On behalf of the
National Governors Association
On HR 3220, the Business Activity Tax Simplification Act
Committee on the Judiciary
Subcommittee on Commercial and Administrative Law
The Honorable Chris Cannon, Chairman
Chairman Cannon and Members of the
Subcommittee, I am Rick Clayburgh, Commissioner of the
NGA policy on the issue of business activity taxes is very clear:
“The nation’s Governors oppose any further legislative restrictions on the ability of states to determine their own policy on business activity or corporate profits taxes. This is an issue of state sovereignty. The U.S. Constitution adequately protects the interests of both states and business.”
The NGA opposes H.R. 3220 because it would unduly interfere with the ability of states to determine and manage their own tax policies. In the simplest of terms, HR 3220 would encourage—and in some cases, mandate— businesses to engage in tax shelter activities to avoid payment of state corporate income and other business activity taxes. It would impose new limits on the ability of states to tax entities engaging in business in the state, and prevent states from taxing income where it is earned. It would reduce every state’s revenue base—with aggregate revenue losses likely reaching into the billions of dollars per year. It would unfairly shift the tax burden to local businesses and render most of these taxes virtually unworkable. Most importantly, H.R. 3220 runs directly counter to our system of federalism and places Congress in the position of making decisions that for over 225 years have been reserved to state and local elected officials.
Let me put the proposals in HR 3220 in context. When we talk about a state’s jurisdiction to tax, also known as nexus, we are asking whether a company has sufficient activities in a state to allow that state to impose a tax on it. Business entities are legal fictions created on paper that have no physical being. These businesses are present in a state through representatives such as buildings, property, or inventory they own or persons they hire, such as employees and independent contractors, to do the company’s work. They are present in the state through the activities they undertake such as leasing, contracting, licensing, selling, and the like. So, the key question is: When are the activities of a company that has no single physical embodiment, sufficient to bring it within the state’s taxing jurisdiction?
Proponents of HR 3220 will tell you that the legislation establishes a straightforward “bright line” standard of “physical presence” for determining nexus, thus providing certainty for the business community. They will also argue that the measure will have little impact on state revenues. Nothing could be further from the truth. Let me briefly address some of the issues raised by HR 3220.
Point #1: Simple and Identifiable Standards
H.R. 3220 purports to establish a bright line physical presence standard for the imposition of state and local business activity taxes. In reality, the measure contains a series of conditions and carve-outs from the physical presence standard that would enable a corporation to engage in a substantial volume of activity in a state without being subject to the state’s tax jurisdiction.
H.R. 3220 provides that an entity may be subjected to tax in a state if it has personnel or property in the state –
In other words, there is nothing simple and nothing bright about the standard in H.R. 3220, and it certainly goes way beyond mere physical presence before a state would be authorized to levy its business activity tax. As an example, a company engaged in “gathering news” could have a permanent building in a state and permanent employees in the state and not be subject to tax. Likewise, a company that sold multiple products into a state could use an independent contractor to perform all its installation, servicing, and repair services in the state and not be subject to tax on its income.
In short, the so-called “bright line” standard that HR 3220 imposes is more a ruse than a reality—and represents a step backward in good tax policy.
Point #2: HR 3220 Legalizes—and even promotes—increased tax sheltering. By requiring that an entity have a physical presence in a state, H.R. 3220 would legalize the use of “intangible holding companies” and other related-party arrangements to shift income among states in a manner that avoids taxation. For the past several years, states have aggressively fought this form of tax sheltering. Many of those efforts would be for naught if H.R. 3220 is passed. In addition, H.R. 3220 would encourage and possibly require additional tax sheltering. Public companies—where corporate officers have a fiduciary duty to shareholders to boost their share prices and reduce their tax liabilities—would conceivably be required to take advantage of the same tax sheltering opportunities that to this point have been considered risky and aggressive. Thus, at the same time that Congress and the Administration are strongly advocating measures to curb the use of Bermuda-type tax shelters that affect the federal tax base, H.R. 3220 would encourage Congress to do an about-face and put its stamp of approval on legislation that would expand and legalize the use of tax shelters for state corporate income tax avoidance.
Point #3: Impact on State Revenue Bases. H.R. 3220 would have a significant impact on state revenue bases. While the fieldwork to estimate the impact of H.R. 3220 is still going on, the total impact will undoubtedly reach into the billions of dollars per year. In fact, one state has already estimated that the impact of the bill would amount to about a 20 percent reduction in its corporation income tax base.
Point #4: The Impact on Federalism. For 225 years, Congress has recognized the sovereign authority of states to raise revenue. This is a fundamental principle of federalism that is essential to the proper balance of the state/federal relationship. H.R. 3220 would decimate this core principle and supplant the authority and judgment of state and local elected officials with the judgment of Congress. It would make Congress and large corporations the arbiters of economic development decisions nationwide. Governors, state legislators, and mayors would no longer independently decide what business is good for the economy of their cities and states, what industry it wants to recruit to bring jobs to its citizens, or what type of business development incentives it wants to provide. Rather, enacting H.R. 3220 will establish a system where out-of-state businesses—businesses that compete for local customers and benefit from the services of state and local government that support the economy— will be exempt from contributing to the local schools, public safety, or transportation infrastructure while increasing the burden on in-state companies and local businesses. Congress should not damage the ability of state and local governments to use taxes to promote competition and fairness that are both constitutional and a major part of their fiscal systems.
For the reasons outlined in this statement, the National Governors’ Association strongly urges the subcommittee to reject HR 3220. Congress should not implement legislation that will discriminate against local merchants and businesses, force states to incur severe revenue losses, and setback over 225 years of the principles of federalism.
Mr. Chairman and members of the Subcommittee, thank you for the opportunity to speak to you today. I welcome the opportunity to answer any questions you may have.