Friday, July 28, 2006

Major tax bill delyed by House of Representatives

The house of Representatives pulled H.R. 1956 before going to a vote on Wednesday because of insufficient support to get it passed. This is major tax news that has gone largely unreported. The significance of this bill is it would change the way states can tax out-of-state companies doing business in their jurisdictions. The term that is used to describe whether a company is liabile to pay taxes in a given state is called Nexus.

Under the commerce clause of the U.S. Constitution, the Federal government essentially sets the rules on how a state can tax an out of state entity doing business. There are different standards for sales taxes and income taxes. For income taxes, the law states that sellers of goods (tangible perdional property) who sell goods in a state, but do not have employees or own property in that state, from being liable for INCOME tax in that state. In the 1950's when this law (P.L. 86-272) was passed, it covered most economic activity. Today, it has less significance because services and intangibles make up a large portion of economic activity, and many states have moved away from income taxes towards gross receipts or franchise taxes, which are not covered by the law.

Congress decided to address this inequity by proposing H.R. 1956, which would have ammended the law that would say all companies would be exempt from income or any other type of entity level tax provided they did not have property or payroll in that state. While this did address the inequity, it rose fierce opposition from state governors, who would lose significant tax revenues. State governments like the status quo because they can tax people who cannot vote in their respective states. This bill, if passed would mean substantial tax savings for many entities that do business in multiple states.

I am of two opinions on this matter. I like the fact that it levels the playing field and it starves state governments of money - which coincides of my 'starve the beast' limited government philosophy. However, the states have a legitimate point regarding tax revenues and fundamental fairness in taxing business directed to the state.

The solution to this is to pass H.R. 1956, but also change the rules for sales tax nexus, allowing the states to have out-of-state companies collect sales tax (especially on internet sales) with a more liberal interpretation of substantial nexus that has been used by scholars. This would address another fairness issue, the taxability of internet based companies versus bricks and mortar companies, and allow states to recoup some of their lost revenues. It would also have the benefits of states working to streamline their sales and use tax policies (National Sales Tax Project) and would turn the tax systems of many states from an income base to a consumption base.

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