Highlights from the MCFE 89th Annual Meeting and Policy Forum

MCFE welcomed a capacity crowd of nearly 200 members and guests to its 89th Annual Meeting at the St. Paul River Centre on October 7.  Following our early morning business session, this year’s policy forum focused on a two issues making headlines – the push for greater “fairness” in business taxation and the disposition of the state budget surplus.  A distinguished group of state and national experts engaged in wide ranging discussions of these important, and often politically contentious, issues.

Commissioners Update

The policy forum began, as is our custom, with a departmental update from Revenue Commissioner Cynthia Bauerly who provided an overview of some key departmental administrative initiatives as well as a look ahead to the forthcoming 2016 session.

Commissioner Bauerly began by highlighting the emphasis the Department has placed on taxpayer education and outreach over the past year – all with the intent to improve understanding of and compliance with the tax system and to ensure all taxpayers pay “no more and no less” than their obligations.  She cited the over 1,000 outreach events the Department has conducted over the past year on issues such as sales tax withholding, business registration and tax filing.  These outreach initiatives include the development of educational videos and further investments in their “plain language initiatives” which has won an award for state government innovation.  Other noteworthy accomplishments include new e-subscription services that provide developments on tax topics of interest and the new electronic certificate of real estate value system – a major modernization and upgrade of what was once a labor and paper intensive process that offers significant value to real estate professionals of all types.  The e-CRV system has also earned the Department an award for state government innovation.

Turning her attention to tax policy and legislation, Commissioner Bauerly noted that given the unusual way the 2015 session ended, 182 tax provisions remain open and are still on the table.  Notably, the Department’s technical and policy bill, which contains a large number of important and vetted provisions, counts as only “one” of that total.  More such provisions are likely to be added and combined with the $2.7 billion worth of proposals remaining open ($4.8 billion when fully phased in) plus the likely prospect of “last minute” federal extenders.  Two economic forecasts before the start of the next session only adds to the uncertainty.  There is considerable interest in figuring out ways to have the shortened 2016 session go as smoothly as possible.  Rumors of early hearings may become reality as all indications suggest an exceptionally busy tax agenda.

Commissioner Bauerly concluded with a summary of the accomplishments of the past several years – among them being improvements in tax fairness, the payback of accounting shifts, and investments in the state’s rainy day fund.  She noted Standard and Poor’s has issued an improved outlook which helps pave the way for the state to regain its triple-A credit rating.  She also noted the twin goals of structural stability in state finances and necessary investments to secure our economic future will remain a focus for the Administration in the session to come.

Business Tax Fairness

How does the concept of “tax fairness” apply to business taxation?  Does the pursuit of fairness require something more than compliance to existing law?  If so, how can it be determined and what are the implications at the state, national and international level for business planning and operations?  These and related questions were the focus of our 2015 tax panel featuring a distinguished group of state tax experts moderated by Council on State Taxation President Doug Lindholm.  Panel participants were Gerald Morris, Vice President and Chief Tax Officer, General Mills; Scott Naatjes, General Tax Counsel and Vice President, Cargill; Judy McNamara, Vice President Taxes, Ecolab; and Jeff Hyde, Senior State Tax Counsel, IBM Corporation.

Framing the panel discussion, Doug Lindholm noted the concept of “business tax fairness” has two separate and very different interpretations.  The first – preserving and promoting equitable and nondiscriminatory taxation of businesses -- is well established as good public policy.  The second interpretation is far more dubious and controversial:  an expectation that businesses should conform to some preconceived societal notion of fairness through their tax bills with an expectation that businesses should pay their “fair share” however that ambiguous notion is defined.  The latter, he said, is receiving greater attention thanks to demagoguery from advocacy groups on tax avoidance that the mainstream press has eagerly picked up and reported on.

