Tax Reform & Its Relevance to Tax Reform & Its Relevance to High Tech Businesses:High Tech Businesses:The State PerspectiveThe State Perspective

Joe HuddlestonJoe HuddlestonExecutive DirectorExecutive Director

2222ndnd Annual SJSU/TEI High Technology Tax Institute Annual SJSU/TEI High Technology Tax InstitutePalo Alto, CaliforniaPalo Alto, California

IntroductionIntroduction

► What is the Multistate Tax What is the Multistate Tax Commission?Commission?

► Why Business Tax Reform?Why Business Tax Reform?

► Fundamental Federal Tax Reform & Fundamental Federal Tax Reform & the Statesthe States

► ConclusionsConclusions

What is The Multistate Tax What is The Multistate Tax Commission?Commission?

► The Multistate Tax Commission was The Multistate Tax Commission was established in 1967 to —established in 1967 to —

Preserve states’ tax sovereignty.Preserve states’ tax sovereignty. Promote uniformity and compatibility in tax Promote uniformity and compatibility in tax

systems. systems. Facilitate the proper determination of the Facilitate the proper determination of the

state and local tax liability of multistate state and local tax liability of multistate taxpayers.taxpayers.

Facilitate taxpayer convenience and Facilitate taxpayer convenience and compliance.compliance.

Avoid duplicative taxation.Avoid duplicative taxation.

What is The Multistate Tax What is The Multistate Tax Commission? (cont.)Commission? (cont.)

► Forty-six states, plus the District of Columbia, Forty-six states, plus the District of Columbia, participate in the Commission.participate in the Commission.

► The Commission speaks with a strong voice to The Commission speaks with a strong voice to Congress and the courts on the need to Congress and the courts on the need to preserve the legitimate tax authority of the preserve the legitimate tax authority of the States from unwarranted federal intrusion.States from unwarranted federal intrusion.

► The Commission recommends uniform tax The Commission recommends uniform tax policies and practices to improve the efficiency policies and practices to improve the efficiency and fairness of state tax systems for both and fairness of state tax systems for both taxpayers and the States.taxpayers and the States.

Multistate Tax Commission Multistate Tax Commission MembershipMembership

Why Business Tax Reform?*Why Business Tax Reform?*

► Business taxes are a significant portion of Business taxes are a significant portion of state and federal tax revenuestate and federal tax revenue

► The design of the current system of The design of the current system of business taxation is widely seen as flawedbusiness taxation is widely seen as flawed

► Business tax reform is a part of the Business tax reform is a part of the discussion about overall tax reformdiscussion about overall tax reform

*This slide and the next are drawn from Highlights of GAO-06-1113T, *This slide and the next are drawn from Highlights of GAO-06-1113T, Statement of David M. Walker, Comptroller General of the United States to the Statement of David M. Walker, Comptroller General of the United States to the U.S. Senate Committee on Finance, U.S. Senate Committee on Finance, BUSINESS TAX REFORM - Simplification BUSINESS TAX REFORM - Simplification and Increased Uniformity of Taxation Would Yield Benefitsand Increased Uniformity of Taxation Would Yield Benefits , Sept. 20, 2006. , Sept. 20, 2006. Notably, this otherwise excellent discussion of U.S. business tax reform does Notably, this otherwise excellent discussion of U.S. business tax reform does not mention state business taxation.not mention state business taxation.

Why Business Tax Reform? Why Business Tax Reform? (cont.)(cont.)

► States have the same reasons as the federal States have the same reasons as the federal government to reform business taxes:government to reform business taxes:

Some features of current business taxes Some features of current business taxes channel investments into tax-favored channel investments into tax-favored activities and away from more productive activities and away from more productive activitiesactivities

Complexity in business tax laws imposes Complexity in business tax laws imposes costs of its own, facilitates tax shelters, costs of its own, facilitates tax shelters, and provides cover for cheatingand provides cover for cheating

Confidence in the fairness of the tax Confidence in the fairness of the tax system —and thus voluntary compliance system —and thus voluntary compliance — is reduced— is reduced

Why Business Tax Reform? Why Business Tax Reform? (cont.)(cont.)

► But states have even more But states have even more compelling reasons to engage in compelling reasons to engage in business tax reform efforts:business tax reform efforts:

Business tax reform in neighboring Business tax reform in neighboring states; and states; and

Federal business tax reformFederal business tax reform

Fundamental Federal Tax Fundamental Federal Tax Reform & the States*Reform & the States*

► State income taxes, for both individuals and State income taxes, for both individuals and corporations, are heavily reliant on the structure corporations, are heavily reliant on the structure of the federal income tax and largely conform to of the federal income tax and largely conform to many features of the federal tax basemany features of the federal tax base

► 46 states and the District of Columbia impose a 46 states and the District of Columbia impose a tax at the corporate or business entity level that tax at the corporate or business entity level that uses net income as at least part of the baseuses net income as at least part of the base

► All of these states effectively use federal All of these states effectively use federal taxable income as the starting point for state taxable income as the starting point for state tax computationstax computations

*This slide and following rely heavily on Harley T. Duncan’s testimony before *This slide and following rely heavily on Harley T. Duncan’s testimony before the President’s Advisory Panel on Federal Tax Reform on April 18, 2005.the President’s Advisory Panel on Federal Tax Reform on April 18, 2005.

Fundamental Federal Tax Fundamental Federal Tax Reform & the States (cont.)Reform & the States (cont.)

► State tax base must necessarily follow State tax base must necessarily follow federal basefederal base

Taxpayer compliance & burdenTaxpayer compliance & burden Reliance on federal compliance systemsReliance on federal compliance systems No 3No 3rdrd party reporting systems party reporting systems

► Basic Premise: Without a federal income Basic Premise: Without a federal income tax, there can be no broadly-based state tax, there can be no broadly-based state income taxincome tax

Fundamental Federal Tax Fundamental Federal Tax Reform & the States (cont.)Reform & the States (cont.)

► A framework for analyzing federal reform A framework for analyzing federal reform proposals and their state tax implications:proposals and their state tax implications:

Conformity impacts — what are the Conformity impacts — what are the structural effects on state tax base?structural effects on state tax base?

““Crowding out” impacts — to what degree Crowding out” impacts — to what degree does federal taxation move into traditional does federal taxation move into traditional state tax areas?state tax areas?

Sovereignty impacts — what is the effect Sovereignty impacts — what is the effect on state tax authority and what range of on state tax authority and what range of options are left to the states?options are left to the states?

Opportunity impacts — what avenues Opportunity impacts — what avenues might be opened for improving state tax might be opened for improving state tax systems?systems?

ConclusionsConclusions

► Business tax reform requires Business tax reform requires structured dialogue to assess structured dialogue to assess interaction with and impact on other interaction with and impact on other elements of overall tax system and to elements of overall tax system and to foster opportunities for improvementfoster opportunities for improvement

► This is especially true in respect of This is especially true in respect of intergovernmental aspects, i.e., state-intergovernmental aspects, i.e., state-federal. federal.

Conclusions (cont.)Conclusions (cont.)

► Fundamental federal tax reform could Fundamental federal tax reform could substantially alter state tax bases and substantially alter state tax bases and authority; federal changes authority; federal changes will will occasion state-level changesoccasion state-level changes

► Any restructuring or simplification of Any restructuring or simplification of the federal tax system must take the federal tax system must take potential impact on state taxes into potential impact on state taxes into account, otherwise state reactions account, otherwise state reactions may negate any benefit of federal may negate any benefit of federal reformreform