TCS Daily


Taxes in 50-Part Harmony?

By George A. Pieler - March 14, 2006 12:00 AM

Who taxes whom, and where, and when, is a never-ending source of controversy between nations. Europe's long-running dispute with the U.S. over export tax breaks is in its third decade, while digital commerce weakens the links between taxpayers and geographic location. And as the U.S. Supreme Court discovered on March 1, the power of states to set tax policy within their borders is very much in contention as well.

The dispute is Daimler-Chrysler v. Cuno, and raises the critical question of tax competition: can states use tax breaks to induce businesses to locate within their borders, or does that infringe on federal power over interstate commerce? Ohio, seeking to encourage business investment in the Toledo area, offered Daimler-Chrysler investment tax credits to build a Jeep plant there. The credits were generally available to companies interested in making new investment in Ohio, regardless of where the company was located or did most of its business.

Cuno et al., contesting Ohio's investment tax breaks with a strong push from Ralph Nader, argue those tax breaks disrupt interstate commerce by de facto penalizing companies that don't invest in Ohio, thereby discriminating against other states. They also claim they're actually harmed by these investment breaks. Their argument? That losing tax revenues to Daimler-Chrysler will require tax hikes on everyone else in the state, or alternatively undermine the state's fiscal position and the Ohio economic climate.

There are precedents in constitutional law criticizing, even striking down, some forms of economic competition among the states, under the theory that some state actions aimed at fostering the local economy actually function like a tariff against interests in other states. In the 1984 case, Westinghouse v. Tully, the Supreme Court told New York it could not calculate franchise taxes differentially, based on whether exports shipped from a physical location in New York. That differential calculation was deemed a de facto tariff against other states, in violation of the so-called 'Dormant Commerce Clause' — areas of interstate commerce where Congress has not expressly legislated, but where state interference is inconsistent with the logic of the constitutional system.

Ohio and Daimler-Chrysler argue there is a huge difference between tax differentials that penalize businesses in other states and tax incentives that, rightly or wrongly, are expected to encourage more business activity in the taxing state. If location-based tax benefits are struck down here, is there any room for states to compete on tax policy at all? Indeed several Justices honed in on this point, particularly Scalia and Souter; the former stressing the legislative prerogatives of states, the latter focusing on the 'free choice' businesses have in claiming tax breaks and accept the conditions attached thereto.

This is an important issue, and while Ohio seemed to have the edge before the Court, the Sixth Circuit Court of Appeals came down strongly the other way. Clearly the U.S. Federal system demands a balance between Federal taxing power and state revenue authorities. The constitution demands the free flow of commerce across state lines. Yet when the virtues of global tax competition are increasingly obvious, it seems wildly imprudent to erect a constitutional barrier to such competition within the U.S. National uniformity in taxation has virtues, but 'forced' harmonization of tax systems not only insulates the taxing question from politics, it drives taxes higher (there is economic as well as political wisdom in 'no taxation without representation').

Nevertheless there is a good policy argument against what Ohio has done. Special tax breaks come at the expense of general tax relief, with no guarantee they will be more productive in generating growth. That's a policy dispute for each state to conduct, though, bad or imperfect tax policies don't violate the constitutional order. Personally I would prefer to see states compete in lowering individual and corporate taxes, and property taxes, rather than try to micro-manage business decisions with targeted tax cuts. But that's just me.

The larger issue, jurisprudence aside, is whether the U.S. wants to follow Europe and severely limit tax competition. On Yale Law School's online "Pocket Part", Michael Graetz, Alvin Warren, and Robert Yablon note that Europe's "preoccupation with nondiscrimination has pushed considerations of economic efficiency, fairness, and administrability to the margins...[and] has deprived EU member states of their ability to weigh important policy tradeoffs." State experiments with such policy tradeoffs is indeed the genius of the American system.

Will we get a clear answer from the Supreme Court in this case? Maybe not: much of the March 1 argument centered on standing, that is the litigants' right to be before the Court claiming Ohio's tax credits harmed them somehow. Cuno et al. may not meet the Court's criteria on standing, letting the Court avoid the underlying tax competition dispute. Indeed Cuno's claim of harm relies on the old bureaucratic standby, 'static' scoring of tax cuts: assume tax cuts always lose revenue, and can't catalyze economic activity enough to fill the state's coffers. With dynamic scoring, considering the economic upside from tax cuts, litigants like Cuno wouldn't even get this far.

Didn't we learn about all this in the 80s? Maybe it's finally the courts' turn to catch up.

George A. Pieler was Tax Counsel to the Senate Finance Committee in the 1980s. He is a Research Fellow with the Institute for Policy Innovation. The views expressed herein are his own.

Categories:

16 Comments

Some questions
How do you enforce tax parity between the states when each has a different tax code. Some, for instance, have no corporate income tax. Are they taking unfair advantage of the others?

And was the Union founded on the principle that all states must be exactly alike?

The author says "...I would prefer to see states compete in lowering individual and corporate taxes, and property taxes". So, in light of the fact that states must balance their budgets, how do you propose to fund state spending? A twenty percent sales tax?

The problem of the states' race to the bottom in offering tax incentives to incoming businesses is a real one, and is robbing them of revenue at exactly the time they need to build new roads, schools, etc to absorb their population influx. I would rather see them form an OPEC-like organization, and agree to stop competing against each other in the interests of all. That way there could be a level playing field. Small businesses with no clout wouldn't have to make up the revenues that major businesses don't have to pay.

