Presentation to the DC Tax Revision Commission

January 31, 2023

Darien Shanske

UC Davis School of Law

dshanske@ucdavis.edu

Agenda

• Primer on the basic legal rules of interstate taxation
• Address (One) key policy challenge for DC: tax more effectively based on source principle.
• Three (complementary) options:
• Improve the Corporate Income Tax
• Impose a Business Activity Tax or a Business Value Tax
• Impose a Digital Services Tax

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Two Bases

• There are two recognized bases on which a state (or nation or locality) can tax:
• Residence (where you live)
• Source (where you/business work or earn income)
• As to source-based taxation of individuals, DC is uniquely disadvantaged.
• Because of Section 602(a)(5) of the Home Rule Act and particularly as interpreted in Bishop v. DC.

Business Source

• But this is not the case for taxation of business on a source basis. For example, DC has a corporate income tax that must be paid based once a taxpayer has more than a threshold amount of gross receipts in DC.
• Furthermore, the portion of a corporation’s income that is taxed in the district is based on the proportion of sales in the district.

Upshot

• DC’s CIT is a source-based tax that is unlikely to trigger much evasion.
• And so one “easy” reform is to improve the CIT. Michael Mazerov has proposed some very good CIT reforms. Here is another:
• Make it more difficult for taxpayers to avoid the CIT through shifting income abroad.

How?

• Conform to federal statutes aimed at clawing back this income.
• Global Intangible Low Taxed Income (GILTI)
• DC does this already but likely can do this better.
• Corporate Alternative Minimum Tax
• The feds recently expanded the clawing back to include accounting income.
• Or expand current combined reporting to include foreign affiliates; this is worldwide combined reporting.
• Industry will claim DC can’t do this, but it can (especially with forethought).

Business Activity Tax

• Many businesses benefit from DC but are not corporations.
• Some pay the unincorporated business income tax but many do not.
• A business activity tax could reach those businesses too because it would not be an income tax.
• This is why Texas adopted a tax like this.

Design issues

• There are many possible designs consistent with being reasonably likely to pass legal muster and amount to sound tax policy.
• For example,
• Gross receipts with limited subtractions (Michael Mazerov’s proposal).
• Following Texas, there can even be a choice of subtractions.
• The tax can be based on the value of the business.
• E.g., some multiple of book earnings. The Swiss wealth tax values businesses this way.

Digital Ad Taxes

• This would be a tax levied on the gross receipts earned on selling digital ads in DC.
• These taxes have become very popular internationally and Maryland was the first state to impose one.

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Why?

• Many of the firms earning the most from digital ads are the best at escaping the CIT and so it is a kind of backup income tax.
• The ads are part of a larger system in which consumers exchange their attention and data for “free” services, such as maps, social media etc.
• As such, these transaction should be taxed under a sales tax.

But isn’t Md’s tax dead?

• Not dead yet.
• A lower court in Maryland did strike the tax down as preempted and unconstitutional, but the Maryland Supreme Court has agreed to hear the case (skipping the intermediate court).
• This suggests the Md Supreme Court was not impressed by something, but that might well be that the lower court made some poor procedural decisions (and I think it did).
• In any event, the Md saga is far from over and anyway will likely only reveal what the Maryland courts think about the Maryland tax.

On the merits…

• I think a DC DST has a very good shot, especially if carefully designed from the start.
• In particular, if a DST is designed and justified as a backup sales tax then the tax is not discriminatory against internet commerce.

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Thanks!

Some more sources

• For why cities and states should continue to tax at the source, see:https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4226430.
• For a primer on GILTI, see: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3485377.
• For the longer version of the argument re : digital taxes, see: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4205398.

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Some data

Source: https://itep.org/wp-content/uploads/corpoffshorechart2.jpg

Another fun data point

Bilicka et al., Tax Avoidance Networks and the Push for a ’Historic’ Global Tax Reform,

https://www.nber.org/books-and-chapters/tax-policy-and-economy-volume-37/tax-avoidance-networks-and-push-historic-global-tax-reform

More

Source: http://gabriel-zucman.eu/missingprofits/

A Few GILTI Mechanics

• GILTI income is income earned beyond a presumed 10% normal return on assets.
• GILTI income is taxed at half the usual rate, so 10.5%.

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