State Tax Reform Amidst Cajun Sausage Making

Steven Sheffrin
Professor of Economics & Director of the Murphy Institute, Tulane University

It was not quite Cajun boudin being prepared in Baton Rouge this winter and spring, but the sausage being concocted in the Louisiana Legislature was equally spicy. With low oil prices and years of “creative” budgets under Governor Bobby Jindal, the new Governor, John Bel Edwards, and the Legislature faced an initial budget shortfall of roughly 16 percent of the state general fund for the next fiscal year. Three separate legislative sessions later, they did reach a balanced budget, although with less revenue than the Governor had wanted. The revenue raisers included a dizzying array of sales tax changes that only temporarily limited exemptions, temporary limits on the refundability of business credits, and various other “haircuts” for business. Not exactly the purest of tax reforms.

But buried in this avalanche of legislation were some serious reforms of the Louisiana corporate tax along the lines that my colleagues and I had recommended to the Legislature last year.

Louisiana is a separate entity state for corporate tax purposes, meaning that every corporation—whether a parent, subsidiary, or holding company—has its Louisiana taxable income calculated separately. Separate entity states are potentially subject to income shifting to out-of-state related parties using intangibles and other tried and true techniques of state corporate tax avoidance. My colleagues and I had recommended combined reporting (where taxable income is calculated based on a unitary group) as a long run solution, but as a first step we urged the state to enact an add-back statute that would disallow deductions for interest, royalties, and other payment to related parties if they were not subject to taxation in other states. The Legislature did, in fact, adopt an add-back statute based on the Multistate Tax Commission model.

The Legislature also tackled apportionment issues. Louisiana had used single sales factor apportionment for certain industries but not for others. We recommended moving all the way to single sales factor apportionment for all industries in order to conform to recent trends in other states and to remove a disincentive from locating property or payroll in Louisiana. More important was adopting “market sourcing” for services with respect to the sales factor, so that Louisiana as a market state could tax a fair share of the income from out-of-state financial companies and other service companies that operated in Louisiana. The traditional approach to locating the source of a sale of a service was in the state where the highest fraction of the cost of the service was incurred—but this method fails to recognize the importance of the market for services in determining business income. Both single sales factor apportionment and market sourcing for services were adopted at the end of the last legislative session.

What explained our success in promoting reform of the corporate tax? First, there were some very sharp legislators who understood that these were good practices and that Louisiana was behind the curve. Second, the new Secretary of Revenue, Kimberly Robinson, was a distinguished state and local tax attorney, well versed in the issues, and supportive of reform. And finally many in the business community welcomed any move towards more explicit regulations and less discretion for the Department of Revenue.

Bigger challenges remain. My colleagues and I were recently appointed to a 13 person Task Force on fiscal reform, which is charged with preparing recommendations by September 1. Fixing the sales tax and income tax are the biggest tasks; many excellent ideas have already been circulated and have broad support. Whether the Legislature really wants tax reform in 2017—as they claim they do—will be the big question.