Tax Policy – Testimony: Oregon Should Conform to the Federal International Provisions under the Tax Cut and Jobs Act
Written Testimony to the House Committee
on Revenue, Oregon Legislature
Chairman Barnhart, Vice Chairs Smith and Smith Warner, and Members of the Committee:
My name is Nicole Kaeding, and I’m an economist and the Director of Special Projects at the Tax Foundation. For those unfamiliar with us, we are a nonpartisan, nonprofit research organization that has monitored fiscal policy at all levels of government since 1937. We have produced the Facts & Figures handbook since 1941, we calculate Tax Freedom Day each year, we produce the State Business Tax Climate Index, and we have a wealth of other data, rankings, and information at our website, www.TaxFoundation.org.
I’m pleased to submit written testimony on Senate Bill 1529, which updates Oregon’s conformity to the Internal Revenue Code (IRC). The bill updates Oregon’s conformity to the IRC on a number of topics, with the largest changes related to the taxation of income earned by multinational corporations. While I take no position on either bill, I do believe that Oregon bill SB1529 is the right approach to conformity on the international tax conformity.
Tax Conformity is Important
The enactment of federal tax reform has far-reaching implications on state tax codes. States such as Oregon rely heavily on the Internal Revenue Code, through a process known as conformity or coupling.
Conformity dramatically reduces the compliance costs of state tax collections. Taxpayers can use their federal 1040 as the basis of their state returns. While all states made modifications to federal adjusted gross income and federal tax income, taxpayers are saved time and energy by not duplicating initial calculations. Conformity also reduces the administrative costs for the state itself. It can define terms based on federal statute and use Internal Revenue Service guidance and publications to help interpret the state’s code. Conformity also makes state tax codes more uniform. Definitions, provisions, and tax treatments are similar across states, reducing compliance burdens for multistate filers, such as corporations.
For these reasons, conformity should be the goal of all states. No two states conform in the same way, but greater conformity should always guide state conversations.
The Taxation of International Income under the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act included a complete overhaul of the United States’ rules on the taxation of international income. Previously, the United States operated under a worldwide taxation system, meaning that U.S. firms paid income taxes in the country where the income was earned, but also paid taxes on the rate differential when the money was repatriated to the U.S. Given that the U.S. had the highest income tax rate in the industrialized world, this was a large deterrent to income back to the U.S. More than $2 trillion in profits were deferred overseas, prior to the Tax Cut and Jobs Act.
The Tax Cuts and Jobs Act corrected this issue. The U.S. now has moved towards a territorial taxation system, where income is only taxed in the country where it is earned.
However, the law also included several other provisions to limit base erosion, preventing abuse of the new system. The first, the Base Erosion and Anti-Abuse Tax (BEAT), is a functional alternative minimum tax of 10 percent on taxable income, limiting the ability of firms to profit shift out of the United States. The second, the Global Intangibles Low Tax Income (GILTI), creates a tax on foreign affiliates on income in excess of 10 percent of a company’s tangible overseas capital income. This limits the ability of U.S. firms to shift their intellectual property to low-tax jurisdictions to avoid domestic taxation. Finally, the Tax Cuts and Jobs Act created a that encourages U.S. firms to locate their intellectual property in the U.S., rather than overseas. (This provision is known as foreign-derived intangible income (FDII).) These three provisions, the BEAT, the GILTI, and the FDII, work together to limit base erosion and profit shifting to lower-tax jurisdictions.
The Tax Cuts and Jobs Act added an additional one-time deemed repatriation of overseas profits. Deferred profits are taxed at 15.5 percent for cash and liquid assets and 8 percent for illiquid assets. Firms have eight years to pay their deemed repatriation payments.
The Impact on Oregon from these International Changes
Oregon, like many other states, conforms to the federal definition of taxable income for C corporations. Because of this connection, the state is impacted by the overhaul of the international tax system contained in the Tax Cuts and Jobs Act. As noted previously, Oregon should work to maintain conformity to the definition of federal taxable income to limit compliance costs for both the state and its taxpayers.
