Could a tax credit system solve the franchise taxes commerce clause debate while limiting the amount of revenue the state loses?
Photo: Gov. Bill Lee, front, flanked by House Speaker Cameron Sexton, left, and Lt. Gov. Randy McNally, right. Photo Credit: John Partipilo
By Adam Friedman [Tennessee Lookout -CC BY-NC-ND 4.0] –
As Tennessee faces a tighter budget in 2024, Gov. Bill Lee’s administration plans to move forward with a significant tax cut and refund for businesses, selling it as a “necessary legislative fix” to avoid a legal challenge.
But not everyone agrees it’s necessary.
Peter Enrich, a state and local tax policy expert at Northeastern University’s School of Law, said Tennessee could implement a change to its business tax — officially known as the franchise tax — and doesn’t need to give out over $1 billion in refunds to some of the state’s largest businesses before a suit is filed.
“I don’t know of any example where, by merely uttering the threat to litigate, you should be able to collect everything you could possibly claim,” Enrich said. “It seems like a corporate giveaway by another name.”
Revenue department officials in Lee’s administration are telling the public they must implement the business tax cut because the way Tennessee collects it could violate a U.S. Commerce Clause provision, which the U.S. Supreme Court interpreted to ban states from discriminating against interstate businesses by subjecting them to the burden of multiple taxation on their income.
The interpretation isn’t new, dating back to a 2015 case where an income tax in Maryland was ruled illegal based on the commerce clause because the state didn’t offer deductions or credits.
Under the administration’s proposal, expected to be filed as legislation in the coming weeks, revenue officials estimate Tennessee will lose $400 million annually and could have to pay several years of refunds, costing between $1-$1.6 billion.
“It has the effect of providing tax relief to companies who have their property here,” David Gerregano, commissioner of the Tennessee Department of Revenue, said during a House finance committee meeting last week.
But Enrich said Tennessee’s other option is to implement a tax credit system that satisfies the commerce clause’s double tax issue and likely won’t result in billions of dollars in refunds.
Under Tennessee’s tax system, a business pays the franchise tax on 0.25% of either the value of its assets in Tennessee or of its state business’s net worth. Companies are required to pay whichever one would generate more tax revenue.
Many of the state’s larger companies pay the tax based on assets rather than net worth, which is the business tax state officials worry violates the commerce clause. This system primarily impacts companies with significant valuable holdings in Tennessee like airplanes, real estate or alcohol distilleries.
Enrich said Tennessee is one of a minority of states that taxes businesses based on a measure of property or net worth, so a tax credit system could satisfy concerns about multiple taxations while being unlikely to result in a significant reduction in tax revenue.
Tennessee Department of Revenue communications director Kelly Cortesi said tax experts with the department and the state attorney general’s office advised the administration to consider the change.
“We believe it is imperative to make this change now, and the administration’s proposed solution is the best way to address the challenge,” she said. “The state is well-positioned to enact this change now thanks to Tennessee’s long record of responsible fiscal management and our significant revenue increases from pre-pandemic levels.”
The revenue department did not respond to the Lookout’s asking if the state had discussed a credit system.
Business tax issue comes as revenue drop means tighter budget
The business tax proposal comes as the state’s revenues have flattened, and this year’s budget faces a significant shortfall; from May to December 2023, state revenue was down over $610 million from the budget amount.
Most of the financial issues surround business tax collections. Last year, lawmakers implemented a significant business tax cut, and through the first five months of the year, the franchise and excise taxes on businesses were $232.3 million short of the budgeted amount.
Jim Bryson, Tennessee Department of Finance and Administration commissioner, told lawmakers there is hope that continued sales tax collection growth could offset the drop in business tax.
The state sales tax remains strong, exceeding estimates despite a three-month moratorium on groceries from August to October 2023. But because of the issues with business tax collections, state officials have yet to comment on whether they will recommend another sales tax holiday this year.
Nashville Democrats move to rewrite franchise tax, other parts of the code
While the Lee administration pushes the franchise tax cut, Rep. Aftyn Behn, D-Nashville, and Sen. Charlane Oliver, D-Nashville, are moving ahead with a proposal to use increases in several business taxes to pay for a statewide Pre-K plan and eliminate the state’s portion of sales tax on groceries.
To pay for a Pre-K plan their legislation calls for a digital advertisement tax on companies selling more than $50 million in online advertisements in Tennessee. Meta (formerly known as Facebook), and Alphabet (commonly known as Google), both of which dominate the digital advertisement market, would be the primary payers of this tax.
To cover nearly $1 billion in lost revenue by eliminating the state sales tax on groceries, Behn and Oliver are proposing legislation to close several loopholes corporations use to lower taxes, by adopting the Worldwide Combined Reporting (WCR) method and a business enterprise tax.
The WCR method, nearly passed in Minnesota last year, aims to stop companies from using subsidiaries to hide state profits in off-shore countries or lower-tax states. The business enterprise tax, which New Hampshire enacted, creates an alternative minimum type tax so corporations can’t reduce their tax bills to zero. A report released by the Economic Policy Institute found that between 2016-2019, 62% of corporations in Tennessee paid no taxes.
“They won’t recognize the tax cut last year resulted in the revenue shortfall this year,” Behn said. “Then, during an election year, they have yet to say whether they will give the people something they wanted in the elimination of the grocery tax.
“Instead, it’s another business tax break to decimate our revenue base.”
