Randy Zook: Modest Set Of Tax Reforms Would Improve State Business Climate

Editor’s note: Talk Business solicited four state business leaders to construct a fairer state tax code. This guest commentary, written by Randy Zook, CEO of the Arkansas State Chamber of Commerce and Associated Industries of Arkansas, is the fourth in the series of four. It appears in the latest magazine issue of Talk Business Arkansas, which you can read online at this link.

Arkansas’s businesses face a daunting array of taxes – national, state and local.

Policy makers and state leaders are constantly seeking new sources of revenue for worthy purposes, but they must also be mindful to not overtax and thereby wound – if not kill – the golden goose in the form of job-creating businesses in our state. The Council on State Taxation (COST) estimates the total for state and local taxes in Arkansas for fiscal year (FY) 2012 at $4.2 billion, an increase of 4.8 percent over FY 2011. By anybody’s measure, that’s a sizeable chunk of change.

How does that compare with our neighboring states, those with which we most often compete for new businesses and expansion capital for existing businesses?

One good measure, also from COST, ranks the state’s total business taxes as a percent of the Gross State Product (GSP), the state version of the widely known Gross Domestic Product (GDP) for the entire country. On that measure, Arkansas looks pretty good:

State Ranking of Business Taxes as Percent of GSP

7. Missouri – 3.9 percent
6. Tennessee – 4.4 percent
5. Arkansas – 4.5 percent
4. Louisiana – 4.6 percent
3. Texas – 5.2 percent
2. Oklahoma – 5.6 percent
1. Mississippi – 6.2 percent

So on balance, we are apparently not abusing our businesses tax-wise. And that’s a good thing. We want to be known as a place that is reasonable, fair and competitive, in order to attract much-needed investment capital and the jobs that come with that capital. We want to see more and better jobs become available for our children and our grandchildren.

How can we improve our tax environment without undermining our state’s very healthy budging process? At the risk of getting down in the weeds on tax policy, let me suggest a few modest, bite-size steps we can take that would dramatically improve both our competitive position and our attractiveness for businesses looking to grow.

Net Operating Loss Carryover Limits are Unreasonable
Arkansas is one of seven states that restrict net operating loss (NOL) carry-forwards to five years. More than 40 states permit NOL carryovers of 10-20 years and 18 states permit both carry back and carry forward of NOLs. The IRS permits both a carry back and a 20-year carry forward of NOLs.

Denying reasonable net operating loss carry forwards unfairly taxes business income, which simply recoups previous losses and amounts to the taxation of phantom income artificially created by the tax code. This severely penalizes loss corporations and becomes even more pronounced during an extended recession.

In 2009, the DFA projected that more than 76 percent of Arkansas NOLs expire without ever being claimed. The agency projected that increasing the carry-forward period to 15 years would result in a maximum revenue loss of $58.6 million in FY 2020, and a 20-year carry-forward would result in a maximum revenue loss of $72.8 million in FY 2025. Arkansas should begin to extend the NOL carry-forward period in installments over time.

Repair and Replacement of Machinery and Equipment
Most states exempt repairs and replacement parts of manufacturing machinery and equipment (M&E) from sales and use tax. Other states apply a reduced rate to repairs and replacements. Arkansas taxes repairs and replacements at the full tax rate of 6 percent.

The Arkansas Business and Economic Development Incentives Study conducted by Fluor Location Strategies and presented to the Arkansas Bureau of Legislative Research in 2006 classified Arkansas as the single “worst” of the 12 states in the Southeast Region on the taxation of industrial materials used in manufacturing.

The Department of Finance and Administration’s (DFA) Legislative Impact Statement prepared for SB331 (2011) estimates the total Impact to state revenues of exempting repair and replacement of manufacturing M&E from sales and use tax would be $38.9 million for FY 2012.

Alabama, Mississippi, North Carolina, and others have phased in exemptions over time. Arkansas is uncompetitive with surrounding states and states in the Southeast region on this issue. Upgrades, repairs and refurbishing of machinery and equipment used directly in manufacturing should be exempt from sales and use tax.

Improve Taxpayer Access to DFA Opinions and Administrative Decisions
In 2007, the Arkansas Supreme Court ordered DFA to begin providing redacted copies of legal opinions issued by the Office of Revenue Legal Counsel in response to requests filed under the Arkansas Freedom of Information Act (“FOIA”).  Most state tax departments make similar legal opinions available for research and review on state web sites.

The DFA continues to resist doing so, although a complete library of legal opinions (and administrative decisions) is provided to auditors, and auditors are encouraged to apply the opinions consistently to other taxpayers. Legal opinions are a valuable research tool. They should be available to all taxpayers in readily accessible form – not just practitioners who understand how to file FOIA requests. The legislature should require DFA to publish redacted copies of legal opinions in searchable form on its website.

DFA’s Office of Hearings and Appeals issues numerous hearing decisions each year, interpreting Arkansas tax law as applied to facts of particular cases. Auditors are encouraged to follow these decisions in auditing other taxpayers, but taxpayers seldom have any knowledge that any relevant decisions exist, or what they provide.

This information is valuable to taxpayers for both planning and administrative appeal purposes. The DFA relies on the confidentiality of tax records law to refuse to release such decisions, even in redacted form. The law concerning the confidentiality of taxpayer information should be clarified to provide that administrative decisions will be released in a form that protects confidential taxpayer information, but makes administrative decisions available for research and review by other taxpayers.

Property Tax on Manufacturing Inventories
Most states exempt manufacturing inventories from property taxes (raw materials, work in process and finished goods). Arkansas taxes such inventories, except to the extent that the inventories are destined for shipment out of state. Five of the six states surrounding Arkansas exempt manufacturing inventories from taxation (Texas is the exception).

Exempting manufacturing inventories will require either a constitutional amendment when/if an opportunity to refer such an amendment arises, or a credit mechanism to offset inventory taxes against other taxes paid.

All of these measures can be done incrementally with the tax impact phased in over a period of a few years. These changes would make Arkansas more competitive and would result in measurable job growth. Our economy continues to limp along at below normal growth rates, due in large part to the political stalemate in Washington.

Fiscal policy, as a result, is not creating the conditions needed for more robust growth. At the state level, though, we can find the political will to do the things that will advance Arkansas.

This modest set of tax proposals is one of those needed adjustments in our business climate.