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Make Nike Happy, but Fix the Department of Revenue

December 17, 2012


Patrick Emerson PhD ,
OSU Economist
Oregon Economics Blog

It is a great pleasure to welcome back Fred Thompson of Willamette University with this guest post on the Nike deal. I have been simply too busy to do this blog and many recent Oregon policy topics (like this one) justice so Fred’s contribution is both timely and very welcome.

Governor Kitzhaber has called the state legislature into special session to give him the authority to make special guarantees to big employers to stabilize their tax structures for specified periods.

This proposal is addressed to an arcane aspect of corporate income-tax policy called apportionment. Apportionment determines how much of a multi-state business’s income is subject to in-state taxation. Most states apportion corporate tax liabilities on three factors: in-state revenue, employment, and assets. For example, if a business earned 5 percent of its revenue, employed 25 percent of its payroll and located 45 percent of its investment in plant and equipment in Oregon, 21 percent of its total income would be subject to Oregon taxes. Recently Oregon changed its corporate tax structure to apportion it on a single factor: revenue. In the example I just cited, only 5 percent of the business’s income would be subject to in-state taxes. The reason Oregon abandoned three-factor apportionment is that it taxes and, thereby, discourages two things that we want to promote: employment and productive investment.

How is single-factor apportionment working for us? Evidently, fairly well. Since Oregon moved to single-factor apportionment, it has outperformed nearly every other state. In fact, only North Dakota’s inflation-adjusted gross state product (GSP) increased faster than Oregon’s during this period. Moreover, Oregon has gone from a middling state in manufacturing to number one, measured in terms of the rate of growth in manufacturing plant and equipment and as a share of value-added GSP. I cannot say that the shift to single-factor apportionment caused these changes, but it certainly didn’t hurt.

Single-factor apportionment has one important drawback. It is associated with greatly reduced corporate income-tax collections – typically on the order of fifteen to forty percent; the higher the tax rate, the bigger the drop. The reason is simple. Single-factor apportionment makes it easy for businesses to bamboozle state tax collectors. One doesn’t have to be very sharp to count employees or buildings. Accurately measuring revenue, especially where businesses hire legions of accountants and lawyers to minimize their tax liabilities, is tough. As a result, although in theory moving from three-factor to single-factor apportionment ought to be revenue neutral, in practice it is not. Consequently, public employee unions, education activists and other groups are pushing to restore three-factor apportionment. This agitation has made Nike and other big employers nervous. Governor Kitzhaber wants to reassure them that they won’t be punished for locating in Oregon.

On balance I think the Governor’s proposal has a lot of merit. But it has two big flaws. The first is that it is discretionary. That means that the Governor would have the authority to make the best possible deal for the people of Oregon. It also means that he would have the authority to make the best possible deal for himself or his party. There is a reason why we prefer our tax rules to be universal and transparent; this proposal violates those reasons. This flaw is easily fixed.

Second, the shift to single-factor apportionment should have been accompanied by an upgrade of tax administration. Most observers believe that Oregon could increase tax payments $450 million a year through better enforcement of the tax code, a fourth of which is due to avoidable underreporting of business income. The state doesn’t have to make reporting requirements more onerous or interactions with taxpayers nastier to collect these taxes. It has the data it needs. What it lacks is the information technology and the sophistication to use that data effectively. For fifteen years upgrading the Department of Revenue’s systems and procedures has been placed on the back burner. It is ironic that the same day the governor asked for authority to reassure employers about its tax policy, it was announced that modernization of the Department of Revenue’s information systems had been deleted once more from the Governor’s budget.

Give the Governor and Nike what they want, but the real priority ought to be upgrading the state’s tax administration. The policy and administration issues are directly linked. Unfortunately, this governor seems more interested in policy than administration. It took him over a year to appoint a successor to Elizabeth Harchenko after she retired as director of the Department of Revenue.

  
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