Isn't the America we want to live in one where everyone shares the same tax burden, and some people don't get to skate at the expense of others?

balancing the budget
The states can balance their budgets by getting rid of the 30-50% of the budget that is unnecessary.

Fundamental problem
The only trouble is, we as a people are undecided as to which 30-50% is unnecessary. Half of us would get rid of any programs that benefit people. The other half would get rid of the programs that benefit industry.

This has been going on for decades
Many states offer companies to relocate an office, a plant, etc, by allowing them to not pay property taxes for the next ten years. AT&T did this in NJ and GA. Chyrsler in AL with their new plant. UNUM in SC. Every business and state nearly does this. And each state profits from the addtional employess they bring to the state as part of the deal.

adding 5000 employees is adding 5000 families that must pay sales and state taxes. must buy homes and pay property taxes, buy services, food, gas, etc. I have not seen one state suffer from this yet. All I seen is booming economies from the additional revenue, stores, malls, and services that must be built to accomidate them.

So we have some greedy ass politican that does not want to offer businesses a break for moving into their state or area and the whole country must suffer? cut me a break and cut off the politican.

disagreement
There are no programs that benefit people. There are many programs that claim to, but none do in reality.

targeted tax cuts - are they really fair?
Seems to me that targeted tax cuts are unfair to those businesses that are already in the state paying their fair share. Taxation policy should, in order to be fair, be somewhat uniform in its treatment of similarly situated taxpayers. Sounds like there is an equal protection argument here - though there would be scrutiny under the rational relation test.

ABD

Really?
Pretty shallow comment. The New Deal, to mention just one, benefitted people. Unionisation was another such. So was Social Security and Medicare/Medicaid.

You put your finger on it
You're correct, Anthony. That's a major topic for discussion in my state, where targeted tax breaks are handed out like advertising flyers. They are manifestly unfair to existing businesses, who no longer have a level playing field. Nor are they fair for the little guys, who don't have the clout to get a break.

They can also be shamelessly gamed by slick players. A major big box outlet, whose name starts with a W and ends in a T, gets tax breaks to break ground in a new location, providing they stay for a minimum of five years. As a result, every five years they close down a number of their stores and build new ones, often just up the street from the old ones. The shopping centers that have grown up around them have to shut down, with no anchor store to buoy them any more.

You could bring suit against the state on equal protection grounds. But you wouldn't get very far. Ours is not just a right to work state, it's a good ole boy state. The law is what the judges say it is.

Grossly Unfair
I'm surprised the existing businesses don't go back to the state and say, "Give us a tax break, or we'll leave."

ABD

they claimed to have,
but they haven't.

If you chart the rate at which poor people were being lifted out of poverty prior to the New Deal vs. after, you will find one change.

Improvement slowed down after the implementation of the New Deal. In other words, fewer people would be poor today, had the New Deal never happened.

Ditto for SS and Medicaid.

All unionization has ever done is shift income from those who aren't unionized, to those who are. And in the long run destroy those industries that were most heavily unionized, resulting in ruin for employees of those industries.

Don't be taken in by intentions. Look at results.

existing businesses
Some do. But they have the problem of an existing plant that either has to be abandoned, or sold to someone else.

Life in the New America
You say "I'm surprised the existing businesses don't go back to the state and say, "Give us a tax break, or we'll leave.""

Many do. And some times it works. When it doesn't, then they start shopping around.

It's not like we're the only state doing this. All fifty are engaged in a race to the bottom. It's just that NC wins the race more often than not. And we previously existing citizens have to foot the bill.

Our business environment is best described as "pro-banking". We are run by the developers, who get to build the new communities around the new businesses. And the banks get to loan them the money. You can look at towns that only have ten businesses. Six of them will be banks. Plus one beauty shop, one gun shop and two pizza carryouts.

Selling old plant
All existing plants in my state are abandoned-- there is no market for them. New businesses invariably build new.

The pattern was established when manufacturing went overseas. Machinery would get auctioned off to the Koreans and Singaporeans, who resell to someone else. The brick hulks get boarded up, as do the towns that used to depend on them.

And that is fair?
No. The tax burden shifts to the home owner and consumer, the vast majority of which do not benefit from the new business.

Also, it doesn't really work. Most businesses re-locate for their own reasons, but a 10-year tax break isn't really it. Besides, what happens after the 10 years are up?

I don't know how many other incentives our state has offered and the result has been limited at best. Also, many businesses who do come here because of the incentives, leave before the 10-years are up. The net result is null for job creation and negative for tax collection.

In the 70's and early 80's we had strong employment, very strong per capita income, low property taxes and about average business taxes. Now we have strong employment, low per capita income, high property taxes and much lower business taxes. You tell me which era was better for the average person?

selling stuff
The point was not that it couldn't be done, the point was that a move to another city was not cost free.

Incentives such as we've been talking about are very effective when a company is looking to build a new plant.
In such a case their is no sunk cost that has to be worried about.
In the case of moving an existing plant, the proposed subsidies have to exceed the moving costs. Which include the probability that you won't get the full economic price from the sale of your existing facility, and the cost of moving people and equipment. Not to mention the lost productivity while moving and setting up, and the fact that some of your best people may decide not to move.

I love the way liberals
refer to economic liberty as a "race to the bottom".

TCS Daily Archives