Combined reporting levels the tax playing field for local businesses

Should a local, DC-based business pay higher tax rates than a branch of a national retailer?

Of course, the answer is no. But that is precisely what has been happening. National corporations can employ complicated tax-avoidance strategies to artificially shift profits they earn in DC to places with lower taxes or no taxes at all. That gives them a distinct and unfair advantage over local DC businesses.

Last summer, the District approved an important reform to its corporate income tax, known as “combined reporting.” Economists and tax experts agree that this is the most comprehensive way to stop corporations from abusing tax shelters. DC’s Chief Financial Officer has concluded the law, which goes into effect in 2011, will raise $20 million in revenue annually.

Combined reporting addresses this practice by combining the profits from the parent company and its fully-owned subsidiaries for state income tax purposes. To determine the amount of corporate tax, there is a formula based on the percentage of business operations in that state compared to activity in other states.

Not surprisingly, combined reporting often faces business opposition. The DC Chamber of Commerce and the Council on State Taxation, a trade association of multistate corporations, have attacked the law, as well as individual corporations such as Verizon, Pfizer, and Home Depot.

A new DCFPI policy brief explains why combined reporting is good tax policy. First, it levels the tax-paying field between national and local companies. Without combined reporting, large national and multinationals have a tax advantage by shifting profits earned in DC to states with lower taxes­­, or no taxes at all. While small businesses and local companies that operate only in DC have to pay their fair share of taxes, larger corporations often don’t.

Of the 45 states with a corporate income tax, 23 already have combined reporting. Sixteen have operated with combined reporting for more than 20 years, including California and Illinois. Studies suggest that combined reporting has not affected their economic competitiveness.

Eliminating combined reporting, as groups such as the Chamber of Commerce are lobbying to do, would create a $20 million budget gap in FY 2012 and beyond. Recent budget deliberations in the District have focused on the need to promote long-term fiscal stability in the face of the recession. Getting rid of combined reporting would require cutting local services or raising other local taxes, while keeping taxes low for large national corporations.

Mayor Fenty and the DC Council made the right move to join 23 other states which use combined reporting. They need to remain steadfast in their decision.