Over the last 15 years, corporate tax cuts have reduced Pennsylvania tax revenue by $3.9 billion a year. This means less money for education, environmental protection, infrastructure improvement and development, and other critical services. Passing combined reporting would eliminate the Delaware loophole, a significant corporate loophole in Pennsylvania that has allowed corporations to avoid paying their fair share of taxes.
One source of Pennsylvania’s persistent budget problems has been the declining share of tax revenue raised by taxes on corporations. The share of general fund tax revenues coming from corporations has fallen from 30% in 1972 to 15% in 2018-2019 because we have eliminated one tax on corporations, the Capital Stock and Franchise tax, and have created new loopholes in our corporate net income tax. Pennsylvania also has a major loophole, known as the “Delaware loophole” which allows 74% of corporations that do business in PA to pay no corporate income tax.
Our corporate tax system uses what is called separate reporting which requires corporations to pay taxes on only the profit they make in Pennsylvania. But many large, multi-state, and multi-national corporations do not show much, if any, profit in Pennsylvania and thus pay no corporate income taxes. Seventy-four percent of corporations operating in Pennsylvania pay no corporate taxes.
It might seem odd that so many major corporations such as Target, Walmart, Exxon Mobil, CVS, and Rite Aid seem to be so eager to operate in Pennsylvania even though many of them make no profits here. Of course, the truth is that they do quite well, but separate accounting enables their Pennsylvania subsidiaries to show few profits on their books. Instead, their Pennsylvania subsidiaries contribute to large profits recorded in states, like Delaware, that have low or no corporate income taxes. Corporations use the magic of internal accounting to take advantage of separate reporting.
Not only does the Delaware loophole cost the state substantial tax revenues, but it is unfair to the usually smaller corporations that are based in Pennsylvania that do pay our relatively high corporate net income tax.
Combined reporting would require all the profits a corporation earns to be recorded regardless of where they were earned. The corporation would then pay taxes on the share of profits that is equal to the share of sales made in the state. For example, if a national company sells 25% of its goods or services in our state, it would pay Pennsylvania taxes on 25% of its combined profits.
Combined reporting makes it harder for multi-state companies to avoid taxes by manipulating their reported income in states like Pennsylvania with a relatively high corporate net income tax rate. Combined reporting would thus enable our corporate net income tax to generate much higher revenues. And that would also make it possible to lower taxes for all corporations while still bringing in more revenue. Much of the benefit of a lower corporate tax rate would flow to smaller, in-state corporations.
While difficult to measure, we estimate that instituting combined reporting for the corporate net income tax would bring in an additional $332 million in revenue in the next fiscal year and $254 billion in 2021-22 by closing the Delaware loophole and reducing the corporate tax rate from 9.99% to 9.49% starting in 2020-21.
The cost of corporate tax reductions have increased over time. These reductions are a result of eliminating one of the two taxes on corporations, the Capital Stock and Franchise tax (CSFT), and adding new loopholes, tax credits, and other tax breaks to the corporate net income tax (CNI).
Corporate taxes have been declining as a share of general fund revenues for many years.
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