Improving Business Taxes

There are three principal types of taxes that represent the majority of the tax burden on businesses in most states and regions: corporate income taxes, sales taxes, and property taxes. Typically, most income taxes and sales taxes are imposed at the state level, and most property taxes are imposed at the local level.

The Good News:

In most regions and communities, the largest source of local government taxes on businesses are property taxes.  Although there is a lot of focus on finding ways to reduce property taxes for homeowners in Pennsylvania, the fact is that Pennsylvania’s property tax system is actually a competitive advantage for businesses located in the state.

Why? It’s not that property tax rates are low (although on average, Pennsylvania’s property tax rates are about average among competitor states).

Pennsylvania’s advantage is that only land and buildings are subject to the tax. Other states tax machinery and equipment, inventories, vehicle fleets, and other items.

As a result, studies by the Pennsylvania Economy League of Southwestern Pennsylvania have shown that the effective rate of property taxes on businesses in Pennsylvania is at the bottom among competitor states, and is substantially lower than in either Ohio or West Virginia, the states adjacent to the Pittsburgh Region.

High property taxes are a problem for businesses, particularly young firms and businesses in cyclical industries, since they must be paid regardless of the business’s level of income or profits.  In many other states, local taxes – not state taxes – represent the majority of the tax burden on businesses.

Consequently, Pennsylvania’s property tax structure provides a significant cost advantage for businesses.

The Bad News:

Unfortunately, the advantages of favorable local business taxes are overshadowed by the problems with Pennsylvania’s state business taxes. State taxes represent the majority of the tax burden paid by businesses in Pennsylvania, and Pennsylvania’s major state taxes are extremely uncompetitive with other states:

• Pennsylvania’s Corporate Net Income Tax of 9.99% is now the second highest in the country and the highest of any major state.  One of the commonly used indicators of a state's business climate is its corporate net income tax, and Pennsylvania's high tax guarantees the Pittsburgh Region a low ranking on many business climate indexes.

• Pennsylvania is one of a minority of states to impose a Capital Stock and Franchise Tax in addition to the Corporate Net Income Tax.  Pennsylvania's combination of a high corporate net income tax and a capital stock and franchise tax makes the state doubly uncompetitive for businesses.  Although manufacturing operations are exempt, most businesses pay the tax on a portion of their operations, and service firms and many types of technology firms are heavily burdened by the tax.

• Pennsylvania is now one of only two states with a cap on net operating loss carryforwards.  Every state recognizes that if a business loses money one year, and makes money the next year, it is unfair to base its tax just on the year in which it is generating income.  So states allow business to carry forward their operating losses from one year into future years.  However, Pennsylvania limits the amount of losses a business can carry forward to $2 million, while every other major state puts no limit on the carryforwards.  This cap makes many manufacturers as well as fast-growing technology startup firms uncompetitive with similar firms in other states.

• Pennsylvania’s Corporate Net Income tax apportionment formula is falling behind other competitor states. All states have formulas for determining how much of a multi-state company's income should be apportioned to that state.  The formulas are based on a combination of sales, property, and payroll. Pennsylvania bases only 60% of its formula on sales, whereas a growing number of states base the formula solely on sales – what is called “a single sales factor” formula.  This means that firms with plants and employees in Pennsylvania would save taxes if they move jobs out of Pennsylvania!

Action Agenda

The following changes to Pennsylvania’s Corporate Net Income tax are needed to make the state more competitive:

Continue the phaseout of the state Capital Stock and Franchise Tax

The Capital Stock and Franchise Tax is currently being phased out by 1 mill per year until it is eliminated in 2011. This will be a major improvement in the state’s competitiveness for those firms that pay the tax, especially business service firms that do not qualify for exemptions. However, the phaseout has already been delayed twice from the original schedule, reducing the potential benefit for competitiveness, and causing Pennsylvania’s tax structure to be seen as unpredictable as well as uncompetitive.

Reduce the Corporate Net Income Tax to 8.5%.

Pennsylvania should reduce the Corporate Net Income tax to the 8.5% level that existed in 1987-1990.  This would bring the rate into a range that would be competitive with many other states.  In order to reduce the impact on the state budget, this reduction could be phased in over a three-year period.

Remove the cap on carryforward of net operating losses.

Pennsylvania should join all of its competitor states by eliminating the $2 million cap on the amount of net operating losses (NOLs) that can be carried forward to future tax years.

Raise the sales factor weighting in the income apportionment formula for the CNI Tax to 100% from the current 60%.  

Pennsylvania should remove the penalty that currently exists on firms for creating jobs in the state by using a single sales factor apportionment formula.

Unfortunately, in December 2005, Governor Rendell vetoed legislation passed by the Pennsylvania General Assembly that would have raised the cap on net operating loss carryforwards and increased the sales factor in the apportionment formula. This was a major setback for efforts to improve the business climate of the Pittsburgh Region.  For more details, click here.

To join a coalition working to address these problems, visit CompetePA.com.