Coase-Sandor Working Paper Series in Law and Economics
Recent legal and economic changes—not to mention the rise in telecommuting caused by COVID--have raised the salience of a long-simmering fact about the operation of state and local income tax systems: some multistate employers and employees pay a combined income tax liability that is higher than the tax they would have borne had they operated in just one jurisdiction. Seemingly beyond the reach of the courts to correct, there have been persistent calls for Congressional action to eliminate or reduce this “duplicative” taxation. This Article suggests that the alleged problem may be both less of a problem, and more resistant to a solution, than is commonly understood. One of the predicates of a national marketplace is the abolition of many state laws that favor instate over interstate commerce. In practice, this aim, though embedded in Constitutional text1 and practice,2 is remarkably hard to attain. In particular, it has proven difficult to reconcile state sovereignty over fiscal affairs with tax neutrality between single state and multistate taxpayers.3 In their efforts to maximize their own tax revenues and other economic interests, states often enact (or try to enact4 ) tax rules that lead to double taxation of multistate taxpayers, that is, rules which result in more than one state imposing tax on a tax base without offset or other regard for taxes levied by other states on that same base. In turn, this duplicative taxation appears to distort taxpayer behavior in ways that confound both the concept and operation of a national economic marketplace. Legal changes and increases in the fiscal pressure on states have exacerbated these distortions, as they have caused many states to raise tax rates and cleverly expand their (asserted tax) jurisdiction. The end result is an increase in the cost and likelihood of disparities in the tax treatment of wholly in-state and multistate taxpayers.
For an old and familiar example of duplicative taxation, one needs to look no further than the states’ use of different formulas for apportioning the business income earned by taxpayers with multistate business activities. For a short period of time, almost all states employed a three-factor apportionment formula.5 This formula apportioned one-third of taxpayers’ income on the basis of in-state sales versus total sales, one-third on the basis of in-state business property versus total business property, and the final third on the basis of in-state payroll versus total payroll.6 Thus, if 30% of Acme Corporation’s total sales were made to customers in State A, a state which also accounted for 20% of its business property and 10% of its payroll, 20% of Acme’s business income would be apportioned to, and taxed by, State A. The other 80% percent would be apportioned to, and taxed by, other states in similar fashion.7 In the best of all worlds, 100% of its income would be taxed in some state.8 However, Iowa, a state with few factories and office buildings but disproportionately more consumers, decided to increase its income tax revenues— in a way that would not scare off actual business investors--by adopting another apportionment formula, one which took into account only the location of sales.9 The difference between the two formulas is readily apparent. If Iowa were just like State A, the sales only formula would apportion 30% of Acme’s income to Iowa—and if the other states in which Acme did business continued to use the three-factor formula, those other states would continue to claim the right to tax a total of 80% percent of Acme’s income. As a result, Acme would be subject to state income taxes calculated with respect to 110% of its actual business income. In short, 10% of its income would be taxed, in full, by two different states, and its overall tax burden would be higher than if it had carried out its business operations in only one state, including Iowa.10
Another example of duplicative taxation arises from the disparate state tax treatment of remote working arrangements. These disparities can lead to duplicative state taxation at both the employer and employee level. Although the existence (and effect) of these disparities is not new,11 the remote working arrangements spurred by the COVID pandemic has drawn renewed attention to them.
At the employer level, a remote worker may provide the state in which the employee is physically present both the “nexus” required to impose a corporate income tax,12 and a tax apportionment based on the “in state” salary of the remote worker.13 Meanwhile, the state in which the employer’s home office is located, using a different definition of an “in state” employee, may include that same salary in the numerator of its apportionment fraction for purposes of determining the corporate income tax owed to that state. The combination would again lead to duplicative taxation.14
Differing definitions of the source of salary income also may lead to duplicative taxation at the employee level. Some states claim the right to tax an individual’s wage income based on the location of the person performing the services,15 while others claim the right to tax such income based on the location of the empIoyer’s office.16 Thus, an individual working from a home located in a state other than the one in which her employer’s office is found might find her salary subject to tax in two states without any offset for taxes paid to the other state.17 There is at present no legal remedy for any of these examples of duplicative taxation. The Supreme Court explicitly blessed Iowa’s use of its single factor formula in 1978, in the case of Moorman Manufacturing Co. v. Bair, 18 and more recently refused to grant leave to hear a case brought by the State of New Hampshire, challenging Massachusetts’ adoption of the location of the employer source rule for apportioning individuals’ personal services income.19
A solution to this apparent problem would probably require action by Congress.20 Conventional wisdom is that the federal government, which is to say Congress if not the federal courts, should restore some level of tax neutrality between single state and multistate taxpayers.21 This Article shows, however, that there is no easy solution to this problem, and perhaps simply none worth attempting. Congress could eliminate some instances of double taxation, at the (possible) expense of overall state tax revenues and while re-allocating revenue from some states to others. But any intervention of this kind would be politically tricky and – more interesting – difficult to justify as a theoretical matter. Moreover, there is no guarantee that states would not work around any rules that Congress established; the duplicative taxation problem could well re-emerge in a slightly different (and perhaps less attractive) guises. Congressional intervention may not be worth the candle, especially when one considers existing opportunities for taxpayer self-help.
Part I of this Article explains how judicial decisions loosening Constitutional nexus requirements have increased opportunities for double taxation. Part II details the failure of state efforts— embodied in UDITPA and the Multistate Tax Compact—to standardize state laws for taxing the income of multistate business income. Part III explains the comparable problem faced by telecommuting employees. Part IV explains why federal courts are incapable of eliminating duplicative taxation using their powers under the dormant Commerce Clause. Part V explores the difficulties inherent in designing a “neutral” tax rule eliminating duplicative taxation, leading to questions about the desirability of ameliorating double taxation through Congressional action. Parts VI and VII continue this discussion by detailing the actions taxpayers currently take to minimize duplicative taxation, and those that states adversely affected by Congressional attempts to eliminate duplicative taxation are likely to take. Part VIII concludes.
Julie Roin, "Duplicative Taxation Among the States: a Problem Not Worth Solving?", Coase-Sandor Working Paper Series in Law and Economics, Forthcoming (2022).