Closing ‘Delaware loophole’ not Corbett priority
HARRISBURG — The House is scheduled to vote next week on a bill that would close the so-called Delaware loophole, which allows some companies to reduce their Pennsylvania taxes by shifting income to a low-tax state.
Republican Policy Chairman David Reed of Indiana County, who sponsored the bill, said it’s an opportunity to recoup money that would be dedicated entirely to reducing corporate taxes. Reed’s bill would reduce the corporate income tax rate to from 9.99 to 6.99 percent by 2019.
“Making our tax structure more competitive will not only put more folks back to work but also have the effect of expanding our tax base and revenue collections through economic growth,” Reed said. “In the end, we are seeking to close the loophole and lower the rates to ensure a level playing for all job creators.”
The political support, however, is muddled, and the issue is complex. There’s bipartisan support in the House, but business is divided, and Republican Gov. Tom Corbett is not on board, at least not now. Some Democrats and unions back closing the loophole, but they want the money spent to plug budget cuts in education and social programs.
“There’s no clear path to legislative approval, much less to gubernatorial signature,” said G. Terry Madonna, a political analyst and pollster. “There’s just no clear signal of the govermor being in favor of this.”
Reed is awaiting a fiscal note from the House Appropriations Committee estimating the amount of revenue brought in by closing the so-called loophole.
The loophole is not specific language one can point to in current law. It’s how tax laws are structured in Pennsylvania, and the deductions allowed for multi-state corporations. They are legal deductions, but the Department of Revenue says some companies abuse them.
The PA Center for Budget and Policy estimates $50 million to $200 million annually could be recovered during the next three years by closing the loophole.
Reed’s bill requires a “legitimate business purpose” for out of state transactions within a company.
If a company pays an out-of-state subsidiary for use of the patent to manufacture “widgets” and that cost doesn’t exceed what would be paid to a non-affiliated company it would be an arm’s length transaction and a valid business purpose, said Todd Brysiak, executive director of the Policy Committee.
The Department of Revenue is trying to crack down on what it calls “sham transactions” aimed at avoiding payment of state income taxes, said Revenue Secretary Dan Meuser.
The department is relying on a 2004 Commonwealth Court decision, which referenced the Black’s Law dictionary, to guide its audit and enforcement actions, said agency spokeswoman Elizabeth Brassell. “A sham transaction is an agreement or exchange that has no independent economic benefit or purpose and is entered into solely for some illegitimate purpose, typically to avoid tax obligation,” Black’s Law says.
Interest and royalty payments are most often manipulated in sham transactions, Brassell said.
Meuser said Corbett places priority on finishing the state budget by June 30. That’s the top priority, Meuser said. Corbett is considering business tax reform that would lower the corporate net income tax but that might not happen until next year, Meuser said.
Pennsylvania’s corporate net income tax of 9.99 percent is the highest flat rate in the nation; Iowa’s is higher but fluctuates. In addition, “America has the highest corporate tax rate in the world,” said David Taylor, executive director of the Pennsylvania Manufacturers Association.
Companies are affected in vastly different ways by tax changes, and Taylor hopes lawmakers will adhere to the most important rule of “do no harm.”
Critics say Reed’s bill won’t produce enough revenue to pay for the proposed income tax cuts.
Reed argues that economic growth — as a result of lowering taxes — would erase any shortfall.