure And Revenue Policy Commission recommended that fiscal notes be required whenever the Legislative Budget Officer identifies a potential fiscal impact (source: NJ SLERP Summary Final Report, 1988). Second, fiscal notes should be more comprehensive. For example, any bill proposing a tax break should include not only an estimate of the foregone revenue but also the tax savings for each group of taxpayers benefiting from the proposed legislation.
Corporate Tax Disclosure
The federal government requires banks, insurance companies and publicly traded corporations to disclose such information as gross receipts, profits, deductions, exemptions and credits as well as federal tax liability. Much of the momentum for the 1986 reform of federal corporate taxes came from public knowledge that many profitable corporations were paying little, if any, corporate taxes.
New Jersey does not require any such disclosure. Passage of a measure requiring corporate tax disclosure along the lines of the federal government would provide citizens and lawmakers with the means to evaluate whether large corporations are paying their fair share of New Jersey’s taxes. Corporate disclosure would allow lawmakers and citizens to understand why some corporations pay less in taxes than they should and identify the reasons other corporations pay too much relative to the tax-avoiders.
Opponents of corporate tax reporting will contend that it will hurt business. However, no corporate secrets will be disclosed. Indeed, no one has purported to show that the detailed federal reporting requirements have hurt businesses nationally. The real basis for such complaints is the fear that the public will find out which firms are not paying their fair share.
A number of states have passed corporate disclosure laws. In Wisconsin, the public has access to the amount of income tax paid by corporations. West Virginia reports the name of corporations receiving any of a number of business tax credits. Arkansas authorized the disclosure by name of taxpayers, the tax credit, tax rebate, tax discount or commission received on a number of tax incentives. In 1992, Massachusetts passed an initiative that would have required corporations to report their net and gross income and assets; each deduction, exemption, credit, offset that reduces income; the percentage used to apportion state income; total tax due and carryovers; and federal net income. The initiative passed but was never fully implemented by the legislature.
For more information on NJCA's Fair Tax Campaign call John Weber at 732-246-4772 x 14 or e-mail: john@njcitizenaction.org