Even pulling every tax lever at the state level fails to generate sufficient revenue to cover existing shortfalls

David Gamage 22, Professor of Law, Indiana University—Bloomington, Maurer School of Law. Darien Shanske, Professor of Law, UC Davis School of Law. Gladriel Shobe, Associate Professor of Law, BYU Law School. Adam Thimmesch, Professor of Law, University of Nebraska College of Law (“Weathering State and Local Budget Storms: Fiscal Federalism with an Uncooperative Congress,” Journal of Law Reform, )//BB

II. State Corporate Income Tax Reforms We propose in this Part a number of reforms to state corporate income taxes.48Although we specifically focus on the state corporate income tax in this Part, many of our proposals apply to the taxation of business income more broadly (i.e., strategically decoupling from the tax cuts provided in the Tax Cuts and Jobs Act of 2017 and in the CARES Act) and will apply equally to states’ taxation of business income by sole proprietors and pass-through entities.Portions of this Part consist of revised and elaborated reforms first proposed in: Darien Shanske, Reuven S. Avi-Yonah & David Gamage, Reforming State Corporate Income Taxes Can Yield Billions, Medium (May 13, 2020), https://medium.com/whatever-source-derived/reforming-state-corporate-income-taxes-can-yield-the-states-billions-5a79f3d22f9b [https://perma.cc/59YM-WCU4]. Before proceeding, though, we recognize that a skeptic might note that state corporate income taxes represent only about 3 percent of state tax revenues, or about $45 billion per year.49U.S. Census Bureau, 2017 State & Local Government Finance Historical Datasets and Tables, https://www.census.gov/data/datasets/2017/econ/local/public-use-datasets.html [https://perma.cc/2DK9-4MCE] (Oct. 8, 2021) (under the “2017 State & Local Government” heading, choose the file labeled “U.S. Summary & Alabama and Mississippi”; the amount is calculated from Table 1 in that file). To put this in perspective, the initial estimates of states’ increased revenue needs caused by the recent COVID-19 economic crises were well over $100 billion annually.50See Leachman & McNichol, supra note 14; Davidson & Harrison, supra note 14. We thus fully acknowledge that the corporate income tax reforms we propose in this Part would not lead to a doubling or tripling in corporate income tax collection. Nevertheless, the reforms we propose in this Part have the potential to address at least significant portions of states’ revenue needs. For instance, moving to worldwide combination has been reasonably estimated to have the potential to raise about $17 billion per year.51Richard Phillips & Nathan Proctor, A Simple Fix for a Billion Loophole: How States Can Reclaim Revenue Lost to Tax Havens, Inst. on Taxation & Economic Pol’y (Jan. 17, 2019), https://Itep.Org/A-Simple-Fix-For-A-17-Billion-Loophole/ [https://perma.cc/W9SQ-5K3X]. That is a significant amount even on its own. Several of the other reforms below are of similar magnitude. To be sure, recession conditions might suppress some of these revenue projections—but maybe not by much, given that many firms remain quite profitable. Further, once states put these reforms in place, not only will state revenues bounce back faster during future economic recoveries, but also state governments may be able to borrow against these anticipated future revenues to meet immediate revenue needs during a downturn.52See infra Part V. That the numbers here can be large should not be too surprising; the yield of the state corporate income tax has fallen sharply over the last few decades, even relative to the decline in federal corporate income taxes.53See, e.g., Michael Mazerov, NCSL Task Force on State and Local Taxation, Legislators: Don’t Feel Guilty about Taxing GILTI, Ctr. on Budget & Pol’y Priorities, at 5 (2018), http://www.ncsl.org/Portals/1/Documents/Taskforces/GILTI.pdf [https://perma.cc/RL2E-8QUJ]. In a sense, the reforms we propose would serve to partially restore the state corporate income tax bases to their prior levels. For those still skeptical, here is another—albeit noisy—data point regarding the money that most states have left on the table, from New Jersey’s experience: 54State of New Jersey, Summary of Budget Recommendations for the Fiscal Year 2021: Budget in Brief 42–44 (2020), https://www.state.nj.us/treasury/omb/publications/21bib/BIB.pdf [https://perma.cc/F2KC-6GQ2]. Corporate business tax does not include energy tax. Figure 1. New Jersey’s Corporate Business Tax (in Billions) This chart demonstrates extraordinary growth in New Jersey’s corporate income tax after it passed several sensible reforms: in 2018, the state conformed to the global intangible low-taxed income regime under the federal Tax Cuts and Jobs Act of 2017 (TCJA), taxed 5% of the repatriation, moved to combined reporting (for 2019), and imposed a 2.5% corporate income tax surcharge for 2018 and 2019 (1.5% for 2020–21).55Assemb. B. 4202, 218th Leg., Reg. Sess. (N.J. 2018). To be sure, the actual 2020 numbers might be lower because of the pandemic, and any number of other factors bespeak caution in extrapolating too far from one state’s experience. Nevertheless, this chart indicates that—consistent with other data, some of which we discuss below—the state corporate income tax can be reformed in sensible ways that yield significant revenue. It is not a good thing, in our view, that states have let their corporate income taxes wither when there is so much to be gained from straightforward reforms. States should broaden their corporate tax bases, period; in a crisis, however, the failure to do what should have already been done represents an opportunity. States need only engage in some ordinary good tax housekeeping to revive their corporate income taxes. Critically, the corporate tax should be part of the mix because it is, at least in part, a progressive tax.56The incidence of the corporate income tax is an enduring mystery, but the common assumption is that it is roughly progressive—that is, that it falls at least substantially on the owners of capital as opposed to workers. See, e.g., Edward G. Fox, Does Capital Bear the U.S. Corporate Tax After All? New Evidence from Corporate Tax Returns, 17 J. Empirical Legal Stud. 71, 72 (2020); David Gamage & John R. Brooks, Tax Now or Tax Never: Political Optionality and the Case for Current-Assessment Tax Reform 25 (Indiana Legal Stud. Rsch. Paper No. 437, 2021), https://ssrn.com/abstract=3801164 (“[M]ost analysts consider [the corporate income tax] to be at least somewhat progressive.”). As discussed earlier, those hardest hit by crises are typically at the bottom of the income distribution. Though there is certainly a case to be made for raising money somewhat regressively in order to spend it progressively, we should not start with such taxes if there is other low-hanging fruit. The reforms we propose, in a thumbnail sketch, are as follows: A. Shift to mandatory worldwide combination.57For further development of this argument, see generally Darien Shanske, White Paper on Eliminating the Water’s Edge Election and Moving to Mandatory Worldwide Combined Reporting, 89 Tax Notes State 1181 (2018). Multinational corporations are still shifting domestic profits abroad.58See infra Section II.A. States can counter this by (reasonably) including these foreign subsidiaries in their corporate tax base. B. Conform to GILTI.59For further development of this argument, see generally Darien Shanske & David Gamage, Why States Should Tax the GILTI, 91 State Tax Notes 751, 751–54 (2019); Darien Shanske & David Gamage, Why States Can Tax the GILTI, 91 State Tax Notes 967, 967–70 (2019); Darien Shanske & David Gamage, States Should Conform to GILTI, Part 3: Elevator Pitch and Q&A, 94 Tax Notes State 121, 121–24 (2019). The TCJA made a half-hearted attempt to combat income shifting. Though moving to worldwide combination would be better, conforming to GILTI at the state level is the minimum measure that a state should take. C. Strategically decouple.60These proposals were first presented in shorter form in: Darien Shanske, Adam Thimmesch, & David Gamage, Strategic Nonconformity, State Corporate Income Taxes, and the TCJA: Part II, 97 Tax Notes State 123, 123–25 (2020). The TCJA and the CARES Act provided a wide range of corporate tax cuts from which states should consider decoupling. D. Income tax surcharge.61The proposals offered in this Section and the three that follow were first presented in Shanske et al., supra note 48. A handful of major corporations will likely be very profitable over the next few years. States should add a temporary income tax surcharge to tax some of these profits. E. Suspend some tax credits. States have been generous in giving large corporations credits reducing their corporate income tax.62See infra Section II.E. Credits of this magnitude were probably never prudent, but given the current crises, it is a particularly apt time to suspend these credits. F. Reform the sales factor. States generally divide the income of multijurisdictional corporations based on their share of a corporation’s sales.63Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159 (1983). Some taxpayers have become skilled at manipulating the location of sales, but there are ways to make the formula harder to game. G. Expand the corporate income tax to include all large businesses. For decades, there has been a shift to the use of noncorporate business entities.64William F. Fox & LeAnn Luna, Do Limited Liability Companies Explain Declining State Corporate Tax Revenues?, 33 Pub. Fin. Rev. 690, 715–16 (2005). It has never made sense that only corporations pay taxes at the entity level. This should be corrected. H. Other reforms. States should, at times, strategically conform to federal tax changes, such as repatriation. A. Mandatory Worldwide Combination States have long confronted the problem of how to tax the income of a multistate business. In general, as a matter of constitutional law, each state can tax only income generated in the state,65See, e.g., Franchise Tax Bd., 463 U.S. 159. but how does one calculate that for an integrated multistate business like a railroad or Apple? If one asks a taxpayer to determine the state in which an integrated multistate business generated income, that taxpayer will naturally argue that most of the business’s income is generated in a low-tax or no-tax state. States arrived at an especially effective solution to this problem. Instead of asking a multistate business to divide up its income, some states ask the business to report all of its income, including income nominally earned abroad, and then apportion some of the income to each state by means of a formula.66Id. The most common modern formula uses the percentage of sales within a state because, among other reasons, the location of a firm’s customers is more fixed than a firm’s other assets.67 . Darien Shanske, A New Theory of the State Corporate Income Tax: The State Corporate Income Tax as Retail Sales Tax Complement, 66 Tax L. Rev. 305, 312–14 (2013); State Apportionment of Corporate Income, Fed’n of Tax Adm’rs (Jan. 2021), https://www.taxadmin.org/assets/docs/Research/Rates/apport.pdf [https://perma.cc/J3SS-7869]. So how much of Apple’s total income is generated in a given state under this system? The answer is the same percentage as the percentage of Apple’s sales within that state. Note that this method—mandatory worldwide combination—eliminates the incentive to shift income to a low-tax jurisdiction. It does not matter where the income is nominally earned because it all goes in the same pot and is multiplied by the usual formula (percentage of sales) to apportion the income.68See generally Jerome Hellerstein & Walter Hellerstein, State Taxation ch. 8 (2020) (discussing the apportionment of corporate income for purposes of the state income tax). The U.S. Supreme Court has upheld mandatory worldwide combination twice.69Barclays Bank PLC v. Franchise Tax Bd. of Cal., 512 U.S. 298, 321–31 (1994); Franchise Tax Bd., 463 U.S. at 196. After the first win for the states, in 1983,70Franchise Tax Bd., 463 U.S. at 196. U.S. trading partners pressured the federal government, which in turn pressured the states, not to use mandatory worldwide combination. The states capit­ulated and offered—and still