Highlighting numerous examples of recent provocative headlines regarding “corporate tax dodging,” and the hundreds of billions businesses “owe society,” he noted that despite the highly inflammatory, conspiratorial messages, there are no allegations of illegality or criminality.  Rather, such messages are fundamentally premised on the notion that corporations are somehow not paying “their fair share” of taxes.  This rather amorphous idea conflicts with the reality that: businesses are bound by tax laws, businesses have a fiduciary duty to minimize their obligations, and there is no patriotic duty to pay more than you legally owe.  The fairness issue has special relevance in the United States, he continued, because we are only one of 6 countries using a worldwide system of taxation – i.e., a business headquartered in the U.S. is taxed on all income earned worldwide.  Even though a credit is given for taxes paid to other countries, the fact that our marginal corporate tax rate is the second highest in the world creates a huge disincentive to bring money back.

Lindholm continued by noting that what exactly constitutes a “fair share” of business taxation has been a topic for debate going back many decades.  The establishment of the interstate highway system dramatically increased the mobility of capital in the United States, leading to issues of how to recognize and apportion income among the states and protect state tax bases.  These complexities led to the drafting of the Uniform Division of Income for Tax Purposes Act (UDIPTA) in 1957 and the establishment of the Multistate Tax Commission to provide agreement and structure for managing these complex issues and making life easier for states and taxpayers.

Today, the digital economy has taken the concept of capital mobility to a completely new and international level, with even more opportunities for tax planning and even greater ability to move profits around.  As a result, the complexities and issues surrounding tax bases and apportionment have increased exponentially.  Unsurprisingly, this has prompted another, even more ambitious initiative: the OECD’s Base Erosion and Profit Shifting (BEPS) project, which Lindholm called “the international version of UDIPTA.”  The parallels with the history of state taxation, he noted, are “amazing.”  Like UDIPTA, the stated intent is to ensure that profits earned by companies are correlated with activities generating the profits.  For UDIPTA the mechanism was formulary apportionment; for BEPS the mechanism is transfer pricing.

But the U.S. experience with UDIPTA offers a cautionary tale.  Lindholm noted that sixty years later “nothing is easier for anyone” as many states have not adopted it and those that have often modified it.  As a result, we have even less uniformity today.  Such history does not bode well for this significantly more complicated and ambitious process.

How do business tax practitioners view the general idea of business tax fairness and major initiatives like BEPS to achieve fairness?  Forum panelists offered considerable insights and commentary that occasionally seemed to be as therapeutic for them personally as it was informative for the audience.

Panelists began by reemphasizing the fundamentals – the fiduciary responsibility and obligations of business tax departments.  Judy McNamara noted her department is not charged with designing business operations to avoid taxes; but rather to design tax strategies to accommodate business needs.  “Business is the boat,” she said, pulling everything else along.  Jeff Hyde echoed this idea noting that businesses make decisions based on return on investment.  Taxes are a part of that calculation, he said, and more empirical data is coming out showing that taxation matters.  Moreover, the lines between “international issues” and “state issues” are increasingly blurry.  With respect to ROI, “states are simply part of the supply chain,” he said, and how they treat income coming back from overseas and its implications for ROI makes a big difference.

Jerry Morris expanded on the mobility issue, noting that “total shareholder value drives every decision General Mills makes and that includes tax.”  U.S. companies are at a major disadvantage because incurring our effective tax rate significantly harms a key business objective – mobilizing capital without any cost or friction.  Taxation puts real pressure on capital structure and competitiveness.  A major problem influencing current business tax fairness agendas, he noted, is the “naïve arrogance we remain the center of intellectual property and the generation of ideas.”  Noting General Mills’ global presence in research and development, he said intellectual property is mobile and can be generated or created anywhere.

Scott Naatjes questioned the thinking and fundamental premise behind business tax fairness, the idea of base erosion.  “What is base erosion?  Some measure of income that someone simply believes they should be able to tax.”  He noted the problem with this idea can best be understood by the starkly different attitudes which exist toward the same economic activity.  He gave an example of a foreign company choosing to build a major factory employing 1,000 people in a community.  Local economic development professionals and governments who would benefit from the revenues would laud such a decision.  But if the parent company charged a royalty to the factory and financed it with debt, the same company would be “cast as villains” by the OECD because the tax base was “eroded” with an interest payment and a royalty payment.