SB1529’s approach of clarifying the interaction between the state’s dividends received deduction and its broader conformity of federal taxable income to ensure that multinational companies are not receiving a double deduction, resulting in negative income in Oregon, is a proper step. Updating conformity is important, and states should clarify that the conformity does not create inappropriate interactions with their state code.
Similarly, with the inclusion of the BEAT, GILTI, and FDII, Oregon’s tax haven law is unnecessary. These three provisions at the federal level work to limit base erosion and profit shifting among multinational companies and their affiliates. Oregon’s tax haven law duplicates the new federal provisions.
Finally, Oregon’s approach of dedicating any revenue from deemed repatriation to the rainy-day fund is a fantastic step that other states should copy. SB1529 directs the Oregon Department of Revenue to transfer the additional tax revenue to the state’s rainy-day fund. The state should be applauded for using this one-time money wisely; adding one-time money to a state budget is always a tempting choice, but it simply forces more difficult decisions in the future.
The federal Tax Cuts and Jobs Act has shifted the tax debate from Washington, D.C., to all fifty state capitals. States such as Oregon are trying to determine how best to conform to the litany of federal tax changes. Oregon’s SB1529 makes important changes to Oregon’s tax structure to properly conform with updated IRC, while maintaining appropriate protections such as dedicating any new tax revenue to the state’s rainy-day fund.
 For more information on conformity, its benefits, or other provisions of the Tax Cuts and Jobs Act, please consult the Tax Foundation’s broader resources on the topic. In particular, Jared Walczak, “Tax Reform Moves to the States: State Revenue Implications and Reform Opportunities Following Federal Tax Reform,” January 31, 2018, https://taxfoundation.org/state-conformity-federal-tax-reform/#7.
 Amir El-Sibaie, “A Repatriation Tax Holiday Sounds Fun, but Comes with a Hangover,” Tax Foundation, August 14, 2017, https://taxfoundation.org/repatriation-tax-holiday-hangover/.
Source: Tax Policy – Testimony: Oregon Should Conform to the Federal International Provisions under the Tax Cut and Jobs Act
Tax Policy – Tax Reform Moving Quickly in Georgia
Tax reform is finally on the table for Georgia, and the House has done its part to make sure it happens, passing a reform bill yesterday. After news broke that Georgia is set to receive an extra $5.2 billion over five years as a result of federal tax reform, the state has moved quickly to use the revenue to change its own tax code. In previous years, Governor Nathan Deal (R) had been hesitant to support an overhaul of the state’s tax code, but this year, he’s supporting HB 918.
HB 918 makes several notable changes. The bill gradually reduces the top individual and corporate income tax rate down from 6 percent to 5.5 percent by 2020. Standard deductions will also double for all taxpayers, up to $4,600 for single filers, $3,000 for married filing separately, and $6,000 for joint filers. The bill is estimated to cost about $5.7 billion over five years.
Georgia is surrounded by states with low or no individual income tax burdens, and this change will help boost the state’s competitiveness. Florida doesn’t levy an individual income tax, while Tennessee only taxes interest and dividend income at a rate of 3 percent. With North Carolina levying a rate of 5.499 percent and Alabama at 5 percent, the only neighboring state with a higher income tax rate than Georgia is South Carolina at 7 percent.
A state’s top income tax rate is generally associated with wealthy taxpayers, but in Georgia, the top rate kicks in at only $7,000 in income. That’s far below the state’s per capita income level of $42,159. This rate reduction, combined with the doubling of the standard deduction, will likely lower tax bills for most taxpayers in the state.