offer—multinational corporations what is called a “water’s-edge” election, which, for the most part, allows corporations not to combine income earned abroad.71Shanske, supra note 57, at 181–82. That is, as to which income of a multinational is domestic and which foreign, the water’s edge election allows a corporation to force the state to accept its accounting. Naturally, the availability of a water’s-edge election encourages multinational corporations to shift income abroad to escape state taxation. Eliminating this election could therefore allow states to tax a substantial portion of the income that multinational corporations continue to shift to low-tax jurisdictions. As noted above, one respected estimate is that states could raise about $17 billion through moving to worldwide combination.72Phillips & Proctor, supra note 51. B. Conforming to GILTI Global Intangible Low-Taxed Income (GILTI) is a category of income added to the federal tax code by the TCJA.73I.R.C. § 951A. GILTI is income nominally earned by the foreign subsidiary of a U.S. corporation that federal tax law deems to have been earned someplace else, such as the United States.74See id. In other words, by means of a formula, the federal corporate income tax uses GILTI to combat the same income-shifting problem that is targeted by worldwide combination. Though there is some complexity, all a state with a corporate income tax has to do is subject GILTI to state corporate tax, and then that state would also be combatting income stripping. The state can then use the same formula that it would ordinarily use to divide up the income of a multinational corporation.75See generally Darien Shanske, How the States Can Tax Shifted Corporate Profits: An Application of Strategic Conformity, 94 S. Calif. L. Rev. 251 (2021) (discussing the various complexities). A state cannot conform to GILTI and adopt worldwide combin­ation; the two are substitutes because both are attempts to ferret out shifted income. A state could offer taxpayers a choice between the two. Between worldwide and GILTI, worldwide is better from the state’s perspective because it simply includes all the income of a multinational corporation without the intrusion of the complicated federal formula for picking out suspect income. That said, conforming to GILTI may be easier politically (and, arguably, administratively), as it requires little more than adding a sentence to the state corporate income tax code that the state is conforming to a provision of the federal tax law meant to combat income shifting. This conformity could raise a lot of revenue; the Penn Wharton Budget Model estimates $382 billion in total GILTI for 2020.76Global Intangible Low-Taxed Income, 2020–2030: Estimates for the U.S. and Massachusetts, Penn Wharton Univ. of Pa. Budget Model (Feb. 25, 2020), https://budgetmodel.wharton.upenn.edu/estimates/2020/2/25/gilti-2020-2030-us-ma [https://perma.cc/FQ5Z-F983]. If states were to follow the federal government and tax half of GILTI, and do so at a 5% rate, then the taxes would yield almost $10 billion annually. To be sure, this is an estimate—and a pre-pandemic estimate at that, like all the estimates we provide. That said, broadening the base in this way is sound tax policy. The ensuant revenue will remain substantial even during a recession given that some firms, quite possibly with a lot of GILTI, are likely to remain profitable.77A related—and complementary—way to expand the corporate tax base through conformity would be to also conform to Subpart F, I.R.C. § 952. For discussion of Subpart F and many more issues involved in GILTI conformity, see Shanske, supra note 67. Note that President Biden has proposed changing the structure of GILTI in various ways. Most of these reforms would not affect how states should conform to GILTI, but some might, and so GILTI conformity may require modulation based on events at the federal level.78Dep’t of the Treasury, General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals 4–6 (2021), https://home.treasury.gov/system/files/131/General-Explanations-FY2022.pdf [https://perma.cc/FQ5Z-F983] (providing proposals to reform GILTI, including elimination of deemed ten percent normal rate of return). C. Strategically Decouple from Federal Tax Cuts States generally piggyback on the federal tax code for purposes of their own tax laws.79See e.g., Amy B. Monahan, State Individual Income Tax Conformity in Practice: Evidence from the Tax Cuts & Jobs Act, 11 Colum. J. Tax L. 57, 61–64 (2019); Mason, supra note 1, at 1274–79. In this Section, we suggest that states take a closer look at that practice and strategically decouple from a series of tax cuts enacted in recent years. Specifically, we suggest that states strongly consider decoupling from the TCJA’s full expensing provision under Section 168(k) and from the CARES Act’s expanded corporate interest deductions and net operating loss provisions. We argue that states should decouple from these specific provisions and similar provisions that might one day be passed in response to future crises. 1. Full Expensing Section 168(k) currently allows taxpayers a 100% deduction for most business equipment and machinery purchases.80I.R.C. § 168(k). That full-expensing section is generally defended as either a supply-side stimulus or a preferential step toward a cash-flow based tax.81See e.g., Erica York, Reviewing the Benefits of Full Expensing for the Post-Pandemic Economic Recovery, Tax Found. (Apr. 27, 2020), https://taxfoundation.org/benefits-of-full-immediate-expensing/[https://perma.cc/RX3N-NYDS]. Full expensing at the state level is inappropriate under either rationale, especially during the COVID-19 fiscal crises. First, as we have noted throughout this Article, states are not in a good position to provide economic stimulus to businesses in times of fiscal distress. That is the type of assistance that should come from the federal government. This point bears repeating: the right question is not whether, all things equal, a state-level tax break would help businesses right now—of course it would. But those dollars must come from somewhere, given state balanced-budget rules. Thus, the right question is whether a relatively small amount of state tax relief is a better use of funds than making cuts to vital services during a recession and pandemic, especially when the federal government has already provided relief. Second, the general economic case for full expensing is uncertain and controversial82See generally, Lily L. Batchelder, Accounting for Behavioral Considerations in Business Tax Reform: The Case of Expensing (Jan. 24, 2017) (unpublished manuscript), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2904885; Steve Wamhoff & Richard Phillips, The Failure of Expensing and Other Depreciation Tax Breaks, Inst. on Tax’n & Econ. Pol’y (Nov. 19, 2018), https://itep.org/the-failure-of-expensing-and-other-depreciation-tax-breaks/ [https://perma.cc/8RLB-CLDA]; cf. Anna Tyger, New Evidence on the Benefits of Full Expensing, Tax Found. (Aug. 15, 2019), https://taxfoundation.org/benefits-of-full-expensing/ [https://perma.cc/ZK7B-8QY8] (making the economic case for full expensing).—especially in a world in which Section 179 of the Tax Code gives smaller firms full expensing already.83Tax Code § 179 allows certain taxpayers the option of deducting certain expenses that would otherwise be capitalized, but the provision is available only up to a limit and for taxpayers whose otherwise eligible expenses are limited in amount. See I.R.C. § 179 (providing these conditions). In contrast, § 168(k) allows full expensing for eligible expenses without limit. See I.R.C. § 168(k). Additionally, although adopting full expensing might move a state closer to what some consider a normatively superior tax base,84See e.g., Christopher H. Hanna, Tax Theories and Tax Reform, 59 SMU L. Rev. 435, 439–45 (2006). states cannot achieve that goal with full expensing in isolation. The existing state corporate income tax deviates from a cash-flow tax by both excluding borrowed funds from income and including those amounts in an asset’s depreciable tax basis while also allowing for interest deductions for the funds used to purchase assets that are fully expensed.85See Joseph M. Dodge, Toward Income Tax Accounting Consistency: Eliminating Accrual, Depreciation, and the Existing Tax Treatment of Borrowing, 18 Fla. Tax Rev. 1, 15 (2015) (discussing these features of the Tax Code). Full expensing alone is a costly, partial move toward a cash-flow tax. It is unwise for states to adopt full expensing as a step toward a complete restructuring of their tax systems without undergoing that complete restructuring altogether. Partial reforms can result in negative tax rates on capital investments and the concomitant encouragement of investments that would not be undertaken absent that tax benefit.86See Hanna, supra note 84, at 451 (“[E]xpensing coupled with an interest deduction on debt-financed investments yields an effective tax rate of less than zero.”). It is especially foolish to engage in such a restructuring during ongoing crises if the transition would result in even less revenue. If states want to move toward a corporate tax base compatible with full expensing, then we recommend (at a minimum) that they disallow all interest payment deductions as part of their corporate tax bases. But seeing as successfully enacting this would require much broader, more involved reform than just decoupling from § 168(k), decoupling from § 168(k) is the easiest and most straightforward path for states to follow during their budget crises. More ambitiously, and as an extension of the foregoing logic, it would also be prudent for states to go further and consider decoupling from the accelerated depreciation generally allowed under § 168—at least absent or until broader reform efforts consider the alternative of ending interest payment deductions and possibly including debt financing in the tax base. Again, a depreciation allowance that would more closely track economic depreciation is justifiable within states’ current systems as a matter of income tax principle and would help them meet their revenue needs. 2. Net Interest Deduction Limitation Related to this discussion are the net interest limitations contained in the TCJA and the CARES Act’s modifications to those rules. The TCJA introduced § 163(j), which limited business interest deductions to thirty percent of a taxpayer’s adjusted taxable income.87I.R.C. § 163(j)(1)(B). The CARES Act loosened that limitation in a couple of ways. First, it raised the threshold percentage from thirty to fifty percent.88Coronavirus Aid, Relief, and Economic Security Act, Pub. L. No. 116-136, § 2306, 134 Stat. 358 (2020). Second, for purposes of tax reporting for 2020, the bill modified § 163(j) by allowing taxpayers to use their 2019—rather than 2020—adjusted taxable income for making their limitation calculations.89Id. The TCJA’s business interest limitation was enacted in conjunction with its full-expensing allowance in § 168(k). And while neither the conference report nor the JCT Bluebook explained why that provision was enacted, the U.S. Senate Finance Committee did discuss that limitation in a section on cost recovery.90See, e.g., U.S. S. Comm. on Finance, 115th Cong., Tax Cuts and Jobs Act: Chairman’s Mark Section-by-Section Summary (2017), https://www.finance.senate.gov/imo/media/doc/11.19.17%20Section%20by%20Section%20—%20FINAL1.pdf [https://perma.cc/C3DQ-6YCQ]. Some therefore view the business interest limitation as a sort of quid pro quo for full expensing—a way of discouraging “excessive debt financing” of assets that could be fully expensed.91See, e.g., Karl A. Frieden & Stephanie T. Do, State Tax Conformity to Key Taxpayer-Favorable Provisions in the CARES Act, 96 Tax Notes State 303, 306 (2020); Jared Walczak, Ranking State Tax Competitiveness After Wayfair and the TCJA, 94 Tax Notes State 413, 417 (2019) (“[The business interest limitation] was intended to eliminate the bias in favor of debt financing over equity financing in the federal code.”). But the business interest limitation of § 163(j) is neither directly tied to nor fully accounts for § 168(k). Section 163(j) limits interest deductions,92I.R.C. § 163(j)(1)(B). but it does not prevent businesses from