PMO Advises Strengthening Corporate Franchise Tax

The Hannah Report - May 23, 2005
   

The Hannah Report

With Gov. Bob Taft’s tax reform plan running hard as it nears completion of the second leg of the Ohio Triple Crown of legislation, Policy Matters Ohio (PMO) is advising state Ohio Senate policymakers to reconsider strengthening the corporate franchise (CFT) tax instead of scrapping it as Taft’s plan does.

Designed to reconfigure a Depression-era tax system for the 21st century, the Taft tax plan has already been changed in the House, and is undergoing more changes in the Senate. Last week, Senate Republicans said they will increase tobacco taxes to offset eliminating increases in alcohol and other tobacco product taxes, real estate transfer fees and funding of Ohio’s children’s hospitals.

But PMO, a Cleveland tax research group, also urged tax reformers to take another look at the corporate franchise tax, an excise tax levied on the value of a corporation’s issued and outstanding shares of stock — a tax Taft wants to eliminate.

PMO said replacing the CFT with a commercial activity tax (CAT) — based on a company’s gross receipts — for non-financial companies would make Ohio one of only six states in the country without a corporate income tax. While the CAT has some positive features, PMO says it should not be used to replace the corporate franchise tax for a number of reasons.

PMO agrees with other tax reformers that the CFT has been weakened so that it does not produce the revenue it once did, due to legislation that has allowed it to be legally circumvented.

An example PMO cites is a bill passed in 1999 by the General Assembly that capped how much companies must pay on their net worth. As many as 19 of the state’s top 50 companies benefited from this cap in tax year 2004, saving millions of dollars. In a recent summary of the tax plan, PMO said it is wrong to weaken a tax, then eliminate it because it has been weakened. A better approach, it said, would be to strengthen it, which could be done easily enough through steps cited below. These include measures to keep companies from planning around the tax.

Even though many big companies manage to limit what they pay under the franchise tax, a number of others continue to pay a significant amount. In tax year 2003, the last year for which such data are available, 95 companies paid at least $1 million, or $204.5 million in total. Though collections remain hundreds of millions of dollars below late 1990s levels, they increased 30 percent in the first 10 months of fiscal 2005, to $774 million. This indicates that the tax remains viable.

PMO said wiping out the corporate franchise tax would mean that highly profitable companies no longer would have any obligation to pay taxes based on their profits, violating a bedrock principle of fair taxation. Some companies would pay millions of dollars less than they do now. Yet it likely would add to the tax burden on low- and middle-income taxpayers, who already pay more of their income in state and local taxes than do affluent Ohioans. Manufacturers are not unduly burdened by the corporate franchise tax, so its abolition is not likely to spur manufacturing investment.

Critics argue that Ohio’s corporate franchise tax should be eliminated because its relatively high rate discourages businesses from operating here. However, Ohio ranks well below average in how much revenue the tax brings in. Most companies are likely to review the taxes they would actually pay, not tax rates that may never be imposed in reality. In any event, taxes are a secondary factor in corporate location decisions. One recent report commissioned by the Ohio Department of Development found that the CAT would be better for the Ohio economy than the two taxes it is designed to replace. But the difference is tiny, and uncertainties such as which companies ultimately would pay the CAT makes it hard to predict the effect one way or the other.

According to PMO’s analysis, Ohio should adopt the following reforms to bolster the franchise tax while making it fairer to those who already pay, and to make sure business pays its fair share of state and local taxes:
• Require companies to report all of their related operations in a single, combined tax filing,
cutting down tax planning that shifts income out of Ohio and artificially lowers corporate
franchise taxes;
• Eliminate the cap on net worth payments, which discriminates against small businesses and costs the state close to $100 million a year;
• Eliminate or limit credits that are steadily weakening the tax;
• Add a throwback provision, under which Ohio would tax sales made by Ohio producers in other states where they are not subjected to tax; and
• Consider bringing pass-through entities such as S Corporations and limited liability companies under the tax, as Kentucky has just done with its corporate income tax.

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