Outdated Tax Systems Holding Back State Economies, Report Says

With many states anticipating or already preparing for budget pressures, state leaders are increasingly looking for ways to increase their revenue streams. A new report from the Pew Center for the States finds that in many cases outdated state tax systems are stifling growth and failing to build a stronger tax base. Authors Katherine Barrett and Richard Greene argue that many of these systems have not been overhauled since the rise of service economy. In 2005, service industries accounted for 68 percent of U.S. gross domestic product; however, only a handful of states tax more than 80 of the 143 most common types of services. At the same time, other industries, particularly telecommunications, are subjected to a variety of taxes based on their former monopoly status.

 

The report focuses on the need to streamline state tax systems, expand taxes on services and limit and monitor the incentives granted to businesses. Barrett and Greene believe that "combined reporting," which forces corporate parents to combine their profits with that of their subsidiaries, could help simplify tax collection while increasing state revenues. Also, by participating in the national Streamlined Sales Tax Project, states can begin to build an effective system for taxing Internet sales as those transactions become more prevalent.

 

Telecommunications companies have suffered most of all at the hands of outdated state tax systems, according to the report. These companies, which once limited themselves to the installation and administration of phone networks, are now an essential force in economic development. They are responsible for the rollout of high-speed data networks and wireless and Internet services. Telecommunications companies are often forced to file more than 500 returns in a state, a relic of their former status as monopolistic players. Barrett and Green argue that this administrative burden has hampered the growth of telecom companies and state telecommunications networks. Only a few states have undertaken any reform of telecommunications tax systems in the past decade.

 

The report cites Robert Lynch of the Department of Economics at Washington College who argues that tax incentives for businesses may spur economic growth, but only when they do not involve a corresponding reduction in government services. In reality, however, Lynch observes that lost revenue frequently results in reduction in services. Economic development efforts should instead focus on building a capable workforce, increasing the volume of high-quality research, and maintaining the state’s infrastructure for growth. Incentives can be a useful tool, but only with a strong accountability measure put in place to ensure they are being deployed effectively.

 

To address this issue, some states are now increasing the accountability requirements for incentive recipients. For example, the Honolulu Advertiser recently reported that the Hawaii Department of Taxation has disallowed 38 percent of claims for the state’s technology tax credit through an audit of past recipients. The claims represent about $22.2 million in potential state revenue. The Act 215 program provides a 100 percent credit for investments in high-tech companies and a 20 percent credit for qualifying R&D investments. The Adviser reports that the rejected credits were disallowed because the company’s activities or costs were not applicable under the program, or the company could not prove that the cost was part of the qualified R&D activity.

 

The Pew Center finds that more and more states are practicing greater oversight over the incentives they offer. Every state that offers tax incentives now undertakes some form of incentive monitoring, which was not nearly as common 10 years ago, according to the report. Eighty percent impose penalties on recipients that do not meet their obligations. An almost equal number of states have tax expenditure budgets that provide data on tax incentives, including potential revenue lost. Thirty-two states publicly disclose information about recipients and/or the tax revenue lost.

 

Download "Growth & Taxes" from Governing Magazine at: http://www.governing.com/articles/1taxmain.htm