deducting interest on debts incurred to purchased assets that are fully expensed under § 168(k). That is highly problematic as a matter of tax policy.93There is no room in the existing income tax—which both excludes borrowed funds from income and includes those amounts in an asset’s depreciable tax basis—for any interest deduction for funds used to purchase assets that are fully expensed. See, e.g., Calvin H. Johnson, Tax Shelter Gain: The Mismatch of Debt and Supply Side Depreciation, 61 Tex. L. Rev. 1013, 1018 (1983); Michael J. Graetz, Implementing a Progressive Consumption Tax, 92 Harv. L. Rev. 1575, 1609 (1979). Section 163(j) is even further limited because it does not apply to all taxpayers. Exempt from the limits are businesses whose average annual gross receipts over an applicable three-year period do not exceed $25 million.94I.R.C. §§ 163(j)(3), 448(c). Thus, it is reasonable for states to evaluate their business interest limitation independently from their depreciation allowances after the TCJA and CARES Act. Pre-CARES Act, states were in two camps: those that conformed to § 163(j), and those that did not—which means that non-conforming groups allowed interest deductions without the § 163(j) limitation.95See Richard C. Byrd, Stephen J. Madden, Jeffrey M. Raney & John T.M. Whiteman, State Responses to the Tax Cuts and Jobs Act: An Analysis from Indiana and Missouri, 58 Wash. U. J.L. & Pol’y 231, 257–59 (2019) (discussing differing state responses). Conformity with the CARES Act for these latter groups would obviously mean two different things: an expansion of the interest deduction for previously conforming states, and a contraction for the others. States that did not previously conform to § 163(j) and limit business interest deductions might want to consider that change. Quite simply, the calculus for states is very different now than it was even immediately after the TCJA was enacted. Limiting an interest deduction for a limited subset of highly leveraged firms is likely preferable to cutting funding for critical state services. States must be concerned with overall welfare rather than focused on only the negative impact that a limited interest deduction might have on particular firms. States that conformed to § 163(j) prior to the CARES Act should have decoupled from the CARES Act’s changes to that limitation—and more generally, states should consider decoupling from similar deduction expansions in future fiscal emergencies. Many businesses undoubtedly need cash in such desperate times, and many also need to incur additional debt to manage shortfalls caused by emergencies. Expanded deductions certainly help those companies, and some argued for CARES Act conformity on that ground.96See Frieden & Do, supra note 91, at 305. But the problem with expanding the state business interest deduction to aid struggling firms was two-fold. First, states were not in a position to provide stimulus funding to firms during the pandemic. Second, there was little fit between expanding the interest deduction and providing relief to firms that were struggling because of COVID-19. The interest limitation of § 163(j) applies to only a select group of firms, and expanding that limit would reverse the modest inroads that the TCJA made into the debt preference in the U.S. Tax Code.97Robert E. Holo, Jasmine N. Hay & William J. Smolinski, Not So Fast: 163(j), 245A, and Leverage in the Post-TCJA World, 128 Yale L.J.F. 383, 383–89 (2018). States choosing to expand the limit would be providing a targeted tax cut to an unknown group of taxpayers to the detriment of the known community in the state. No change in the tax laws can be viewed in isolation from the state’s overall mission and goals. In light of these considerations, states should not conform to the CARES Act changes to the business interest limitation, and states that previously decoupled from § 163(j) should consider adopting that provision now. 3. NOL Changes Before the TCJA, the federal tax code allowed taxpayers to carry net operating losses (NOLs) back for two tax years and to carry them forward for twenty years.98I.R.C. § 172(b)(1)(A)(ii)(I) (2016) (amended 2017). The TCJA eliminated taxpayers’ ability to carry back their NOLs but allowed an unlimited carryforward.99§ 172(b)(1). The Act also limited taxpayers’ use of NOLs in any given year to 80% of their taxable income.100§ 172(a)(2). These provisions served both to raise revenue for offsetting the TCJA’s revenue reductions and to prevent taxpayers from using losses incurred in post-TCJA years to offset income earned under the old 35% corporate tax rate. The CARES Act modified these rules again. Under the new law, corporations are allowed to carry back losses incurred in tax years ending after December 31, 2017, and before January 1, 2021, for five years.101§ 172(b)(1)(D). The TCJA’s 80% limitation is also suspended for tax years beginning before January 1, 2021.102§ 172(a)(1). The CARES Act did not eliminate the TCJA’s indefinite carryforward. If one is solely focused on getting taxpayers cash in any way possible during a recession, these expansions obviously work—for some. The NOL expansion allows taxpayers to carry back losses unburdened by an 80% limit. In a world where the tax year is used just for administrative convenience, an unlimited carryback may also make sense. A taxpayer who earns a profit in Year 1 and loses it in Year 2 has, on net, earned nothing. A carryback recognizes the oddities that result from adopting reporting periods for tax purposes. Again, however, states have more to consider than simply getting companies cash in any way possible. As with the aforementioned net interest limitation modification, merely pointing out that some companies would benefit from expanded net operating loss utilization does not justify this policy change. States should again consider the overall cost and distributional aspects of that expansion and whether the state could better help its residents and businesses through other means. States, again, cannot be in charge of stimulus funding during a recession. Firms must look to the federal government for that support. Notably, most states already decouple from the federal NOL rules in one way or another, and most do not allow any NOL carryback.103See Frieden & Do, supra note 91, at 308; see also Hellerstein & Hellerstein, supra note 68, at § 7.16. NOL carrybacks at the state level raise difficult issues regarding the amount and source of the losses for taxpayers operating in multiple states. Either the calculations are imprecise or the administrative burden is incredibly high.104Hellerstein & Hellerstein, supra note 68, § 7.16[1]; Katherine Loughead, State Conformity to Federal Pandemic-Related Tax Provisions in CARES and ARPA, Tax Found. (Apr. 1, 2021), https://taxfoundation.org/state-conformity-cares-act-unemployment/ [https://perma.cc/KY8R-DZAQ]. States that use state-specific calculations for precision purposes already use NOL calculations independent from the federal amounts, so conformity becomes a matter of state tax and economic policy rather than one of harmonization with the federal government. An unlimited NOL provision might make more sense at the state level than at the federal level if states’ tax rates have remained unchanged. But states have other policy considerations—as evidenced by their current NOL practices—and their tax codes do not necessarily reflect good tax policy at every turn. For example, every state with an income tax conforms to the federal step-up in basis at death,105See I.R.C. § 1014(a) (providing that the tax basis of property that is inherited is generally the property’s fair market value at the time of the prior owner’s death). and states offer a wide variety of targeted tax breaks for particular industries or taxpayers.106Hellerstein & Hellerstein, supra note 68, § 4.14[3][b][v] (“[V]irtually every state with an income tax offers a credit for investing in particular types of facilities, hiring a specified number of new employees, or spending a certain amount of money in the state on particular activities.”). It is just reality that states’ tax bases reflect political and economic considerations that go beyond pure tax policy.107See, e.g., id. In the NOL context, states have erred on the side of more limited NOL use than is allowed under federal law, so the question is whether they should have changed course in the midst of the pandemic. We obviously cannot consider each idiosyncrasy in states’ budgets or tax bases, but it seems clear that conformity as pure stimulus would be overbroad. The CARES Act’s NOL expansions apply to losses incurred well before this pandemic,108Supra notes 101–02 and accompanying text. so the changes are not tied to pandemic losses. NOL expansions would also obviously work to get cash into the hands of affected corporations. But that does not mean that conformity makes sense for states as a method of relief. Every taxpayer would benefit in the form of additional funds, but that was true before this pandemic as well. States must prioritize, and they likely cannot afford this type of nontargeted relief. D. Temporary Corporate Income Tax Surcharge Many businesses suffered losses during the recession. A few prospered. It is not imposing a moral judgment to suggest that businesses that do relatively well should pay more in taxes to offset the increased budgetary costs of the downturn. Put concretely, we may be grateful to Amazon for its delivery service, but it still seems appropriate to tax it on its profits in order to help main street businesses. It might be particularly appealing to tax a firm that is profiting during the recession on its “excess” profits,109Reuven S. Avi-Yonah, It’s Time to Revive the Excess Profits Tax, Am. Prospect (Mar. 27, 2020), https://prospect.org/coronavirus/its-time-to-revive-the-excess-profits-tax/ [https://perma.cc/D34Q-LWWK]; Reuven S. Avi-Yonah, Taxes in the Time of Coronavirus: Is It Time to Revive the Excess Profits Tax? (Univ. of Mich. Pub. L. Rsch. Paper No. 671, 2020), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3560806. but designing and implementing a new tax would be a heavy administrative lift for a state during a pandemic. Fortunately, the regular corporate income tax is already something of an excess profits tax, to the extent that by definition it will tax only profitable firms, and those firms are likely to be less common during a downturn. As for those few profitable firms, a temporarily higher corporate income tax rate would reflect that putting a greater share of profits toward the common good is especially urgent. For instance, suppose that a state were to adopt a 3% corporate income tax surcharge for three years. This could raise some extra revenues in the depths of a recession from those most able to pay. This surcharge could be imposed only above a threshold, so as to apply only to larger businesses that are unlikely to face serious liquidity problems, and with respect to which the corporate income tax can also serve antitrust-related goals. That is, if one believes that the most profitable firms (and thus the ones paying most of the corporate income tax surcharge) are so profitable because they are earning supernormal profits,110See generally Fox, supra note 56. there is an extra reason to tax these profits to the extent one believes that these firms’ monopoly power imposes costs on the rest of us.111Reuven S. Avi-Yonah & Lior Frank, Antitrust and the Corporate Tax: Why We Need Progressive Corporate Tax Rates, 167 Tax Notes Fed. 1199, 1199–201 (2020). Note that pairing progressive tax rates with a state corporate tax base that has been successfully broadened through moving to worldwide consolidation or conforming to GILTI would be a sensible permanent reform. E. Suspension (or Capping) of Some Corporate Tax Credits and Deductions States offer a multitude of tax credits. The consensus is that these do little to encourage economic development,112David Gamage & Darien Shanske, Tax Cannibalization and State Government Tax Incentive Programs, 82 State Tax Notes 197, 199 n.13 (2016). but this is not the place to fight that battle. What we want to emphasize is that some tax credits have grown so large that they could dramatically reduce the value of these suggested reforms. Our principal example