Executive Committee Home

June 1, 2006

Dear Chairman Grassley and Senator Baucus:

The nation's governors urge Congress to vigorously oppose S. 2721, the "Business Activity Tax Simplification Act of 2006". This bill represents an unwarranted federal intrusion into state affairs that would create numerous loopholes allowing companies to avoid and evade state business activity taxes (BAT); increase the tax burden on small businesses and individuals; alter established constitutional standards for state taxation; and cost states more than $6 billion annually.

As stated above, there are five key reasons why Congress should oppose S. 2721. First and foremost, this bill represents a blatant and unnecessary intrusion into the states' authority to govern. U.S. courts have long recognized the authority to structure one's own tax system as a core element of state sovereignty. S. 2721 would interfere with this basic principle by altering the constitutional standard that governs when states may tax companies conducting business within their borders. As discussed below, this change would shrink state tax bases by relieving out-of-state businesses of BAT liability while allowing larger in-state companies to circumvent tax laws by legalizing questionable tax avoidance schemes. These outcomes would effectively constitute a federal corporate tax cut using state tax dollars - a decision that, fundamentally, should be left to state elected officials.

Second, S. 2721 promotes avoidance of state taxation. At a time when the federal government is closing loopholes in the federal tax code, S. 2721 would subvert state tax systems by creating opportunities for companies to structure corporate affiliates and transactions to avoid paying state taxes. The bill's physical presence standard would significantly raise the threshold for taxation in most states and, according to a January 20, 2006 report by the Congressional Research Service (CRS), lead to more "nowhere income." CRS added that if the bill is passed, exceptions to its physical presence standard, including its massive expansion of P.L. 86-272 to services, "would... expand the opportunities for tax planning and thus tax avoidance and possible evasion." Congress should oppose S. 2721 because it is bad tax policy that would distort economic decisions and encourage avoidance and evasion of state taxes.

Third, this bill would favor large, multi-state corporations to the detriment of small businesses and individual taxpayers. By raising the jurisdictional standard for taxation, S. 2721 would effectively limit a state's business activity tax base to in-state companies. Out-of-state vendors could therefore compete for customers against in-state businesses with the advantage of inequitable tax responsibilities. At the same time, larger in-state companies with the size and means to hire professionals specializing in tax avoidance could minimize or eliminate their state business tax liability, thus placing a disproportionate tax burden on smaller, in-state businesses and individual taxpayers. Companies willing to compete for customers and earn revenue in a state should share the responsibility of paying for state services that benefit all businesses.

Fourth, S. 2721 would alter the existing constitutional standard for taxation of business activity. The U.S. Supreme Court has never required a physical presence standard for imposing business activity taxes. In fact, last October the Court let stand a North Carolina Court of Appeals decision stating that economic presence, not physical presence, was the appropriate standard for determining if a company has sufficient contacts to impose a business activity tax (A&F Trademark, Inc., et al. v. Tolson, 605 S.E. 2d 187 (N.C. Ct. App. 2004), review denied (N.C., 2005), cert denied, 126 S. Ct. 353 (2005)). S. 2721 would disrupt this well-established constitutional standard and call into question state business activity tax systems in every state.

Finally, S. 2721 represents a huge state pre-emption that will result in the loss of billions of state dollars. A survey released by the National Governors Association found that a substantially similar House bill, H.R. 1956, would cost states more than $6.6 billion annually. The Senate bill may in fact cost states more money because it adds to the number of activities that would not trigger state tax liability. Unlike the federal government, states are required to balance their budgets and must replace lost revenue by either increasing taxes or cutting programs. If Congress wishes to reduce corporate taxes by $6 billion annually, it should do so using federal tax dollars, not state revenues.

For these reasons, Governors strongly oppose S. 2721 and call upon Congress to defeat the bill.

Sincerely,

c:          Senate Finance Committee Members