(The Center Squre) – As part of his newest budget proposal, Gov. Josh Shapiro suggested accelerating an ongoing reduction of Pennsylvania’s corporate net income tax. While that sounds like a good idea for the state’s economy, it appears to come with some strings attached – ones that likely won’t sit well with many of the state’s businesses.
“During my campaign, I heard from the Chamber [of Business and Industry] and countless businesses across Pennsylvania who wanted to see faster cuts to the corporate net income tax – and that’s exactly what this budget does,” said Shapiro during his Feb. 4 address. “Let’s be more aggressive and speed up these tax cuts by two whole years so that we can compete more effectively and unleash our commonwealth’s full potential.”
His plan would reduce the 7.99% tax rate, called CNIT for short, by 0.75% annually, instead of the current 0.5%, which would get the rate to 4.99% in 2029, instead of the original plan of 2031.
The CNIT is paid by corporations on the profits they make in Pennsylvania.
It’s no secret Pennsylvania’s tax environment has made it less competitive with other states, including some of our neighbors. That’s why the General Assembly and then-Gov. Tom Wolf in 2022 agreed to reduce the rate, which had been the second-highest in the nation.
During the past several years, the commonwealth has failed to attract several major corporations or projects to the state. Many ended up in neighboring states, such as an Intel computer chip plant that will be built in Ohio and Amazon’s east coast headquarters that was built in Virginia — both of which would have brought billions in new economic development to Pennsylvania.
The commonwealth’s CNIT, at a rate of 9.99% when those two projects were being considered, is believed to have been a factor in both decisions.
An economic analysis conducted by the U.S. Census Bureau’s Center for Economic Studies in 2017 found that when state tax rates increase, corporate entities reduce the number of establishments per state, the number of employees and the amount of capital invested per facility. Additionally, they found that increases in state tax rates frequently prompted companies to reallocate business activity to lower-tax states.
Supporters of the CNIT reduction point out that, given those findings, it’s more than likely that when one state’s tax rate remains high while other states reduce their rates, the number of business locations, investments, and jobs in the high-tax state will decline.
Since the 2022 CNIT agreement, some legislative Republicans have introduced bills to speed up the rate reductions, but those bills failed to gain enough support to get to the governor.
Cutting two years off the time frame to get the rate to 4.99% is still not nearly as fast as many Republicans would prefer, but it’s still quicker than the current rate reduction schedule.
However, the governor has indicated he wants something in return for the more rapid rate reduction.
“While we speed up those cuts, let’s make our tax system simpler, more modern, and more streamlined to spur even more economic growth,” said Shapiro, whose budget proposal tacks on the requirement of combined reporting, which would have all Pennsylvania corporations combine their profits from all of their subsidiaries, including ones that operate outside of the state, to determine taxable income.
Combined reporting has been a Democratic proposal for years in Harrisburg, but it has never gained traction with Republicans. Even with the continued reduction of the CNIT factored into the administration’s calculations, Shapiro’s budget anticipates $264 million in additional CNIT revenue when including the change to a combined reporting policy. Shapiro also ties to the CNIT reduction the inclusion of financial institutions in the CNIT tax base. That wouldn’t begin until 2026, so the impact of that change on revenue estimates for the coming fiscal year is limited.
“We were already on the path to the reduction of the CNIT that we had negotiated with Gov. Wolf,” said Sen. Scott Martin, R-Strasburg, chair of the Senate Appropriations Committee, responding to the governor’s budget address. “The piece we really need to talk about is the combined reporting aspect, which basically puts that at a whole different level for what it all means for a lot of folks in our business community. I’m sure you’ll be hearing from a lot of those who would be impacted by that.”
Historically, the state’s CNIT rate that’s hurt the state’s competitiveness and does “more damage to us trying to grow the state,” Martin added.
In a later press release, the senator expressed concern about various revenue estimates made by Shapiro’s budget, including $3.7 billion in additional net revenue from the CNIT phasedown acceleration. When coupled with combined reporting, Martin suggested it was a sizable exaggeration.
Advocates for combined reporting claim it would close what they call the “Delaware loophole,” which they say allows Pennsylvania corporations to avoid paying the CNIT by transferring assets to Delaware holding companies, resulting in tax at lower rates.
In simplistic terms, a corporation located in Pennsylvania had been able to establish a Delaware investment holding company as a subsidiary to hold its intangible assets, such as intellectual property like patents, trademarks and trade names. These intangible assets could be contributed tax-free to the subsidiary, which would then be the legal owner of the property. The Pennsylvania parent could then shift revenue – and profits – to its Delaware subsidiary by paying licensing fees for the right to use that intangible property, like the use of a trademark, but at a lower tax rate than Pennsylvania’s CNIT rate.
However, that so-called “loophole” was effectively closed starting Jan. 1, 2015, by Act 52 of 2013. Act 52 included provisions to require the add-back to income of intangible expenses – including interest expenses directly related to intangible expenses – on transactions with affiliated entities.
According to the Pennsylvania Chamber of Business and Industry, these provisions within Act 52 resulted in an annual increase of $60 million to $80 million in tax collections.
Additional Pennsylvania tax rule adjustments in 2022 changed the sourcing for sales of certain intangible property to where the benefit is received instead of where the activity is performed. Those 2022 alterations also included the state’s economic nexus rules, which were adjusted to require corporations with no physical presence in Pennsylvania but sales of $500,000 or more sourced to Pennsylvania to file a CNIT return. Those changes increased state tax revenue by about $200 million, according to the chamber.
While supporters of combined reporting argue that it is the best way to combat corporate tax avoidance, critics point to studies illustrating that it does more harm than good.
A 2010 analysis by the National Conference of State Legislatures, or NCSL, found “combined reporting has no direct effect on state tax revenues.” The study indicated there was “no evidence that combined reporting enhances tax revenues,” and instead produced a small decrease because of a negative impact on the gross domestic product of states with high corporate tax rates. The findings did note there may be a small increase in corporate tax revenue in lower tax rate states, though in every instance – regardless of tax rate – combined reporting comes with “the cost of a modest decrease in the size of the state’s economy.”
Additionally, the chamber argues that combined reporting would significantly increase the cost and complexity of filing tax returns and uncertainty in tax collection forecasts, produce more tax appeals and litigation, and create a disincentive for multi-state firms to do business in Pennsylvania.