is state R&D credits, at least in some states.113Legislative Analyst’s Office, Current State R&D Tax Credits 2 (2011), https://lao.ca.gov/handouts/Econ/2011/Current_State_R_D_12_5_11.pdf [https://perma.cc/6G6D-LG7J] (analyzing California’s R&D and credit) [hereinafter LAO]. For a survey of R&D credits in states in the northeast, see Heather Poole, Selected States R&D Tax Credits, https://www.cga.ct.gov/2015/rpt/2015-R-0209.htm [https://perma.cc/6A4L]. These are expensive, costing California alone almost $2 billion annually.114Cal. Dep’t of Fin., Tax Expenditure Report: 2019–20, at 8, https://www.dof.ca.gov/Forecasting/Economics/Tax_Expenditure_Reports/documents/Tax_ExpenditureReport_2019-20_B.pdf [https://perma.cc/9T9M-FLNA]. Depending on the year, that is as high as twenty percent of all that California collects in corporate income tax.115See State Government Tax Collections, Corporation Net Income Taxes in California, FRED https://fred.stlouisfed.org/series/CACORPINCTX (last visited Feb. 18, 2022) (reporting that California collected about billion in corporate tax in 2017 and billion in 2019). Even worse, R&D credits in some states, again, like California, which has a particularly generous credit structure, can be stockpiled. It is likely that many of the taxpayers shifting profits have also been stockpiling credits; there were $11 billion in credits stockpiled in California in 2009, likely concentrated in the very profitable industries, such as pharmaceuticals, that would likely pay more in tax under the other corporate reforms.116See LAO, supra note 113, at 5–6. It is estimated that a shift to worldwide combination could net California almost $3 billion annually,117See Philips & Proctor, supra note 51. but this would not amount to much during a crisis if the most profitable firms use their $10+ billion stockpile of credits to negate the tax. We hope that a time will come to reconsider state R&D credits and other credits.118In fairness, state-level R&D credits have been shown to have some effect at attracting more research activity, but at the expense of other states. See, e.g., Daniel J. Wilson, Beggar Thy Neighbor? The In-State, Out-Of-State, and Aggregate Effects of R&D Tax Credits, 91 Rev. Econ. & Stat. 431 (2009). But, as with the temporary surcharge we propose, states must be able to tax the actors with greater ability to pay during an economic downturn. R&D credits should thus be suspended, for, say, a few years or some other rough estimate during a recession. F. Reform the Sales Factor As noted earlier,119See supra Section II.A (discussion of mandatory worldwide combination). states have shifted to dividing up the income of a multinational corporation by using a formula based on the percentage of sales in a state. This approach has turned out to be expensive. For example, in 2014–15, the last available year for which data were collected, California estimated that it loses almost $1 billion per year120Cal. Dep’t of Fin., Tax Expenditure Report: 2014–15, at 7 tbl.2, https://www.dof.ca.gov/Forecasting/Economics/Tax_Expenditure_Reports/documents/TER_9_15_2014.pdf [https://perma.cc/S5TB-TJV8] (showing an estimated loss of 0 million). because of this formulaic shift—roughly ten percent of its total corporate income tax collection.121See supra note 115. How can that be? California is a big market state, after all. One likely reason is that taxpayers have gotten very good at gaming the sales factor.122Darien Shanske, Expanding State Fiscal Capacity, Part I: Combining an Entity-Level Consumption Tax, Improved Sales Factor Apportionment, and a Tax on a Federal Windfall (the QBI Deduction), 22 Fla. Tax Rev. 448, 487–99 (2019). Reforming the sales factor could therefore raise a lot of revenue, especially if some of the other reforms we discuss are also adopted. We propose two reforms below.123See Reuven S. Avi-Yonah & Kimberly A. Clausing, Toward a 21st-Century International Tax Regime, 95 Tax Notes Int’l 839, 846–47 (2019); Shanske, supra note 122, at 487–99. First, the law of the sales factor should be refined to apportion a sale to its ultimate destination in all cases, including sales of tangible personal property. States generally permit sales to be located where a middleman—e.g., a wholesaler—takes title to the goods.124See Shanske, supra note 122, at 497–98. The problem with this rule is that it encourages taxpayers to sell to intermediaries in low-tax jurisdictions. Reforming the rule to apportion a sale to its ultimate destination would be actionable; a corporation could look to information it retains in the usual course of business, because surely businesses generally know where their customers are. If the corporation does not have this information and cannot obtain it from its wholesalers, then it could use any reasonable method, including population, to fill in the gaps. A second reform we propose to the sales factor is for corporations to be required to submit an accounting of where they would locate all their sales using the method they have used for the state in question. Corporations should also report where they are reporting sales to other states with the single sales factor. It might not seem odd to a California auditor, for instance, if California’s sales factor for a corporation was only eight percent—so a bit below the state’s share of U.S. GDP125See Katharina Buchholz, Which States Are Contributing the Most to U.S. GDP?, Statista (Apr. 12, 2021), https://www.statista.com/chart/9358/us-gdp-by-state-and-region/ [https://perma.cc/9V5U-PEBJ].—but it would rightfully raise alarm bells if the disclosure of this method revealed a ten percent sales factor for Nevada, which has less than one percent of U.S. GDP, or for the Cayman Islands. How could such small jurisdictions absorb such a high proportion of the sales of a large multinational corporation? G. Expand the Corporate Income Tax to All Entities There has been a shift away from the corporate form over the last few decades; prominent commentators link the shift to the decline in the productivity of the state corporate income tax.126Fox & Luna, supra note 64, at 715–16. In any event, it does not make much sense for two large businesses to be subject to different tax regimes solely because one is a corporation and the other is not. The tax system should be neutral as to different decisions regarding business organization. One possible objection is that we would not want to pull millions of small businesses into the corporate tax regime. That concern is valid, as such businesses often are not C corporations. Yet the corporate tax could be extended to just the largest noncorporate businesses with little loss of revenue.127Matthew J. Knittel & Susan C. Nelson, How Would Small Business Owners Fare Under a Business Entity Tax?, 64 Nat’l Tax J. 949, 974 (2011) (“Using a million gross income and deduction test, we find that 99 percent of the entities deemed a business (54 percent of total filers) are also a small business, and they reported 18 percent of total business income and 16 percent of net business income for tax year 2007.”). This is another example of a change that could yield significant revenue, especially as the economy improves. This is not an abstract proposal, as Texas’ franchise (margin) tax is imposed on all business entities,128Tex. Tax Code Ann. § 171.0002 (West 2021). except those with revenue below a certain threshold (about $1 million).129§ 171.002(d)(2). H. Other Reforms: Strategic Conformity States should be on the lookout for other kinds of opportunities. For example, sometimes the federal government changes the tax law in ways that states do not automatically conform to but that they should conform to. A significant example of this involved repatriation.130For a more in-depth version of this argument, see Darien Shanske & David Gamage, Why (and How) States Should Tax the Repatriation, State Tax Notes 317, 317 (2018). Under the U.S. international tax law regime that ended in 2018 with the TCJA, the United States—at least nominally—sought to tax the profits of multinational corporations on the basis of their worldwide income.131For a brief introduction to the U.S. approach to taxing companies with international operations, see Susan C. Morse, International Cooperation and the 2017 Act, 128 Yale L.J.F. 362, 363–66 (2018). At the same time, the regime permitted U.S.-based multinationals to defer payment of tax on profits earned overseas until that money was brought home.132Id. Until a foreign subsidiary repatriated its profits to its U.S. parent, the profits were not subject to U.S. tax.133Id. Naturally, large multinational corporations left a lot of money—over $2 trillion—stashed abroad.134Jeff Sommer, A Stranded Trillion Overseas Stash Gets Closer to Coming Home, N.Y. Times (Nov. 4, 2016), https://www.nytimes.com/2016/11/06/your-money/strategies-corporate-cash-repatriation-bipartisan-consensuss.html [https://perma.cc/H3QH-5BTB]. Much of that money represented profits that were substantively earned in the United States by virtue of the contributions made by U.S. workers and consumers, and that would have been taxed in the U.S. if not for the increasing allure of shifting profits.135Harry Grubert, Foreign Taxes and the Growing Share of U.S. Multinational Company Income Abroad: Profits, Not Sales, Are Being Globalized, 65 Nat’l Tax J. 247, 247 (2012). The TCJA deemed all the deferred income repatriated and subject to tax.136I.R.C. § 965(a). But it then applied special low tax rates to these profits, effectively exempting most of the profits from tax.137I.R.C. § 965(c). Most state corporate income taxes were not set up to recoup this loss, because they did not conform to this new provision of the Code or were otherwise not set up to tax this kind of income.138Jared Walczak & Erica York, GILTI and Other Conformity Issues Still Loom for States in 2020, Tax Found. (Dec. 19, 2019), https://taxfoundation.org/gilti-state-conformity-issues-loom-in-2020/#Repat [https://perma.cc/5PKR-L3NA]. Amazingly, states still did not act to recoup the loss even at the depths of the crisis.139Karl A. Frieden & Erica S. Kenney, Eureka Not! California CIT Reform Is Ill-Conceived, Punitive and Mistimed¸ Taxnotes (May 24, 2021), https://www.taxnotes.com/tax-notes-international/corporate-taxation/eureka-not-california-cit-reform-ill-conceived-punitive-and-mistimed/2021/05/24/60lsy [https://perma.cc/FL5L-3ZTW]. We hope that states will be quicker to embrace easy, progressive, and sound solutions like taxing repatriation the next time around. III. State Personal Income Tax and Wealth Tax Reforms During a fiscal emergency like the COVID-19 pandemic, states should focus on raising revenue from their most fortunate residents to ensure the health, safety, and welfare of the entire community.140This Part restates and builds upon reforms that were first proposed in Adam Thimmesch, Darien Shanske & David Gamage, Strategic Nonconformity to the TCJA, Part I: Personal Income Taxes, State Tax Notes 1, 17 (2020). In that vein, we suggest that states consider modifying their personal income tax rate structures to make these taxes more progressive—rather than (say) tinkering with personal exemptions or standard deductions. That recommendation especially applies to the nine states that impose flat-rate income taxes.141Federation of Tax Administrators, State Individual Income Tax Rates, Taxadmin.org (Feb. 2021), https://www.taxadmin.org/assets/docs/Research/Rates/ind_inc.pdf [https://perma.cc/5G7H-GZN5]. Those states should impose graduated rates, at least for a limited period (for instance, as temporary high-income surcharges). States that already have graduated rate structures should look to either adding brackets or raising the tax rates for those in the highest brackets. That recommendation applies with special force to the many states with graduated structures that are effectively flat. For example, the top bracket in many states kicks in once an individual has over $20,000 of taxable income.142Katherine Loughead, State Individual Income Tax Rates and Brackets for 2020, Tax Found. (Feb. 4, 2020), https://taxfoundation.org/state-individual-income-tax-rates-and-brackets-for-2020/ [https://perma.cc/EE8N-FLCQ]. Those structures are progressive in name only. And while those states may not be willing to abandon their