A New Theory of the State Corporate Income Tax: The State Corporate Income Tax as Retail Sales Tax Complement

Abstract

The state corporate income tax has been and remains a vital source of income for the states. The theoretical justifications for this tax, however, are weak and, as reasonably predicted based on its poor design, the state corporate income tax has been in decline as a source of state revenue for decades. Nevertheless, states have taken important steps to shore up their corporate income taxes. At least one of these major reforms, apportioning the state corporate income tax base on the basis of in-state corporate sales, was probably undertaken on the basis of implausible policy arguments. Despite the ad hoc (at best) nature of these reforms, they have changed the state corporate income tax for the better. An initial goal of this Article is to collect this positive news at a time when most fiscal news remains bleak.

The argument at the heart of this Article starts from the analytical observation (first made by Charles McLure) that these changes to the state corporate income tax have made the tax into an odd type of sales (consumption) tax. This Article then argues that this observation is important because this new corporate income tax is reaching sales on which no retail sales tax is due (e.g., most services) and sales on which no retail sales tax is generally remitted (e.g., sales made by certain internet retailers). This means that the new corporate income tax is acting not only like a sales tax, but as a complement to poorly designed state sales taxes. This Article argues that, assuming that states will not act directly to broaden their sales tax base, they can act to broaden their consumption tax base indirectly through their corporate income taxes.

Keywords: state corporate income tax, single sales factor, formulary apportionment, destination basis