As New York and Connecticut continue to assert their authority to tax companies that have little to no physical presence inside their borders, Congress is considering stepping in to limit states from applying “economic nexus” rules as a way to collect additional revenue.
In mid-April, the Washington, D.C.-based Tax Foundation testified on state tax competition and collections, as the U.S. House of Representatives considers the proposed Business Activity Tax Simplification Act of 2011.
The act would include limits on the power of states to tax individuals and corporations that are not physically present in their state, with the Tax Foundation arguing that goes against a free flow of interstate commerce.
The Tax Foundation says about half of states have adopted an economic nexus standard for taxes on business activity, even on those that do not have property or employees in a state but nevertheless sell products or services there.
“If this standard is widely adopted, we will not have corporate income taxes but corporate consumption taxes, whereby states mostly exempt resident companies from tax obligations while imposing them on out-of-state companies,” said Joseph Henchman, director of state projects for the Tax Foundation, noting the liberal use of corporate tax credits employed in many states. “Residents should be paying taxes where they work and live, and jurisdictions should not tax those who don”™t work and live there ”¦ Economic nexus is a nebulous, amorphous standard that quickly leads to states asserting the power to tax everything, everywhere. It is an alarming trend that even the best-intentioned state legislator is being swept along in.”
In 2010 under former Gov. M. Jodi Rell, Connecticut established a nexus standard that taxes companies that have a significant “economic presence” in Connecticut ”“ even if they have no physical presence here that includes direct employees. If a company has sales in excess of $500,000, nexus exists for the purpose of taxation; and the commissioner of the Connecticut Department of Revenue Services (DRS) has the power to determine if a company”™s frequency or quantity of dealings in Connecticut expose it to taxation under corporate nexus.
The law exempts from taxation, however, online merchants, cataloguers and others that solicit, process and deliver orders to Connecticut from locations that are in other states or countries.
Testifying before the Connecticut General Assembly this spring, DRS Commissioner Kevin Sullivan said he supported the general concept of Connecticut taxing purchases of Internet merchandise in the future.
The debate comes even as state revenue collections rebound in the current fiscal year that ends this June ”“ in New York, total taxes and fees were up 5.5 percent through March, including a 10-percent gain in sales and use taxes, but only a 4.2-percent increase in personal income taxes.
In Connecticut, total collections were up 7 percent through March from the same period a year earlier, with taxes on insurance, gas and real estate transfers the only major tax categories to see a decline. Income tax collections are up 12 percent from fiscal 2010, while sales and use tax collections are up 5 percent.
Still, both states face massive budget deficits, with New York electing to close its gap through spending cuts; and Connecticut increasing income taxes on middle-class and wealthy residents to close its own.
“We are in a deep hole this year,” said Benjamin Barnes, head of the Connecticut Office of Policy and Management, testifying in Hartford this month. “We really don”™t have a whole lot of time before we can reasonably anticipate that another economic downturn will occur; and we need to do everything in our power to ensure that there are ample reserves on hand to weather that storm, hopefully more easily than we”™re weathering the current one.”