overall economic or political goals underlying those effectively flat-rate structures, they should ask for more from their millionaires than from their entry-level schoolteachers during a global pandemic or other severe crisis. High-income taxpayers received the bulk of the tax cuts from the TCJA143Jennifer Bird-Pollan, Revising the Tax Law: The TCJA and Its Place in the History of Tax Reform, 45 Ohio N.U. L. Rev. 501, 523–24 (2019) (“On the distributional side, most commentators agree that the large majority of the benefit of the tax cuts enacted under the TCJA will accrue to higher-income and wealthy taxpayers.”). and have greater capacity to shoulder the state tax burden. Again, at a minimum, temporary surcharges on the highest-income state taxpayers could help state governments endure the coming fiscal storms. Worth underscoring here is the tautology that an income tax is a tax on income. Suppose someone in the restaurant business earned a high income in tax years 2018 and 2019, and thus profited handsomely from the TCJA. In 2020 this taxpayer earned much less because of the pandemic. Adding a new higher bracket or two will have little or no effect on them while they are down, although they might well need to pay more when their earnings have been restored. A. Taxing the QBI Windfalls There exists a more specific way in which state governments should consider reforming their personal income taxes, so as to claw back some of the windfall given to high earners by the TCJA: states could affirmatively tax their residents’ “QBI windfalls.”144Shanske, supra note 122. The twenty percent qualified business income (QBI) deduction of § 199A was one of the more questionable provisions in the TCJA145Daniel Shaviro, Evaluating the New U.S. Pass-Through Rules, 1 British Tax Rev. 49, 52–53 (2018). and served largely to retain a consistent tax rate differential for taxpayers who earned income through investments in corporations and through pass-through entities.146Michael S. Knoll, The TCJA and the Questionable Incentive to Incorporate, State Tax Notes, 977, 977 (2019). It is unclear why maintaining this arbitrary rate distinction is a preferred policy goal. In any event, the TCJA did not completely accomplish that goal. The QBI deduction is not available to all taxpayers and is subject to a variety of conditions and phaseouts.147E.g., I.R.C. § 199A(b)(3), (c)–(e). The QBI deduction is also highly regressive and distortionary. The Joint Committee on Taxation estimated that more than three-fourths of the benefit would go to those earning $200,000 and above.148Joint Committee on Taxation, JCX-32-18, Tables Related to the Federal Tax System as in Effect 2017 Through 2026, at tbl.3 (Apr. 23, 2018), https://www.jct.gov/publications/2018/jcx-32-18/ [https://perma.cc/Y6PF-SL9A]. Those with earnings above $1 million received nearly half the benefit.149Id. The deduction is also expensive, projected to cost about $40 billion in 2018.150Id. Thus, even taxing away half the benefit would raise about as much as shifting to mandatory worldwide combination. Almost no states conformed to the QBI deduction for purposes of their own personal income taxes,151See Jared Walczak, Tax Foundation Analyzes State Tax Codes Following Federal Reform, 91 State Tax Notes, 579, 597 (2019) (discussing how few states would be impacted by the federal deduction). and for good reason. The dubious policy reason given for this change at the federal level did not apply at the state level given the lack of state corporate tax rate changes. States that have not yet decoupled from the § 199A deduction should do so. We also think that states should go further and affirmatively tax their residents’ QBI windfalls.152For more on this proposal, see Shanske, supra note 122. The § 199A deduction granted to residents saves them from paying federal income tax on up to 20% of their earnings.153I.R.C. § 199A(a). That windfall thus increased those residents’ taxpaying capacities and represents a pool of funds that states could access in a progressive way to help the entirety of their populations.154See Gary Guenther, Cong. Rsch. Serv., R46650, Section 199A Deduction: Economic Effects and Policy Options 12 (2021), https://sgp.fas.org/crs/misc/R46650.pdf [https://perma.cc/QHN7-NRDE]. Our proposal is not to tax the QBI benefit retroactively; only current and future beneficiaries would pay the tax. Further, we propose clawing back the benefit only at higher-income levels. Again, the idea is that those who can pay more should pay more in an emergency, and they should pay out of their ill-conceived federal windfall. B. Strategically Decoupling from Federal Tax Cuts We considered strategic decoupling in our discussion of the corporate income tax above,155See supra Section II.D. but it is also important for states to strategically decouple from federal tax changes that negatively impact their personal income tax codes as well. That decoupling would include many of the same provisions that affected the corporate income tax, due to the reporting of business income from pass-through business entities on personal income-tax returns. For example, states should consider decoupling from the expansion of the NOL rules in the CARES Act for purposes of both of their corporate and personal income taxes. One provision in the CARES Act was particularly problematic for state personal income taxes alone—the Act’s retroactive expansion to the deductibility of “excess business losses.”156Tax Cuts and Jobs Act of 2017, Pub. L. No. 115-97, § 11012(a), 131 Stat. 2054. We advise states to decouple from that change as well. One of the TCJA’s revenue raisers was a new limitation on high-income earners’ ability to deduct so-called “excess business losses.”157I.R.C. § 461(l). Excess business losses are losses from a trade or business that exceed the sum of the taxpayer’s income from trade or business activity and another $250,000, or $500,000 in the case of a taxpayer filing jointly with a spouse.158Id. at (l)(3). Disallowed losses are carried forward to future years, so the limitation is effectively a timing provision.159Id. at (l)(2) The CARES Act changed this limitation retroactively and deferred its application until tax years beginning after December 31, 2020.160Coronavirus Aid, Relief, and Economic Security (CARES) Act, Pub. L. No. 116-136, § 2304(a), (b)(3), 134 Stat. 313 (2020). The result was a significant, and retroactive, loss of revenue for states.161See Michael Mazerov, First, Do No Harm: States Can Preserve Revenue by Decoupling from CARES Act Tax Breaks for Business Losses, Ctr. on Budget & Pol’y Priorities (Jan. 4, 2021), https://www.cbpp.org/research/state-budget-and-tax/first-do-no-harm-states-can-preserve-revenue-by-decoupling-from-cares [https://perma.cc/3H4C-LHUV] (providing estimates of state revenue losses from this change in law). The TCJA’s change to the excess business loss rules presented the worst of state tax conformity. The change was retroactive. Its effects were targeted at high-income taxpayers.162Clint Wallace, The Troubling Case of the Unlimited Pass-Through Deduction: Section 2304 of the CARES Act, U. Chi. L. Rev. Online (June 29, 2020), https://lawreviewblog.uchicago.edu/2020/06/29/cares-2304-wallace/ [https://perma.cc/K2BF-WLDA]. It applied in the middle of a pandemic when states were ill-equipped to study its effects. And the cut was not even targeted at taxpayers with demonstrated need.163The retroactive nature of the CARES Act’s modification meant that taxpayers with losses prior to the COVID-19 pandemic would benefit even if they were doing fine, or particularly well, in 2020. Relief was available to all taxpayers who had excess business losses in 2018 or in 2019. Perhaps one could make an argument for liberalization of the excess business loss limitation for taxpayers with 2020 losses—though we think even that argument would be strained—but allowing taxpayers relief without any regard to their 2020 position makes no sense for states. It should go without saying that it makes even less sense for states to add state-tax relief to the much larger federal tax break offered to those impacted by this change. For these reasons, states would be well advised to decouple from, or refuse to conform to, the CARES Act’s modification of the excess business loss rules. States should also review other federal tax changes that impact their personal income taxes and strategically decouple to protect both the amount and distribution of their state personal income tax collections. Most broadly, examples like that of excess business losses indicate that states should generally consider moving away from fixed conformity to federal tax law such that the default is that their tax systems do not blindly follow federal choices.164See generally Mason, supra note 1. Or states should even consider having their own tax systems. See Monahan, supra note 79. C. State Wealth Tax or Deemed Realization Tax Reforms More ambitiously, we also urge states to consider wealth tax or deemed realization tax reforms, at least temporarily, to raise needed revenue to weather budget crises.165The proposal provided in this Section was previously explored in Gamage & Shanske, supra note 45, at 859. At least two promising options could be designed and implemented sufficiently quickly (at least in some states) to make good policy responses to budget crises. First, absent administrative constraints, the best solution is a one-time wealth tax on state residents—which is backward-looking in that the approach would tax wealth accumulated previously. Hence, it is less subject to tax-gaming and other detrimental taxpayer responses. Such a wealth tax should be designed with a large exemption, so that the tax would only apply to the wealthiest, who are generally better positioned to weather the downturn as compared to others—especially the beneficiaries of major state spending programs.166Daniel Markovits has made a similar proposal at the federal level. See Daniel Markovits, A Wealth Tax Is the Logical Way to Support Coronavirus Relief, N.Y. Times (Apr. 21, 2020), https://www.nytimes.com/2020/04/21/opinion/coronavirus-wealth-tax.html [https://perma.cc/ELP7-CW3Z]. Of course, administrative constraints complicate this story. States currently lack a general wealth tax, and it is unlikely to be feasible for them to design and implement a major new tax quickly. Moreover, some states face legal prohibitions against general taxes on wealth; for instance, article XVI, section 3, of the New York State Constitution states that “[i]ntangible personal property shall not be taxed ad valorem nor shall any excise tax be levied solely because of the ownership or possession thereof, except that the income therefrom may be taken into consideration in computing any excise tax measured by income generally.” Thus, because such a large share of wealth consists of intangible personal property (chiefly in the form of financial assets such as stocks and bonds), any meaningful New York wealth tax would likely require a constitutional amendment. Nevertheless, these barriers leave open at least two promising reform options. The first is a new statewide real property tax with a large exemption level (or circuit-breaker) so that only the wealthiest residents or businesses would be subject to it. Such a new tax (or surtax) could piggyback on the existing administrative valuations for real property taxes, and thus could be designed and implemented quickly. Needless to say, this would only be a quick option in states without constitutional limits on property tax rates or other legal and administrative barriers. In any case, this proposal could be designed and implemented as a temporary measure, meant for raising the revenue needed to weather an economic downturn. The second option is a new tax or deemed realization measure on the stock of unrealized capital gains. This could be done in several possible ways. For instance, the new tax could consist of a deemed realization of a percentage (for example, fifty percent) of unrealized gains that would then immediately be taxed at the state’s income tax rates, with an exemption so that this new levy would apply to only the wealthiest taxpayers. This option would be more difficult to design and implement and would likely need to rely substantially on self-reported