September 13 , 2007 . . . . . . . . . . . . . . . . . . read Eric Zorn's Tribune column
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All but one of the purported "loopholes" have been suggested by Governor Blagojevich in prior years, and all of them have been rejected by the Illinois legislature in this and prior years. These proposals are in addition to the significant anti-business proposals pursued by Governor Blagojevich and enacted in 2004--not to mention yet another $300 million in additional employer taxes already enacted this year. All in the name of making business pay its "fair share."
The truth of the matter is that employer taxes account for almost 50% of the total state and local taxes collected by all Illinois state and local governments in FY 2006 and that percentage continues to rise. From 2002 to 2006, corporate income taxes grew by 73.5%. Franchise and business license taxes grew by 86.6%. Property taxes on business went up by 38.2% and unemployment and workers compensation taxes went up by 53.5%.
Many of the tax law changes branded a “loophole” are, in fact, critical components of a business tax climate that allows Illinois companies to aggressively compete in the global economy. Each of these tax laws was designed to improve and enhance the Illinois economy by encouraging employers to increase investment in people and property in our state. Each helps keep the cost of doing business in Illinois competitive with other states. All serve a legitimate and necessary business purpose. Following is an explanation of the Governor's business tax proposals.
1. "Include Puerto Rico and Outer Continental Shelf in definition of U.S."
Background: Illinois requires corporations that are engaged in a unitary business to compute their Illinois income tax liability on a combined basis; that is, by treating multiple corporations who operate related businesses as a single taxpayer. Illinois is considered a "water's edge" state since current law generally requires the taxable income of all unitary group members to be included in the Illinois return, except for the taxable income of companies that conduct more than 80% of their business activities outside the United States (referred to as the "80/20 test"). Current law defines "United States" to include only the 50 states and the District of Columbia as does the federal Internal Revenue Code. The combined taxable income of all the corporate members is then apportioned or divided between the 50 states using the single sales factor apportionment method -- multiplying all taxable income of the group by a ratio established by comparing sales in Illinois to total sales in the United States. The Governor's proposal would expand the definition of "United States," for corporate income tax purposes, to include Puerto Rico and all U.S. possessions and territories. This would result in the taxable income from companies doing more than 80% of their business in Puerto Rico or a U.S. territory or possession being included in the Illinois unitary group's apportionable tax base.
The Governor's rhetoric suggests that companies engaging in manufacturing activities in Puerto Rico and other U.S. possessions do so to illegally avoid taxes. While many types of businesses incorporate outside the United States for many different reasons, many were actually encouraged to do so by the federal government. Many years ago the federal government recognized the fact that the U.S. needed to do something to create jobs in poverty stricken Puerto Rico and other U.S. possession islands. To accomplish that goal, the federal government enacted IRC Sec. 936 legislation that exempted manufacturing income earned in Puerto Rico from U.S. taxation. The tax benefits received were one of the more significant reasons that investments were made by U.S. businesses in Puerto Rico and possession islands rather than in other foreign countries. The sunset of this federal law in 2005 resulted in an exodus of many of those companies from Puerto Rico as Puerto Rico could no longer compete against more cost effective foreign (Caribbean and Central/South American) locations. The Governor's proposal would now impose Illinois income tax on income earned by the remaining manufacturing companies located in Puerto Rico which would only encourage a faster exodus to foreign locations so, in the long run, Illinois won't see these tax dollars for very long. Meanwhile, the United States will continue to have a special obligation for the economic situation of the people of Puerto Rico and other U.S. possessions that will translate into U.S. taxpayer supported programs and expenditures for the islands.
2. "Require income tax withholding on gaming winnings over $1000 from non-residents."
The Illinois Chamber has no position on this proposal as the primary impact is on individuals and not businesses.
3. "Return to 3 Factor income tax apportionment for non-service companies (or repeal single sales factor apportionment)."
Background: As noted above, the Illinois income tax uses as a tax base all of the combined taxable income of related corporate members doing business in more than one state and then apportions or divides that income between the states in which the companies do business using the single sales factor apportionment method -- that is, it multiplies all taxable income of the group of corporations by a ratio established by comparing sales in Illinois to total sales in the United States. Prior law used a ratio of payroll, property and sales in Illinois as compared to payroll, property and sales everywhere else in the United States.