With respect to BEPS specifically, Naatjes spared no criticism and pulled no punches arguing it is a revenue grab masquerading as a fairness pursuit with potentially disastrous implications for business.  “Don’t believe the BEPS effort is neutral, he said, “and don’t believe there is economic substance you can actually judge.  What you are seeing is erosion in the rule of law.”  He continued by saying BEPS is really an effort to cajole countries into increasing taxes on capital, and the question is who is going to dare to move first.  “If you have different operations in five countries each with a different function – all five countries think they earned everything.  That’s how BEPS works.”

Of primary concern, he continued, are the implications for operations in developing nations – where the judiciary is “routinely bought and paid for.”  Revenue authorities with subjective standards plus unlimited information about every aspect of your operations are a recipe for disaster.  “This will be an absolute catastrophe,” he stated.  He noted the only solution would be binding arbitration in third world countries, which they will not agree to given the ability to reach across borders and take as much as they want based on some abstract theory of fairness that nobody can identify and which cannot be litigated.  “It’s not about everybody being more fair, don’t buy that for a minute,” he concluded.

Turning to state-level fair share initiatives, Lindholm raised the issue of “tax havens” noting that Montana, Oregon and D.C. have now published lists of tax havens.  Jeff Hyde replied that in his discussions with states pursuing this idea he emphasizes that having a lower tax rate doesn’t make a country a haven, and if that were the case the entire rest of the world could be considered a tax haven compared to the United States.  No less disconcerting is that “fairness” in state taxation of foreign generated income is often interpreted as “we deserve 100% of it.”  States were once laboratories of democracy,” he concluded, “but have now become incubators of very strange tax concepts.”  Judy McNamara commented that on a personal level she fully understands and appreciates the public and media frustration and headshaking with respect to the most aggressive tax planning practices reported in the news.  “I get it” she said, and being grouped with such practices is frustrating.  Ultimately, however, the lasting solution is to stop moralizing and fix the tax code.

Since every business tax dollar is ultimately reflected in higher prices, lower wages or lower returns on investment why in the pursuit of fairness are we taxing business at all?  It’s a question that can probably only be raised in a forum like ours.  Noting that the economic burden of taxation will be borne by the factor that has the least capacity to change, Scott Naatjes argued we are in a world where capital flows freely everywhere but labor and consumption is sticky.  Thus, he maintained, the question of whether business is paying their fair share is really a question of how much you want to burden labor and consumption.

A related question, he continued, is why we would want to have a system that treats identical economic things differently.  Different tax treatment of business structures, different treatment of organizational entities, and different treatment of debt versus equity – all of these introduce fundamental unfairness and friction in a business tax system.  There are simple solutions, he maintained, but politically impossible to understand and advance.

Discussion turned to fairness in state compliance issues, specifically regarding non-resident withholding which varies significantly between states.  Panelists highlighted the practical challenges and uncertainties surrounding non-resident withholding, as well as federal extender bills, and international reporting risk.  As panelists noted, these issues not only have potential legal implications for companies but also entail real economic risk. 

One hour of panel discussion could only scratch the surface of the controversial issue of business tax fairness, but two takeaways were clear.  First, as Lindholm concluded there is “a wide gap between perception and reality” with respect to business taxation.  Few outside of tax professionals really understand the issues and the complexities.  Especially when it is so easy to prey on this lack of understanding to advance political agendas and bad policy, it is incumbent for tax professionals (and organizations like ours) to educate others on how the tax system should and shouldn’t work.

Second, the best definition of business tax fairness is adherence to all the principles of sound tax policy – competitiveness, administrative efficiency, transparency, stability, equity, and minimal economic distortion.  States that do this well will have a very good chance to obtain the revenue they need without chasing capital away.

The Economists’ Look at the Surplus

By some expectations, the state budget surplus could be as large as $2 billion heading into the 2016 session with no shortage of proposals on both the tax and spending side on what to do with that money.  Our second panel brought together a group of distinguished economists to obtain some advice regarding the surplus from those trained to look at the Minnesota economy from a big picture perspective.  Participants included: King Banaian, Dean, School of Public Affairs, St. Cloud State University; Toby Madden, Principal, Power Parametrics; Art Rolnick, Senior Fellow, Humphrey School of Public Affairs; and Paul Anton, Anton Economics.