appraisals—backed by auditing and penalties—for valuation purposes. But the revenue potential should still be reasonably large, and because so much wealth is constituted by publicly traded securities, neither self-assessment nor auditing ought to be prohibitively onerous.167Mark Gergen estimates that seventy-three percent of the total value of income-producing assets are publicly traded securities. Mark Gergen, How to Tax Capital, 70 Tax L. Rev. 1, 22 (2016). It might also be possible to design screening mechanisms that would use tax frictions to deter wasteful tax planning without imposing excess costs on taxpayers not engaged in such wasteful tax planning. See David Gamage, A Way Forward for Tax Law and Economics? A Response to Osofsky’s ‘Frictions, Screening, and Tax Law Design,’ 61 Buffalo L. Rev. 189, 190 (2014) (“Incorporating the analysis of screening mechanisms into the design of tax frictions, then, has the potential to improve the tax law’s ability to deter wasteful tax planning while imposing lower costs on regular business transactions.”). See generally Leigh Osofsky, Who’s Naughty and Who’s Nice? Frictions, Screening, and Tax Law Design, 61 Buffalo. L. Rev. 1059 (2013) (explaining such screening mechanisms). By taxing these unrealized gains now, states would in effect be accelerating what would otherwise have been future tax payments (at least in theory, as in practice much of unrealized gains are never realized or recognized because of provisions like stepped-up basis upon death). This is appropriate, because the effect of taxing unrealized gains during a downturn would be to at least partially counteract the fiscal volatility roller coaster by moving revenues to when they are needed most. In a sense, then, one might think of the current nontaxation of unrealized capital gains as a sort of emergency rainy day fund that states should now tap. It could be argued that either of these partial wealth tax reform proposals (which we explained earlier) could cause liquidity problems, even for the wealthy. Therefore, as a matter of design, the tax could permit a payment schedule, much like the deemed repatriation in the Tax Cuts and Jobs Act.16826 U.S.C. § 965(h). Such a schedule should contain a reasonable interest rate because states should consider borrowing against this stream of income to pay for immediate needs. Another possible objection to a tax of either type is that the wealthy might simply leave the state. There is significant economics literature on these issues.169See generally, Cristobal Young, Charles Varner, Ithai Z. Lurie & Richard Prisinzano, Millionaire Migration and Taxation of the Elite: Evidence from Administrative Data, 81 Am. Socio. Rev. 421 (2016); Joshua Rauh & Ryan J. Shyu, Behavioral Responses to State Income Taxation of High Earners: Evidence from California (Nat’l Bureau of Econ. Rsch., Working Paper No. 26349, 2019). We read this literature as implying that migrations from so-called high tax states have so far not represented a phenomenon that should overly trouble states considering more progressive taxation.170For example, we are not considering what would happen if states imposed much higher tax rates than they currently do. Regardless of how one reads the literature as to ongoing income taxes, our proposed tax measures represent a one-time tax on previously accumulated wealth or gains. Thus, there should be a minimal behavioral response. These taxes are not only broadly progressive and efficient, but they also could be designed to address deeper issues of inequality. Income and wealth inequality have become increasingly pressing issues at both the federal and state levels. Accordingly, recent Pew Research Center polling reveals that six in ten U.S. adults believe that there is too much inequality in the country today, and 84% of those who see inequality as a problem believe that the government should increase taxes on the wealthy.171Juliana Menasce Horowitz, Most Americans Say There Is Too Much Economic Inequality in the U.S., but Fewer than Half Call It a Top Priority, Pew Rsch. Ctr. (Jan. 9, 2020), https://www.pewresearch.org/social-trends/2020/01/09/most-americans-say-there-is-too-much-economic-inequality-in-the-u-s-but-fewer-than-half-call-it-a-top-priority/ [https://perma.cc/QZ4G-Q47R]. Yet states and the federal government do a very poor job of taxing the true economic income of the very wealthy.172See David Gamage, Five Key Research Findings on Wealth Taxation for the Super Rich (July 27, 2019), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3427827. For the top 0.1% of taxpayers, whose incomes derive primarily from the returns on owning wealth (rather than from salary or wages), structural features of state and federal income taxes make these taxes “so porous as to be largely symbolic.”173Id. (citing Edward J. McCaffery, The Death of the Income Tax (or, the Rise of America’s Universal Wage Tax) 2 (USC Gould Sch. of L. Ctr. for L. & Soc. Sci., Working Paper No. 18-25, 2019)). Thus, other relatively progressive reforms we have discussed, such as reforming personal income taxes, will not be progressive at the very top of the income distribution if not paired with a wealth or deemed realization tax. In that light, either option—a new statewide property surtax on the very wealthy or a new statewide tax on the unrealized capital gains of the wealthy—would help ameliorate the lack of effective taxation of the very rich. There is good reason to impose these taxes at any time, but during a pandemic and recession, these tax reform proposals are clearly well advised. Recall, when the federal government fails to act sufficiently, there is a zero-sum game at hand. Either states and localities must cut vital services, thereby prolonging the recession, or they avert these cuts by raising tax revenues. IV. State Sales Tax Reforms Raising sales tax rates would be regressive and is not a good reform option for coping with economic crises.174The proposals in this Part were first provided in two prior essays: Gladriel Shobe, Grace Stephenson Nielsen, Darien Shanske & David Gamage, Why States Should Consider Expanding Sales Taxes to Services, Part 1, 98 State Tax Notes 1349 (Dec. 21, 2020); Grace Stephenson Nielsen, Gladriel Shobe, Darien Shanske & David Gamage, How States Should Consider Expanding Sales Taxes to Services, Part 2, State Tax Notes 45 (Jan. 4, 2021). However, states should consider expanding their sales tax bases to include services. There are many reasons why states should consider this, the most pressing of which is that taxing services would significantly increase revenue in most states.175The state-level revenue projections in this Part are descriptive—they reflect estimates for proposed or enacted state tax packages—rather than normative and prescriptive. They may therefore include tax revenue from items that policymakers and scholars generally agree should not be included in the base. This is especially problematic for business inputs, which currently comprise around 40% of most states’ tax bases. See Hellerstein & Hellerstein, supra note 68, § 12.03. For example, when Utah attempted to expand its retail sales tax base to include all services by default in 2019, state auditors estimated the bill would bring in an additional $230 million in revenue in 2020.176Fiscal Note, H.B. 441, 63d Leg., Gen. Sess. (Utah 2019), https://le.utah.gov/~2019/bills/static/HB0441.html [https://perma.cc/X7P6-YMWR] (on the right-hand side of the webpage under “Related Documents,” choose the file labeled “Fiscal Note”). In 2017, Illinois estimated that it could bring in an additional $1.2 to $3 billion per year if it taxed the same services that Iowa taxed (which taxes a relatively broad range of services).177Keith Staats, A Tax on Services?, Ill. CPA Soc’y: Insight, Tax Decoded (Spring 2017), https://www.icpas.org/information/copy-desk/insight/article/spring-2017/a-tax-on-services [https://perma.cc/U52M-PUJZ]. Many other states have provided similar revenue estimates. For example, Connecticut, which already added certain services to its sales tax base in 2012, could raise an additional 0 million to .5 billion by expanding its sales tax to include more services. See Derek Thomas, Revenue Options Are Key to Addressing Budget Shortfalls and Supporting Thriving Communities, Conn. Voices for Child. (Jan. 2017), https://ctvoices.org/wp-content/uploads/2017/05/Revenue-Options-2017-FINAL-updated.pdf [https://perma.cc/DPW7-VK8Z]. North Carolina, which passed legislation that added several services to its tax base in 2016, estimated that the change brought in at least $84.8 million in sales tax revenue in the first year.178See H.B. 1030, 2016–2017 Gen. Assemb., Reg. Sess. (N.C. 2016), https://www.ncleg.gov/documentsites/committees/House2015-24/2016%20Session/06-07-16/Summary%20of%20Senate%20Finance%20Package%20in%20Senate%20Budget.pdf [https://perma.cc/9AXV-BFQB]; NC Adds Sales Tax to Services, BGW CPA, https://www.trustbgw.com/blog/2016/03/01/nc-begins-taxing-services [https://perma.cc/H7HM-MFUL]; see also Jared Walczak, Enhancing Tax Competitiveness in Connecticut, Tax Found. (July 31, 2018), https://taxfoundation.org/connecticut-tax-competitiveness/#_ftnref32 [https://perma.cc/KSG5-DG7V]. Since each state includes a different mix of transactions in its sales tax base, economists and policy makers have found it difficult to make concrete projections about how much revenue a broad services tax would raise if all states were to add consumer services to their tax bases. At least one estimate, though, places the potential “annual, nationwide revenue yield from taxing all services purchased by households” in the tens of billions.179See Michael Mazerov, Ctr. on Budget & Pol’y Priorities, Expanding Sales Taxation of Services: Options and Issues iii, 4 (2009), https://www.cbpp.org/sites/default/files/atoms/files/8-10-09sfp.pdf [https://perma.cc/7UYK-2Y5W] (estimating billion and granting exemptions for certain household essentials); FTA Survey of Services Taxation – Update, Fed’n of Tax Adm’rs (July–Aug. 2017), https://www.taxadmin.org/btn-0817_services [https://perma.cc/EA2H-9DHU] (noting that although many states tax services like hotels, event admissions, utilities, and repair services, only a small minority of states tax personal and professional services that make up the majority of service transactions). Beyond the revenue potential, taxing services makes substantive policy sense, too. First, expanding the base would help modernize state sales taxes.180E.g., Michael Leachman, Four Ways to Modernize State Sales Taxes, Ctr. on Budget & Pol’y Priorities (July 9, 2013), https://www.cbpp.org/blog/four-ways-to-modernize-state-sales-taxes [https://perma.cc/AB82-CLYM]. The recent Supreme Court decision in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018) allows states to require businesses to collect and remit state sales tax on internet purchases. The Wayfair decision helped bring state sales tax regimes into the twenty-first century, but it represents just one piece of the “modernization” puzzle. See generally David Gamage, Darien Shanske & Adam Thimmesch, Taxing E-Commerce in the Post-Wayfair World, 58 Wash. Univ. J.L. & Pol’y 71 (2019) (discusing the Wayfair case and its implications); David Gamage & Devin J. Heckman, A Better Way Forward for State Taxation of E-Commerce, 92 B.U. L. Rev. 483 (2012) (discussing the problems with state taxation of e-commerce prior to the Wayfair decision). When states first adopted sales taxes, the purpose was to capture consumer spending.181Kirk J. Stark, The Uneasy Case for Extending the Sales Tax to Services, 30 Fla. State Univ. L. Rev. 435, 440–41 (2003). At that time, consumers spent much more on goods than services, so states were able to tax the majority of consumer spending by taxing the sale of goods (and excluding all but a few services).182See Robert Tannenwald, Are State and Local Revenue Systems Becoming Obsolete?, 4 New Eng. Econ. Rev. 27, 31 (2001) (describing administrability concerns for taxing service transactions); Hellerstein & Hellerstein, supra note 68, § 12.05 (“When state legislatures first enacted general sales taxes during the 1930s, they confined the tax base largely to sales of tangible personal property, with taxation of services limited to utility services and