It takes two to tangle a tax system

Last week, when Gov. Pawlenty announced his 21st Century Tax Reform Commission to reform business taxes, in Massachusetts

Governor Deval Patrick's quest to tighten corporate tax laws and reap hundreds of millions of dollars in new revenue might be undermined by a last-minute amendment providing new offshore tax breaks that was tacked onto the legislation by the House, according to state officials.

I'm not going to prejudge the outcome of the Minnesota Commission's work, but it will be interesting to see if this panel of business people will operate under any different mindset than their business lobbyists do, slipping in amendments that take money out the back door while reformers like Patrick are walking around closing the windows.

The issue hinges on a complex tax regulation called combined reporting, which is designed to prevent large, multistate corporations from shifting certain profits to other states that have lower tax rates. The House-approved corporate tax legislation would require companies in Massachusetts to combine all income and apportion the Massachusetts share.

Minnesota is gradually shifting its apportionment of corporate taxes toward a heavier weighting on sales versus property and payroll. This will benefit companies with headquarters or a major facility in Minnesota that sell products nationally or worldwide. Companies that sell in Minnesota but have relatively modest in-state operations may pay more with a sales-only formula.

Whenever there are differentials in tax rates, businesses will try to exploit them. While those favoring reduced state taxes focus on the threat of businesses leaving the state, uprooting operations carries its own costs and risks. It's usually more practical for a company to do the same thing any governor does — shift the money.

Instead of moving revenue between departments and programs, the business seeks ways to move sales and expenses to different states or countries with more favorable policies.

For example, this Wall Street Journal article described a Wal-Mart maneuver establishing an office in Florence, Italy, for the purpose of avoiding Illinois taxes.

The dispute with Wal-Mart is part of a wider effort by some states to crack down on what they believe is abusive use of so-called 80/20 companies. These companies are domestic subsidiaries that conduct at least 80% of their business overseas. States typically don't tax income from outside the U.S., and many companies have used 80/20 subsidiaries to legitimately shield foreign operations from state taxation.

The Commission's charter is to look for tax-related barriers to business investment and capital formation and for ways the business tax system can be simplified. So far, so good. But no government sets out to create a complicated tax system. It gets that way over time as individual and business taxpayers seek ways to pay less — and seek incentives that supposedly advance the public good.

Almost any change in the tax code contains potential for new mischief. If the Commission's recommendations can help state businesses without creating new losers and new loopholes, the members will have done great work indeed.

— Charlie Quimby