Moderated by former MCFE president Todd Rapp and taped for rebroadcast on Minnesota Public Radio, panel discussion focused on several relatively “rapid fire” questions on the budget and the general economy.  The accompanying table summarizes those questions and our panelists’ responses (note that not every panelist answered every question).

In response to an audience question about whether an expanded sales tax base should be used to support transportation through general fund appropriations, there was unanimous support among the panelists for the continued use of the gas tax.  The gas tax is an efficient tax, its user fee-like qualities conform well to the benefit principle of taxation, and as a general rule we should try retain the relationship between the funding of roads and the use of roads.

Can tax reform be part of the agenda?  Anton suggested if there is political interest in tax reform now is the time to do it.  Surpluses offer the opportunity to “buy down” political resistance from those negatively affected by reform.  He noted there are many reform ideas from tax commissions past worthy of consideration if the motivation to pursue reform really exists.

What was especially intriguing about the panel was the significant amount of shared opinion and concurrence on so many issues.  Panelists shared a sense of conservatism, tempered ambitions, and fiscal prudence with respect to the 2016 surplus.  Concepts such as improving the budget process through regular and robust cost benefit analyses of programs, and movement toward greater reliance on consumption taxes were endorsed by all.  From those trained to look at the Minnesota economy from a perspective beyond elective politics, this is advice well heeded.

Luncheon Speaker Douglas Baker: A Report Card for Minnesota

As a company with $14 billion in annual sales, serving customers in more than 170 countries, St. Paul-based Ecolab is keenly attuned to the issues and trends shaping the landscape for economic growth and business competitiveness.    As the leader of Ecolab, Chairman and Chief Executive Officer Doug Baker offered attendees a unique and highly engaging assessment of where Minnesota currently stands through his “report card” for Minnesota.

“Grading” the state, he began, starts with understanding the economic and demographic trends shaping the state’s future.  He discussed four key themes: the introduction of millennials into the workforce, the increasing diversity of the state’s population, the changing role and influence of technology (which he noted has really only just begun and puts us on the precipice of another industrial revolution) and the realities of a global marketplace.   Given that backdrop, Minnesota should focus on attracting and keeping talent, ensuring education systems that work, and supporting the development and growth of industries that matter in light of these trends.

So how is Minnesota doing?  Baker highlighted the much-heralded CNBC “Best Places for Business“ scorecard, which recently ranked Minnesota first in the nation. He noted our number-one overall ranking is due to higher weighting given to our quality of life and education factors; our relative performance on cost of doing business and business friendliness was substantially lower.   He cautioned that it’s a mistake to think these other areas of performance don’t matter.

Revisiting the CNBC report, Baker graded Minnesota on each area of performance.

Overall, Baker gave the state a B-  grade, noting that the primary concern in each of these areas going forward is “how” we deliver the results everyone wants, needs, and has come to expect along with the need to revisit programs and practices to improve the return on investment of tax dollars.

He added one final issue of concern not captured in the scorecard but nevertheless critical to Minnesota’s continuing competitive success:  fiscal policy.    Based on current trends, he noted, spending growth is projected to exceed revenue growth through 2025 by nearly 40% (7.4% versus 5.3%) This “growing spending imbalance” is exacerbated by what he called a “tippier” fiscal system based in part on more volatile revenue sources.   Moreover, he said, projections assume stability which does not exist –  the reality is, “spending growth accelerates when things get bad and revenue growth turtles.”    Fiscal discipline with an eye toward sustainability is vital to our continued success.

Baker concluded with a renewed call for cooperation between business and government, heralding this important dimension of the state’s culture.  “The business community shouldn’t take Minnesota for granted,” he said, “and Minnesota shouldn’t take the business community for granted.”   Both have to respect their complementary strengths and work together to have policies that make sense while pursuing better ways to achieve these shared objectives together.