admission fees.”). Since the mid-twentieth century, consumer spending has shifted toward services and away from goods.183Jonathan J. Church, Explaining the 30-Year Shift in Consumer Expenditures from Commodities to Services, 1982–2012, Bureau of Lab. Stats. (Apr. 2014), https://www.bls.gov/opub/mlr/2014/article/explaining-the-shift-in-consumer-expenditures.htm [https://perma.cc/ZX38-3WKT] (showing that since around 1990, Americans have spent more on services than on commodities). Sales of goods may have been a workable, albeit imperfect, sales tax base in the past when services expenditures were not as high as they are today.184Bureau of Econ. Analysis, U.S. Dep’t of Com., National Income and Product Accounts, NIPA Tables, Section 1 – Domestic Product and Income, tbl.1.1.5 (Dec. 22, 2021), https://apps.bea.gov/iTable/iTable.cfm?ReqID=19&step=4&isuri=1&1921=flatfiles#reqid=19&step=4&isuri=1&1921=flatfiles. Today, however, services account for sixty-nine percent of consumer spending.185Id. Put simply, most state sales taxes are based on the economy not as it is today, but as it existed nearly a century ago. It is further worth noting that the U.S. tax system as a whole, considering both the state and federal levels, dramatically undertaxes spending as compared to every other developed nation.186See, e.g., Ajay K. Mehrotra, The Myth of the “Overtaxed” American and the VAT that Never Was, 2 Mod. Am. Hist. 97, 97–98 (2019); Andrea Louise Campbell, America the Undertaxed, 91 Foreign Affs. 99, 99–100 (2012). This is because every other developed nation raises a large portion of its overall revenues from a value-added tax (VAT).187Mehrotra, supra note 186; Campbell, supra note 186. By contrast, the U.S. federal government levies neither a VAT nor any substantial tax on spending, and U.S. state governments’ sales taxes are much smaller in both scope and magnitude as compared to other nations’ VATs.188Campbell, supra note 186. Second, a tax on services could help eliminate the current arbitrary distinctions between closely related consumer goods and services, which may distort consumer choices by artificially making service transactions less expensive.189Alan R. Romero, Including Legal Services in State Sales Taxes, 29 Harv. J. on Legis. 280, 286 (1992); Stark, supra note 181, at 448. For example, if purchasing a lawnmower with a useful life of four years and hiring a lawn care service over that same time period each cost $400 before sales tax, and only the purchase of the lawnmower is taxable, the fact that the purchase of the lawnmower is taxed makes it more expensive relative to the cost of the lawn care service. A general maxim of tax policy is that broad-based taxes are superior at minimizing economic distortions.190See, e.g., Shahira ElBogdady, The Inefficiency of Targeted Tax Policies, Joint Econ. Comm. Republicans (Apr. 1997), https://www.jec.senate.gov/public/_cache/files/fe2eafaa-f355-462f-b515-15ad4a8f5e74/the-inefficiency-of-targeted-tax-policies-april-1997.pdf [https://perma.cc/YJ6A-ZSL7]; David Gamage, How Should Governments Promote Distributive Justice?: A Framework for Analyzing the Optimal Choice of Tax Instruments, 68 Tax L. Rev. 1, 20 (2014) (describing this “general prescription” as the “tax-smoothing principle”); David Gamage, The Case for Taxing (All of) Labor Income, Consumption, Capital Income, and Wealth, 68 Tax L. Rev. 355, 381 n.85 (2015) (“[T]he tax-smoothing principle has been called ‘the broad base rule.’”). Expanding state sales taxes to include services would broaden the base of these taxes and enhance their efficiency. Indeed, the arbitrary sales tax distinction between goods and services results in higher taxes on goods because the items that remain in the tax base must bear the full brunt of the sales tax revenue burden.191For example, Illinois ranks forty-third in the United States for the breadth of its sales tax base, but thirteenth for its sales tax rate. Chi. Metro. Agency for Plan., The Benefits of Adding More Services to Illinois’ Sales Tax Base 3 (2019), https://www.cmap.illinois.gov/documents/10180/986064/Benefits+of+adding+more+services+to+IL+sales+tax+base.pdf/98029a31-c167-689f-2b6c-2367c8239a6e [https://perma.cc/5ER7-6UEW]. Adding services to their sales tax base gives states the option to lower their overall average sales tax rates (perhaps after state finances have recovered from the economic effects of the pandemic), which reduces the price for goods and services that are already subject to sales tax without reducing overall sales tax revenue.192Hellerstein & Hellerstein, supra note 68, § 12.05. Of course, all consumption taxes raise significant design concerns. First, business inputs should generally remain untaxed.193For example, most countries that use a VAT also follow the “credit-invoice method” to make intermediate business transactions taxable but creditable. Briefing Book: How Would a VAT Be Collected?, Tax Pol’y Ctr., https://www.taxpolicycenter.org/briefing-book/how-would-vat-be-collected [https://perma.cc/3MQ4-AYA9]. This means “there are no net taxes on sales between registered VAT businesses,” and only “the full value of the final sale to the consumer bears tax.” Id. When business inputs are taxed, businesses raise retail prices to cover sales taxes paid on transactions during production, a concept often referred to as “tax pyramiding” (i.e., a tax on a tax).194See, e.g., Michele E. Hendrix & George R. Zodrow, Sales Taxation of Services: An Economic Perspective, 30 Fla. State Univ. L. Rev. 411, 416 (2003); Mazerov, supra note 179, at 25–26 (“pyramiding”); Shanske, supra note 122, at 465–66. This is especially problematic in the sales tax context where there may be many levels involved in production processes. To address this problem, states need to implement credits, deductions, or exclusions for business-to-business purchases so that services can be incorporated into the sales tax base without exacerbating concerns related to tax pyramiding. Another potential concern is that sales taxes (like other consumption taxes) are generally considered regressive because they are imposed at a flat rate, and lower-income taxpayers spend a greater proportion of their income on goods and services.195See, e.g., Elaine S. Povich, Why States Are Struggling to Tax Services, Pew Rsch. Ctr. (June 27, 2017), https://www.pewtrusts.org/en/research-and-analysis/blogs/stateline/2017/06/27/why-states-are-struggling-to-tax-services [perma.cc/G4VN-33R6]. Yet this concern is likely to be more than offset by the progressivity of how revenues are spent. Because most of the major categories of state spending benefit low-income populations, the overall result of funding incremental spending or preventing cuts through an expanded sales tax base would be, in fact, progressive.196See Gladriel Shobe, Disaggregating the State and Local Tax Deduction, 35 Va. Tax Rev. 327, 334 (2016). A. Which Services to Tax If states decide to expand their sales tax bases to include more services, they will need to determine which services to bring under the sales tax umbrella. Services can be divided into roughly three categories: services consumed primarily by businesses, services consumed primarily by households, and services consumed by both businesses and households. Economists generally agree that, in order to avoid “tax pyramiding,” states should not tax business-to-business transactions when “the same goods or services are taxed multiple times” along the production process.197See Robert J. Cline, John L. Mikesell, Thomas S. Neubig & Andrew D. Phillips, Sales Taxation of Business Inputs: Existing Tax Distortions and the Consequences of Extending the Sales Tax to Business Services, 35 State Tax Notes 457 (2005). See generally Jared Walczak, Tax Found., 2020 State Business Tax Climate Index 35–36 (2019), https://files.taxfoundation.org/20191021155857/2020-State-Business-Tax-Climate-Index-PDF.pdf [perma.cc/XB4F-PGVP] (scoring states based on their tax systems and giving the worst sales tax scores to states that tax the most business inputs). Furthermore, taxing business inputs distorts the allocation of resources by incentivizing businesses to provide those services in-house, even if those services could be produced more efficiently by a third party.198Despite the arguments against imposing sales taxes on business inputs, states collect an average of 42% of their sales tax revenue from business inputs. See Karl Frieden & Fred Nicely, Council on State Taxation, The Best and Worst of State Sales Tax Systems 9 (2018), https://www.cost.org/globalassets/cost/state-tax-resources-pdf-pages/cost-studies-articles-reports/the-best-and-worst-of-state-sales-tax-systems-august-17-2018-final.pdf [perma.cc/RG62-PBXA]. Therefore, states that choose to expand their sales tax bases should proceed cautiously with respect to services consumed primarily by businesses.199It is worth noting that although states should avoid expanding the number of business-to-business services in their tax base, business inputs currently make up a significant portion of many states’ sales tax base. See Hellerstein & Hellerstein, supra note 68, § 12.03 (“[B]usiness inputs in fact make up a healthy portion of most states’ sales tax bases. Indeed, most nationwide studies conclude that business inputs as a share of the sales-tax base average about 40 percent for forty-five states and the District of Columbia.”). States would also be well advised to consider adding a credit, deduction, or exemption for business-to-business sales rather than trying to exclude categories of services from sales tax bases. But if politics or other obstacles prevent the adoption of such a credit, deduction, or exemption, then it may be prudent to partially or fully exempt services primarily consumed by businesses. By contrast, policy makers generally support taxing services consumed by households.200See, e.g., Mazerov, supra note 179, at 29–30. The purpose of a sales tax is to tax personal consumption, and the consumption of services by households, such as lawn care services for a home or the services of a personal trainer, is a form of personal consumption. According to a survey by the Federation of Tax Administrators, although a handful of states tax more than 100 services (e.g., Hawaii and New Mexico tax 167 and 164 services respectively), most states tax far fewer.201See FTA Survey of Services Taxation – Update, supra note 179, at 1. Many of those untaxed services are consumed primarily by individuals, including household storage, dating services, gyms, tanning and hair salons, and personal instruction (like golf lessons or fitness coaching).202See id.; see also Nicole Kaeding, Sales Tax Base Broadening: Right-Sizing a State Sales Tax, Tax Found., at tbl.3 (Oct. 24, 2017), https://taxfoundation.org/sales-tax-base-broadening [perma.cc/25YQ-UUGK]; Mazerov, supra note 179, at 38–43. The third category of services includes services consumed by both businesses and households. This category is obviously more complicated because states would need to find ways to capture personal, but not business, consumption of these services. For all three categories, the best way to accomplish this goal is by granting deductions for intermediate business transactions or by reforming the current system of business-to-business credits, rather than trying to exclude categories of services from sales tax bases, since these services are often (but not always) consumed by businesses. B. Mechanics of Expanding the Sales Tax Base Over the last thirty-five years, many state legislatures have proposed expanding their sales tax bases to broadly capture services.203See, e.g., Fla. Stat. § 212.059 (1987), repealed by 1988 Fla. Laws 19; S.J.R. 938, 34th Gen. Assemb., Reg. Sess. (Fla. 2002) (never passed); Mass. Gen. Laws. ch. 64H, §§ 1–33 (1991), amended and partially repealed by 1991 Mass. Acts 4; Mass. Gen. Laws. ch. 64H, § 1 (2013) (amending the sales tax to include “computer system design services”), repealed by 2013 Mass. Acts ch. 95; 2007 Mich. Pub. Acts 92, repealed by H.B. 5408, 94th Leg., Reg. Sess. (Mich. 2007); see also, e.g., Indiana Fiscal Policy Institute, Sales Taxation of Services in Indiana: Concepts and Issues 6–7 (2009), http://www.indianafiscal.org/Resources/Documents/Sales-Taxation-Services-Indiana.pdf [perma.cc/TQ28-KJS4] (describing