A Vat Brews Trouble For Corporate America

It has been 70 years since the U. S. Supreme Court affirmed the method states use to tax corporate income. Today, 45 states impose such levies on businesses operating within their borders. Now, a Feb. 19 high court ruling upholding the only state value-added tax in the country has left corporate executives wondering whether revenue-hungry state governments will sock business with costly new taxes.

The 6-2 decision ended a decade-long effort to overturn Michigan's Single Business Tax. Instead of taxing corporate income, Michigan calculates the value added to goods and services by a company's activities nationwide. It then computes a tax based on the portion of payroll, sales, and property within the state. Such titans of American capitalism as Alcan Aluminum, Coca-Cola, and Union Carbide waged war against the tax, claiming it unconstitutionally discriminated against nonresident companies by overestimating the value of their Michigan operations.

Justice Anthony M. Kennedy's majority opinion rejected that argument. In upholding Michigan's tax, the court used the same reasoning it had employed to affirm the constitutionality of other state business taxes. That may open the door to wide adoption of the controversial VAT, already used in much of Europe. "There's no question other states will be thinking of this," says Amy Eisenstadt, a tax lawyer at the Council of State Chambers of Commerce.

WHAT INCOME? The Michigan case was brought by Trinova Corp. a Maumee (Ohio) industrial-parts manufacturer. In 1980, when the dispute began, the company paid its Michigan sales force $500,000 and sold $104 million worth of goods there. Although the company claimed a loss of $42.5 million on its federal tax return that year, Michigan billed the company for $293,000 in taxes. Michigan enacted its tax in 1976 for three key reasons: It replaced a handful of other business taxes with one single assessment, VAT revenue was more stable than corporate income tax collections, and the state believed that special incentives would increase investment.

Over the past decade, several states, including Minnesota and Louisiana, considered a similar VAT. But skeptical state lawmakers balked at the unfamiliar levy. Now, states such as Florida are giving the tax a second look. A state chamber of commerce study suggests that a VAT could help prevent a projected $1 billion-plus budget shortfall.

States are frustrated with sales and corporate income taxes, which generate almost 45% of state revenues (chart). That's because sales taxes miss the growing service economy. And state treasuries find it tough to collect corporate income taxes from small businesses and foreign-owned companies. "These taxes tend not to fit the economic realities as well as they did years ago," says Dan Bucks, executive director of the Multistate Tax Commission, a private group that coordinates state tax policy.

Even with the Michigan decision, the politics of enacting an entirely new corporate tax system remain perilous. In Florida, big business fears a VAT would damage the state's pro-business image. "It's a bad way to go," says Jon Shebel, president of Associated Industries of Florida, a trade group. "It puts you at a competitive disadvantage." But with federal aid declining and demand for local services exploding, states are hungry to tap reliable new revenue sources. Corporations can only hope they do better in state legislatures than they did before the Supreme Court.

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