The Illinois Chamber of Commerce actively supported the 1998 legislation to adopt “single sales factor” apportionment in Illinois. This legislation removes a corporate tax penalty for Illinois-based companies that increase their investment in Illinois payroll and property. It also encourages out-of-state companies that are currently exploiting the Illinois consumer market to increase their investment in Illinois to the benefit of all Illinois taxpayers. We view the single sales factor legislation as a critical economic development tool for the State of Illinois.
A repeal of single sales factor legislation rewards out-of-state companies with a significant Illinois tax reduction while penalizing Illinois-based companies with a substantial tax increase. Illinois companies already contribute to the economy through property tax, sales tax, motor fuel tax, utility taxes, and a myriad of other taxes and fees, as do their employees. Out-of-state companies who profit from the Illinois marketplace and directly compete with Illinois businesses should also pay their fair share of corporate income tax.
Business investment in Illinois is the single best way to create new jobs, spur the economy and increase government revenues. Single sales factor apportionment encourages investment in Illinois without unduly decreasing revenues to the State. Estimates of the perceived “cost” of single sales factor apportionment of which the Chamber is aware, are based on numbers projected from 1998 and 1999. They are not based on actual and current tax return information and, more importantly, do not take into account new investment in Illinois—the very goal of the single sales factor legislation.
Other states are aggressively pursuing single sales factor apportionment while Illinois has benefited by being a leader in adopting it. Currently only 10 states have an equally weighted standard 3 factor apportionment formula. Twenty states now double weight the sales factor and thirteen states either have single sales factor or are in the process of phasing it in. Repealing the single sales factor formula as more and more states are moving to adopt it will only make Illinois’ business climate less competitive.
4. "Decouple from 2004 QPAI (qualified production activities deduction) federal tax legislation."
Background: This proposal refers to the federal enactment of the "qualified production activity income" (QPAI) deduction. It is part of a federal tax law program that is intended to encourage domestic investment by providing taxpayers that perform certain activities (manufacturing, film production, production of electricity, natural gas, & potable water; or construction, engineering and architectural services, for example) in the U. S. with a tax incentive to continue and increase those activities here as opposed to overseas.
The Governor proposes that we "decouple" from the federal tax provisions and eliminate the Illinois tax benefit that was automatically created when federal taxable income --the starting point for computing Illinois taxable income-- was reduced by the federal QPAI deduction. The Illinois Chamber believes it is important to encourage businesses to locate and maintain business activities in the United States and, in particular, in Illinois. Accordingly, we oppose efforts to remove tax benefits that encourage companies to locate in our state.
The impact on economic development of repealing this deduction should not be ignored. Of the surrounding states, only Indiana has repealed the QPAI deduction. All other surrounding states have chosen not to do so. Retaining the federal QPAI deduction is a significant means of promoting in-state manufacturing jobs at a time when businesses are looking to reduce costs and are weighing increased investment in Illinois against opportunities and costs available in other states or nations.
5. "Repeal deductions for foreign and domestic dividends received by corporations."
Background: At the federal level, the purpose of the dividend received deduction (DRD) is to prevent multiple layers of corporate level income tax from being imposed on the same underlying earnings or income. For example, earnings of a domestic subsidiary are taxed when earned by the subsidiary and, if not for the DRD, the same earnings would be taxed a second time when distributed to the parent corporation as a dividend. The DRD prevents pyramiding of income tax. Since Illinois adopts federal taxable income as the starting point for computing Illinois corporate income tax, domestic dividends have already, and automatically, been deducted from the Illinois income tax base. On the flip side, no federal DRD is allowed for dividends received from a foreign affiliate because there is no risk of double taxation--the foreign affiliate's income/dividends have not been taxed in the U.S. before they are received here. Dividend income from foreign corporations 80% owned and controlled by a U.S. parent receive an 85% federal DRD and the parent receives a foreign tax credit on the repatriated earnings on which local taxes were previously paid.
The Governor's proposal would eliminate any DRD for both domestic and foreign corporations taxable in Illinois. Since the U.S. Supreme Court has struck down DRD schemes that favor domestic dividends over foreign dividends, (See Kraft Gen. Foods, Inc. v. Iowa Dept. of Revenue, 505 US 71 (1992)) as a violation of the commerce clause, there is no option to tax only foreign dividends and leave domestic dividends deductible. The end result is that there will be pyramiding of income tax on domestic dividends but not on foreign dividends. That makes foreign dividends more attractive and further encourages companies to move manufacturing operations to foreign locations. For purposes of economic development in Illinois, this proposal is a serious negative as most states currently allow both a domestic and foreign dividend received deduction. It also encourages foreign takeovers of U.S. based multinational companies, since a company will retain more of its profits if dividends are only taxed once. While more tax dollars will be earned initially as a result of the Governor's proposal, in the long run the state's economy will sustain another serious blow.
