In 2011, we will again see proposals to repeal the corporate income tax to “encourage economic development”. The only real effects will be to further reduce revenue and make it harder to make the long-term investments that will produce sustained economic health.
South Carolina collected $216 million in corporate income taxes and an additional $89 million in corporate license fees in FY10-11. That $305 million (a 37 % increase over FY09-10) represented 5 % of gross General Fund revenue. Improving economic conditions make further growth in FY11-12 highly likely. The Board of Economic Advisers’ November 2011 estimate placed corporate income taxes at $242 million and corporate license fees at $92 million for FY11-12.
South Carolina charges a flat 5 % corporate income tax. For in-state companies not doing business outside South Carolina, that is a 5 % tax on net income. For multistate corporations, income is apportioned among the states in which the corporation operates. As of 2011, that South Carolina apportionment is done solely on the basis of sales. If 1 % of your sales are in South Carolina, you pay South Carolina tax on 1 % of your net income nationwide.
Although Governor Haley has argued that eliminating the corporate income tax will have the effect of encouraging small businesses, very few South Carolina “C” corporations, those entities which pay corporate income taxes, are small businesses. Most South Carolina businesses are pass through entities, sole proprietorships, partnerships or “S” corporations and LLCs taxed as such. The income passes through to the individual income tax returns of their owners. Under legislation passed a few years ago, those entities are eligible to elect to pay the corporate income tax rate or the existing individual income tax rates.
The SC Department of Revenue does not publish good data on corporate income taxes. The SC Department of Commerce has put out data on 2008. According to that information, 80,866 corporations filed in 2008. About 89 % of them had no tax liability. About 68 % of the revenue came from foreign (non-South Carolina) firms. Although they had dipped some, 2008 profits and revenues were better than in 2009 and 2010.
Then State Economist Bill Gillespie told Senate Finance Committee the last time it considered eliminating corporate income taxes that the state corporate income tax had no particular impact 0n business location decisions. That is doubtless especially true now that we have transitioned to the Single Sales Factor to allocate taxes for multistate corporations based entirely on sales.
I asked and none of my neighbors plans to buy a Boeing 787. None of Boeing’s profits from sales of the 787 will be allocated to South Carolina. Similarly, any new manufacturers with significant sales beyond the state will not be paying much, if any, corporate income tax to South Carolina. The same is largely true for most large South Carolina manufacturers who sell the bulk of their product outside the state.
The only potential business recruits that might be impacted in any way are foreign businesses with significant South Carolina sales but no current presence in the state creating the nexus that triggers South Carolina’s ability to tax the corporation. Distribution facilities don’t trigger that nexus in any case. It’s hard to think who might bring a manufacturing plant to the state making them suddenly liable for much new tax. In any case, as the Department of Commerce notes, “SC has one of the lowest corporate income tax rates.”
The research on tax reduction effects on economic development pretty clearly show effects which, as economist Timothy J. Bartik, one of the leading authorities on the issue notes, “are not huge.” Further, Bartik notes: “If the state and local tax cuts are financed by cutting public services, the result may be lower business activity.” (“Solving the Problems of Economic Development Incentives,” Growth and Change, 36(2), Spring 2005, 139-166, 142.)
All of this suggests that eliminating the corporate income tax in South Carolina carries with it a large price tag and precious little return. Not taxing corporations a little bit is not enough to attract them to our state if we don’t invest in human capital (education and health care), infrastructure and quality of life. We can’t do that without tax revenues.