Lowering the individual income tax rate not only provides relief for individual taxpayers in Georgia, but for businesses, too. As I noted earlier this week, it’s important to remember that many businesses pay individual income taxes. These businesses, including sole proprietorships, partnerships, and S corporations, are structured as pass-through businesses, and pay taxes through the individual income tax code, not the corporate income tax. Lowering the rate would benefit both individual taxpayers and businesses in the state.
The reduction of the corporate income tax rate from 6 percent to 5.5 percent will also help the state compete for corporate investment. Florida, South Carolina, and North Carolina all levy a lower rate than Georgia, and North Carolina in particular is stiff competition – the state is recognized for its pro-growth tax code.
The Georgia bill passed the House on Thursday, 134 to 36. Similar legislation has previously passed in the Senate, and the governor supports the bill, so it doesn’t appear that it will face many obstacles before passage.
Sound tax policy is centered around the idea of broad bases and low rates, and the federal government has done the difficult work of broadening the base for states. Georgia is moving to do its part now to lower the rates. If the bill passes, Governor Deal and the Georgia legislature deserve credit for working to make the state more competitive, helping to attract new investment and provide tax relief across the state.
Source: Tax Policy – Tax Reform Moving Quickly in Georgia
Tax Policy – Idaho Tax Reform Bill Advances
Like most states, Idaho anticipates increased revenue under the new federal tax law, which broadens the state’s tax base. States effectively have three options: (1) do nothing and keep the money; (2) decouple or otherwise tinker with their codes to return the windfall to the taxpayers; or (3) conform with the changes while returning the excess to the taxpayers in the form of rate reductions or structural reforms. Idaho is taking the latter (and superior) route.
In January, the Idaho State Tax Commission estimated that conformity with the new tax law would increase state revenue by $97.4 million, due chiefly to the loss of the personal exemption, worth nearly $412 million in increased revenue. Idaho’s standard deduction and personal exemption both conform to federal levels, meaning that the state’s standard deduction will be $12,000 for single filers this year, up from an anticipated $6,500 (cost: $340.5 million), but the personal and dependent exemptions are eliminated (savings: $411.8 million). Restrictions on itemized deductions are projected to yield an additional $55.3 million.
Outside the higher standard deduction, Idaho’s largest revenue loser under tax conformity is the new pass-through deduction. Idaho is one of only six states with tax codes written in such a way as to incorporate the new federal deduction, which, as we’ve argued previously, is nonneutral and offers little economic benefit. Implementing this new tax preference for pass-through businesses will cost Idaho an estimated $30.8 million.
Recognizing that doing nothing would result in an unintended tax increase, Idaho policymakers, following the lead of Gov. Butch Otter (R), appear to be coalescing around House Bill 463, a plan which:
- Adopts a 0.475 percentage point across-the-board individual income tax rate cut;
- Incorporates the new, higher standard deduction;
- Follows the repeal of the personal and dependent exemptions;
- Creates a new $130 per child tax credit to offset the loss of the personal exemption; and
- Reduces the corporate income tax rate by 0.475 percent.
The bill passed the House and reported out of committee in the Senate on a 5-4 vote yesterday.
This plan involves a net tax cut of $104.5 million, as the reforms and rate reductions cost $201.9 million, while the additional revenue anticipated from federal conformity only runs $97.4 million. Not all states will be in a position to adopt a tax cut, but in Idaho, that opportunity exists. These changes would yield an improvement of three places on the corporate tax component of our State Business Tax Climate Index, which measures tax structure, and an improvement of two places on the individual income tax component. The variety of ways that states are likely to respond to federal tax reform makes such projections tenuous, however, because many other states are likely to implement changes as well.
Overall, House Bill 463 would represent an improvement to Idaho’s tax code, as it makes the state’s high tax rates more competitive and avoids an unlegislated tax increase. It could, however, be made even better by decoupling from the pass-through deduction, which confers little economic benefit, and instead conforming, in whole or in part, to a new federal provision called “full expensing,” which removes some of the tax code’s disincentives for domestic investment by allowing the cost of capital investment—like other business costs—to be written down immediately. Unlike the pass-through deduction, full expensing increases tax neutrality—consistent with the idea that the tax code shouldn’t pick winners and losers—and would make the state more competitive.
