Tax Foundation expert offers ideas about congressional involvement in state tax policy

The Tax Foundation’s Joseph Henchman spent some time on Capitol Hill this week offering the U.S. Senate Finance Committee some ideas about Washington’s proper role in state tax policy:

Most of the time, Congress should let the states do their thing, even if it’s bad policy. But in a few very important situations, Congress has the power and the responsibility to get involved in state tax policy. Two situations, in fact.

The first is to preserve the power of the federal government. States cannot tax the Federal Reserve, for instance, and there are federal laws banning state taxes on nonresident members of Congress and nonresident members of the military.

The second situation goes to the reason why we adopted the Constitution in the first place. States went wild under the Articles of Confederation: port states punitively taxed commerce going to interior states, and vice versa. Tariff wars proliferated. So the Constitution was adopted, giving Congress the power to restrain states from enacting laws that harm the national economy by discriminating against interstate commerce.

In short, states will put their own interest ahead of the federal interest every time. They have an incentive to shift tax burdens from physically present individuals and businesses, to those who are beyond their borders, nonvoters. When this behavior is not prevented by Congress or the courts, the results can be taxpayer uncertainty, incompatible standards, and harm to national economic growth.

As one example, take a multistate corporation with operations in 5 states. If each of those 5 states imposes a state corporate income tax, the company’s profit must be divvied up, or apportioned, among the 5 states. That’s so no state taxes more than fair share and no multiple taxation occurs. States game this, bending their apportionment rules to tax profits that were earned in other states. Congress recognized this problem, and set up the Willis Commission in 1959 to adopt one uniform apportionment standard. That threat got the states to adopt one on their own, although without congressional force backing it up, the states began drifting away from it soon afterward. Today, only 11 states stick with the uniform apportionment rule. The rest have abandoned it to grab revenue from other states.

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