6. "End deduction for company owned life insurance."
This proposal would decouple from federal income tax laws and require Illinois companies to report as taxable income the gain on any company owned life insurance policy after allowing a deduction for premiums paid by the employer. It would increase the tax liability of small companies who carry life insurance on key employees at a time when the business is necessarily recovering from a catastrophic event.
7. "Tax canned software which is subject to written license agreement."
The Governor proposes creating a new lease tax on computer software which will lead to the outsourcing of technology jobs. Illinois tax treatment of leased business software is an important incentive for investment in technology and high-tech jobs. Repealing this tax treatment will create a powerful incentive to move tech jobs to low cost countries like India. This proposal would tax custom business software applications that are licensed to Illinois businesses--not sold to them.
8. "Extend the insurance tax to industrial insurance."
This is a new proposal that we are still looking into. We will provide more information when we have completed our review.
9. "Repeal the exemption for fuel transported to out of state destinations."
Current Motor Fuel Tax laws provide that the tax is due on motor fuel used in Illinois, but because of constitutional limitations, the tax cannot be imposed on transactions in interstate commerce--i.e., fuel that is delivered to an out of state location. The state in which the fuel is used has the right to impose a motor fuel tax on such sales. The Governor proposes to circumvent the constitutional limitations by altering the very nature of the motor fuel tax from a tax that is imposed on Illinois sales or use of motor fuel to one that is imposed on fuel "received" in Illinois by a distributor. The end result is that all fuel received in Illinois or passing through Illinois in a pipeline will be subject to Illinois motor fuel tax. Distributors incurring the new tax will likely pass the tax on as an increase to the cost of fuel sold both to Illinois and out of state users which will further increase the cost of a gallon of fuel. It will also result in decisions to locate future pipeline and refineries in other states where no additional tax is imposed.
10. "Cap the amount of sales tax revenues large retailers are allowed to keep."
Retailers are allowed to keep 1.75% of the sales taxes they collect for state and local governments to cover costs incurred by them in collecting those taxes. Twenty-seven states currently offer retailers’ discounts because they recognize that there are real economic costs to business that arise out of tax collection duties.
The current exemption is actually inadequate--the discount allowed Illinois retailers only covers about half of the actual cost of collecting State and local sales tax. A PriceWaterhouse study conducted in 1990 reported a national average cost estimate of 3.48% of total sales tax liability. Non-reimbursed costs are absorbed as costs of doing business and/or are passed on to consumers in increased prices. Legislation that would eliminate or reduce the retailer’s discount would force businesses to absorb more than half the cost of collecting sales tax on behalf of the government!
The retailers’ discount is not a tax loophole, but a legitimate (and only partial) reimbursement of costs to retailers who collect taxes on behalf of the State. Retailers acting as involuntary tax collection “agents” of the State must incur costs associated with determining the proper amount of tax to charge depending on the geographic location, type of product, payment arrangements, rate and appropriate tax base. They must consider the appropriate state and local rate and be aware of product exemptions, entity exemptions and use exemptions. Retailers have extensive record keeping requirements and multiple filing and payment obligations and deadlines. Simple human error can result in the assessment of substantial penalties and interest. Legitimate differences of opinion on the proper interpretation of a tax law can result in additional litigation and appeal costs.
SUMMARY: It is appalling how little concern the Blagojevich administration appears to have about the economic consequences to their preferred tax policies. If adopted, Governor Blagojevich’s policy choices: 1) ignore federal tax law and economic incentives for U.S. employers established by the Congress, 2) disrupt and distort interstate commerce regarding motor fuel, 3) disregard the economic development value of maintaining a competitive and level playing field when tax administration and incentives are compared, 4) demonstrates amazingly little sympathy for the retailer’s compliance burden and risk, 5) ignores the magnitude of employers’ current tax and fee liability and 6) deny that the total cost of doing business should be of sufficient concern that employers might actually make business investment decisions to avoid or limit exposure in Illinois.