Tax reform, after all, is at least partly about leveling the playing field. The principle of neutrality represents the understanding that the goal of taxation is to raise revenue, not to engineer particular economic outcomes. At the federal level, tax reform has proven a generational event. At the state level, it need not be—but there is no time like the present to ensure that state tax codes are oriented toward economic growth. That’s something Idaho policymakers appear to recognize.
Source: Tax Policy – Idaho Tax Reform Bill Advances
Tax Policy – Oregon’s Chance to Limit a Flaw in the Federal Tax Code
Oregon has been at the center of state tax policy for the last several years: first, Measure 97, then the debate of creating a new business tax in 2017, followed by Measure 101 in January. This legislative session is no different. Oregon’s debate on how to tax pass-through businesses is a national flashpoint, and here, Oregon has the chance to lead.
The federal Tax Cuts and Jobs Act provided a generous 20 percent deduction for pass-through businesses. These are businesses that pay taxes on the individual side of the tax code, compared to C corporations. Proponents of pass-throughs argue that they represent small businesses, but that isn’t always the case. Some of the largest businesses are organized under this structure.
The deduction was predicated on growing small businesses. Instead, it adds complexity to the tax code, and encourages creative accounting to take advantage of the large deduction. The downsides of providing preferential treatment to pass-throughs became apparent during Kansas’s recent experiment, when individuals, including Kansas University men’s basketball coach Bill Self, restructured their financial holdings to benefit from the special tax treatment.
So why does this matter in Oregon?
Oregon is one of a few states that “couples” to this unneeded deduction. States like Oregon use the federal tax code as the basis of their tax code. This makes it easier for the tax filers, saving time and energy, and it reduces costs for the state. But Oregon’s connection to the federal tax code is unique. Oregon is one of only six states that would include this deduction in their state calculations.
Now, a bill championed by Senator Mark Hass (D), the chairman of the Senate Finance committee, would remove this provision from the Oregon tax code.
Conformity should be the goal of Oregon, but Oregon should not include this deduction—a clear example of bad tax policy—in its tax code.
It puts the state’s budget into jeopardy. The Legislative Revenue Office estimates that it would cost the state $192 million in tax year 2019.
Opponents of Senator Hass’s plan argue that this is a tax hike on Oregon businesses, an argument that stretches the imagination. No business currently receives this deduction in Oregon; preventing it from existing in the state doesn’t cause a tax increase.
Similarly, opponents argue that this would punish or disadvantage small businesses. First, pass-through businesses come in all shapes and sizes. Second, Oregon already provides a tax benefit to pass-throughs through lower tax rates. An individual in Oregon pays the state’s top income tax rate at $125,000 in income, while a pass-through doesn’t pay the 9.9 percent rate on its income until it has $5 million in income.
Finally, opponents are arguing that the limits on the pass-through deduction are being put in place to finance “corporate handouts.” The “corporate handouts” are allowing businesses—including pass-through businesses—to deduct their capital costs immediately. This is one of the best provisions in the Tax Cuts and Jobs Act, which will increase productivity and investment in the state, leading to higher wages and more job opportunities for Oregonians.
Senator Hass’s proposal to limit the special pass-through deduction in Oregon is the right choice, protecting the state’s budget, while advancing sound tax policy.
Source: Tax Policy – Oregon’s Chance to Limit a Flaw in the Federal Tax Code
IRS Tax News – Partnership audit adjustments addressed in proposed regs.
The IRS issued proposed regulations addressing how partnerships and their partners adjust tax attributes to take into account partnership adjustments under the new centralized partnership audit regime.
Source: IRS Tax News – Partnership audit adjustments addressed in proposed regs.