unsuccessful attempts to expand service taxes in Florida, Massachusetts, Maryland, and Michigan, but noting New Jersey’s successful but significantly more narrow expansion of taxable services). Many have failed. For example, Utah and Maryland legislators proposed significantly expanding their sales tax bases to include more services, in 2019 and 2020 respectively, but the local business communities mobilized against and defeated the proposals.204H.B. 441, 63d Leg., Gen. Sess. (Utah 2019) (bill not passed); see, e.g., Lisa Riley Roche, Despite Business Backlash, Utah’s Tax Reform Bill Headed to House Floor, Deseret News (Mar. 1, 2019), https://www.ksl.com/article/46502054/despite-business-backlash-utahs-tax-reform-bill-headed-to-house-floor [perma.cc/ENE5-TB2S]; Pamela Wood, Maryland Lawmakers Defeat Sales Tax Expansion That Was Pitched as Way to Pay State’s Share of Kirwan Education Improvements, Balt. Sun (Mar. 5, 2020), https://www.baltimoresun.com/politics/bs-md-pol-ga-no-sales-tax-20200305-au3kz74nivfcbelxkuiquz2bj4-story.html [perma.cc/M6M4-WUXQ]; Ovetta Wiggins, 5,000 Emails in 3 Hours: Blast of Opposition to Md. Bill Expanding Sales Tax, Wash. Post (Mar. 2, 2020), https://www.washingtonpost.com/local/md-politics/business-owners-blast-house-democrats-plan-to-extend-sales-tax-to-services-in-maryland/2020/03/02/2fc678a2-5cab-11ea-b29b-9db42f7803a7_story.html [perma.cc/9X4E-9XVH]. Similarly, when Michigan tried to tax a long list of enumerated services in 2007, “widespread public opposition” caused the state legislature to repeal the tax on the day it was scheduled to go into effect.205Monica Davey, States Seeking Cash Hope to Expand Taxes to Services, N.Y. Times (Mar. 27, 2010), https://www.nytimes.com/2010/03/28/us/28taxes.html [https://perma.cc/ADT3-SVAR]; 2007 Mich. Pub. Acts 93 (adding a long list of both consumer and business services to Michigan’s use tax base by adding § 3(d)), repealed by 2007 Mich. Pub. Acts 145. Additional examples of states that have proposed, but failed to pass, legislation that would have added services to their sales tax base include Florida (1987 and again in 2002), Massachusetts (1991), Nebraska (2013), Ohio (2013), Louisiana (2013), Minnesota (2013), and Pennsylvania (2015).206See Andrew Phillips & Muath Ibaid, The Impact of Imposing Sales Taxes on Business Inputs 16 (2019), https://www.cost.org/globalassets/cost/state-tax-resources-pdf-pages/cost-studies-articles-reports/1903-3073001_cost-ey-sales-tax-on-business-inputs-study_final-5-16.pdf [perma.cc/8MKR-9683]; see also Mass. Gen. Laws. ch. 64H, §§ 1–33, amended and partially repealed by 1991 Mass. Acts 4; Samuel B. Bruskin & Kathleen King Parker, State Sales Taxes on Services: Massachusetts as a Case Study, 54 Tax Law 49 (1991) (detailing and analyzing Massachusetts’s attempt to tax a long list of services); Fla. Stat. § 212.059 , repealed by 1988 Fla. Laws 19; S.J.R. 938 (never passed); Vicki L. Weber, Florida’s Fleeting Sales Tax on Services, 15 Fla. State U. L. Rev. 613 (1987). In contrast, several states and the District of Columbia have successfully expanded their sales tax bases over the past decade. For example, Connecticut increased the number of services in its sales tax base from 85 to 99, the District of Columbia expanded its services tax base from 75 to 91, North Carolina increased its list of taxable services from 36 to 62, and Kentucky added an additional 17 services in 2018.207See FTA Survey of Services Taxation – Update, supra note 179; Chi. Metro. Agency for Plan., supra note 191, at 6. Health clubs, home maintenance services, automotive repair, car washes, parking lots, storage, carpet cleaning, and bowling alleys were among the many services added to these jurisdictions’ tax bases.208See FTA Survey of Services Taxation – Update, supra note 179. These examples show that although expanding a state’s tax base to include services may be politically difficult, it is still possible. Why have some states been able to successfully expand their sales tax bases to include services while others have failed? Many factors determine whether a bill is successful. For example, states’ current sales taxes often capture goods (like auto parts) but not adjacent services (like mechanics’ services), which can create economic distortions by treating closely related transactions differently.209See Shobe et al., supra note 174, at 1352–53. When state legislatures add new items to the sales tax base, additions that reduce distinctions between closely related transactions may prove more politically feasible and easier to administer, in part because they likely affect vendors who are already collecting and remitting sales tax. Another factor that appears to affect the outcome is whether the proposed legislation taxes business inputs. States that include business-to-business service transactions in their proposed bills provoke strong opposition from the states’ business communities, who argue that the proposed legislation will result in tax pyramiding.210Phillips & Ibaid, supra note 206, at 18 (“[E]ach of these proposals failed, in large part due to opposition from the business community. Generally, the policy objections were not to the expansion and modernization of the sales tax base to include the growing services sector, but to doing so without limiting the base expansion to household services.”). For example, Michigan’s proposed legislation faced strong opposition because it would have captured many services used primarily by businesses: management, scientific, and technical consulting; office administration; merchandise warehousing and storage; and industrial and graphic design.2112007 Mich. Pub. Acts 93 (incorporating specific industry codes from the 2002 North American Industry Classification System (NAICS 2002) by reference, including NAICS 2002 codes 5416, 5611, 4931, and 5414). Proposed legislation in Florida, Louisiana, Massachusetts, Minnesota, Nebraska, Ohio, and Utah faced similar defeats after their respective business communities argued that the bills would have taxed business inputs.212See Phillips & Ibaid, supra note 206, at 16; Weber, supra note 206, at 626, 628 (explaining that under the 1987 Florida law, all services purchased by nearly all businesses would be subject to sales tax); Hendrix & Zodrow, supra note 194, at 427 (stating that the 2007 Florida proposal would have expanded the tax base to include many business-to-business transactions); H.B. 441, 63d Leg., Gen. Sess. (Utah 2019) (exempting manufacturing, wholesale trade, and most financial services, but providing no exemption for legal, accounting, and most architectural and engineering services). Massachusetts’s 1991 law would have taxed professional services like legal, accounting, engineering, and architectural services only when provided to businesses, not individual consumers. 1990 Mass. Acts 209 (defining many “services” for consumption tax purposes to include services only if “provided to businesses”). In contrast, jurisdictions that have successfully added services to their tax base have primarily added personal services, not business inputs.213See FTA Survey of Services Taxation – Update, supra note 179. Although those jurisdictions received pushback from certain interest groups, such as health clubs, they also received support from policy makers who argued that the bills targeted personal consumption and were thus grounded in sound tax policy.214See, e.g., Joseph Bishop-Henchman, Vida Fitness Spreads Half-Truths About DC Tax Cut Bill, Tax Found. (May 30, 2014), https://taxfoundation.org/vida-fitness-spreads-half-truths-about-dc-tax-cut-bill [perma.cc/65VK-2CBK]. Therefore, while there are certainly many factors that affect the outcome of any proposed bill, it appears that legislation that avoids taxing business-to-business transactions is more likely to pass. State legislatures will need to determine whether to expand their sales tax bases by switching from an “incremental” approach to a “comprehensive” approach. Most states take an incremental approach to taxing services, meaning they exempt services from sales tax by default and then specifically subject certain services to sales tax by state statute.215Typically, those states’ retail sales tax regimes capture all sales of tangible personal property by default unless expressly exempted and then include a list of taxable services in the statutory definition of “retail sale.” See, e.g., Wash. Rev. Code § 82.04.050(1)(a) (2017) (“‘Sale at retail’ or ‘retail sale’ means every sale of tangible personal property.”); Id. § 82.04.050(2)(a)–(e) (2017) (“‘[R]etail sale’ includes the sale of . . . labor and services rendered in respect to: . . . The installing, repairing, cleaning, altering, imprinting, or improving of tangible personal property of or for consumers, . . . cleaning, fumigating, razing, or moving of existing buildings, . . . [a]utomobile towing,” etc.). In contrast, other states—including Hawaii, New Mexico, South Dakota, and West Virginia—take a comprehensive approach by taxing all services by default and then granting exemptions, such as exemptions for business-to-business transactions and essential services.216Hawaii, New Mexico, and South Dakota impose gross receipts taxes on businesses that provide services. Haw. Rev. Stat. § 273-13 (2021) (4% tax on “gross proceeds of sales, or gross income” of service businesses); N.M. Stat. Ann. §§ 7-9-3.5(1) & 7-9-4 (2021) (“[G]ross receipts is imposed on any person engaging in business in New Mexico,” where “‘gross receipts’ means the total amount of money or the value of other consideration received from selling property . . . or from performing services.”); S.D. Codified Laws §§ 10-45-2, 10-45-4, 10-45-4.1, & 10-45-5 (2021) (taxing “gross receipts of all sales of tangible personal property” and gross receipts from “engaging or continuing in the practice of any business . . . unless the service is specifically exempt”); S.D. Codified Laws § 10-45-12.1 (2021) (expressly exempting healthcare, education, and local transportation (except for limousines!)). Although the tax is paid by businesses, not the consumer, the end result—a consumption tax on services—is the same, since businesses will pass the gross receipts tax costs on to consumers through higher prices. West Virginia includes services in its retail sales tax base, but it exempts all professional services. See W. Va. Code §§ 11-15-2 & 11-15-3 (2021). Although the comprehensive approach naturally captures more services in a state’s sales tax base, seemingly making it the most attractive option for capturing a broad range of services, only South Dakota has successfully switched from an incremental to a comprehensive approach.217See Mazerov, supra note 179, at viii. Every other state’s attempt to make this switch has been defeated, in large part because the business community has argued that a comprehensive approach sweeps a large number of business inputs into the tax base.218See Phillips & Ibaid, supra note 206. Thus, it may well be that an incremental approach is more politically achievable than aiming for a more ambitious, comprehensive one. For guidance on navigating the political obstacles, state governments might look to jurisdictions that have successfully implemented the incremental approach, like Connecticut, Kentucky, North Carolina, and the District of Columbia.219See FTA Survey of Services Taxation – Update, supra note 179.

V. State Borrowing

We remain mindful that the tax reform proposals suggested above, despite all of their merit, might not be enough, even if there is substantial federal support, and especially if there is not.220

See Darien Shanske & David Gamage, The Case for State Borrowing as a Response to the Current Crises, 97 Tax Notes State 1137 (2020), for a prior version of the proposal in this Part.

Indeed, given the variety of taxes states currently employ, the diversity in state economies, and the different conditions of various state budgets, some shortfalls seem very likely, at least in some states. And it is important to remember here that it will likely fall to states in many instances to shore up local finances. Thus, if the effects of an economic crisis are not to fall upon those most vulnerable, states (and localities) need tools beyond raising revenues in the short, or even long, term.