Single factor, many questions

When the Legislature first heard of single factor apportionment based on sales (SFAS) early this session, the hot, new economic-development tool was touted as a way to make new-economy mutual fund businesses race into the state. The bill now emerging from the Legislature, which could virtually eliminate income taxes for old-economy pulp and paper and very broadly defined high-tech industries, raises questions about what sort of race Maine is in.

States have long wrestled with the problem of how to assess income taxes on corporations that have operations in more than one state. Since the 1920s, most states have used what is called the Massachusetts formula — a state’s share of corporation’s taxable income was the simple average that state’s share of the corporation’s total property, payroll and sales. Very few states use that formula today, most give more weight to the in-state sales component. Under SFAS, which has become increasingly popular during the last decade, only in-state sales are considered.

This, naturally, is very attractive to businesses that have a lot of property, a big payroll and a small amount of in-state sales. It can, in many cases, entirely eliminate state income taxes and its use is growing: Of the 47 states that levy corporate income taxes, only 17 still use the old Massachusetts formula; 20 weigh sales more heavily; seven use SFAS, principally targeted at financial-services companies; three use SFAS unconditionally.

Speaking recently before a Maine business group, Robert Tannenwald, vice president of the Federal Reserve Bank in Boston, observed that tax breaks are only one factor — and a middling one at that — in the creation of an overall favorable business climate. Of greater importance, he said, is a well-educated workforce and modern infrastructure.

In a recent paper on SFAS, Mr. Tannenwald observed that while it may be a powerful, cost-effective job-creation strategy in some cases, it also raises serious questions of tax fairness, of whether a corporation’s tax burden should be proportional to the benefits it receives from government services. Someone has to pay to educate that workforce and to build that modern infrastructure — to shift that cost entirely to businesses not included in an SFAS plan and to wage-earners is a recipe for disgruntlement.

In the most comprehensive study of the subject, University of Chicago economist Austan Goolsbee finds that SFAS can, in fact, stimulate employment at a low cost to a state treasury. But there is a major caveat: in virtually every case, that stimulated employment was not the creation of new jobs, but the shifting of a SFAS-receiving corporation’s jobs from one state to another. That’s why Prof. Goolsbee calls it “a race to the bottom,” that’s why his study is titled “Coveting Thy Neighbor’s Manufacturing.” That’s where the questions of how an overall business climate is created and who pays for it come in.

It’s time lawmakers began asking those questions, and seeking answers. Too often state tax breaks essentially subsidize job loss: In 1998, Maine pulp and paper industries received in excess of $5 million in state assistance as they cut in excess of 550 jobs; the generous tax break to General Dynamics will, at best, slow job loss at Bath Iron Works.

Job retention and slowing job loss are important, but creating new, good-paying jobs is more important. And since the impact SFAS would have on making Maine a more attractive location for a multi-state corporation’s operations is easy to calculate, corporations that want in on it should first be able to show what operations would be shifted here. If Maine is about to enter the race to the bottom, lawmakers can at least first ask what the prize is.