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May 3, 2021

GILTI and California: Show Me the Money Edition

Back of the envelope calculations indicate significant revenue can be raised if California conforms to GILTI.

 

[Cross-posted from Medium]

By Darien Shanske

The California Legislature is considering a bill (AB 71) that would subject 50% of a category of income derived from federal tax law, known as Global Intangible Low-Taxed Income (GILTI), to California’s corporate income tax. In short, GILTI represents an attempt by the federal government to estimate, by formula, how much income — really earned in the US — has been shifted to low-tax jurisdictions to avoid US tax.

I have written extensively about what GILTI is, why states should tax it, why they can tax it and even why this is likely to raise a lot of revenue.

 

The current serious consideration of including GILTI in the California corporate income tax base merits a deeper dive into the data in order to arrive at a necessarily rough range of estimates. To be clear, I am not an economist and am not offering a model. Rather, I am extrapolating from publicly available information provided by leading economists through the use of what I believe to be reasonable assumptions.

On the high side, I will start with an analysis done by the Penn Wharton Business Model (PWBM), based primarily on IRS data. According to the PWBM, the GILTI formula should produce $388 billion of GILTI at the national level in 2021. This number, not surprisingly, reflects a good estimate as to the total amount of income shifted by US-based MNCs. Based on this number, the California proposal would raise about $1.7 billion in revenue per year. To arrive at this estimate, I am assuming that 10% of (50%) GILTI would be apportioned to Ca, which is a reasonable guess based on recent reports issued by the FTB (average factor of about 11% in 2017, 8% in 2018).

New Jersey has seen its CIT flourish after conforming to GILTI (and making several other substantive changes in 2018, including a rate increase and taxing 5% of the repatriation) and so the notion that GILTI conformity can yield substantial revenues is not outlandish.

The steadily declining yield of California’s corporate income tax similarly suggests there is a substantial upside to reforming the corporate income tax base. (Observe that the small reduction in rates on its own does not look like a good explanation for such a steep decline.)

 

[See chart on page 3 of this document: https://calbudgetcenter.org/wp-content/uploads/2021/03/IB-FP-Corporate-Taxes.pdf]


(Note that this high-end estimate derived from PWBM might actually be conservative if one believes that there is going to be an economic boom over the next few years.)

 

What of the low end of the range? We do have one piece of actual data on the amount of GILTI that has actually been reported to the IRS, which is that 81 of the largest corporations, with ¼ of total corporate income, reported about $100bn in GILTI in 2018. Note that if we just multiply 100bn by 4, then we are back to our high-end estimate of about $400bn in GILTI per year. Yet one might reasonably believe that these large companies represent a disproportionate amount of GILTI. One might also believe that these sophisticated taxpayers have found numerous ways to reduce their tax liability — perhaps by gaming the formula or by transmuting GILTI income into something else (e.g., so-called subpart F income). In California, it might turn out that some of the taxpayers with GILTI are already not taking a water’s edge election, which take them out of the GILTI inclusion proposal because, as to these taxpayers, income shifting is being countered in another way.


Note that California conformity proposal is written in such a way that it does not conform to federal regulations governing the GILTI calculation that are very likely to undermine it further. And, California already includes a different kind of suspect income (subpart F) into which GILTI income can be transformed in its tax base and so that particular stratagem will not reduce California revenue.

 

And so I think a lower bound of 200bn in GILTI at the national level for 2021 is reasonable — that means that between the vagaries of revenue estimation and taxpayer strategies, aggressive and benign, the estimate from PWBM is about 100% too high. In that case, conforming to GILTI would raise about $850 million/year.


This would mean a range of between $850mn and $1.7bn annually, subject to substantial caveats.


AB 71 would also subject the deemed repatriation of IRC 965 to taxation. This is another topic I have written about. The amount of revenue that could be raised by this change is also hard to estimate. It is not clear how much revenue was deemed repatriated, how much might have already been subject to California tax and how much corporations have chosen to pay on a deferred schedule (which is what AB 71 would tax). First, as to the repatriation that was formally subject to California tax already because the revenue was actually repatriated (about $1 trillion — again, based on FTB data), I think that not much tax was already paid on this revenue because so many of these same taxpayers had (and have) a surfeit of tax credits to use against the California corporate income tax. AB 71 caps the use of these credits against the repatriation (or GILTI) at $5mn. Second, I think a conservative estimate of how much of the repatriation taxpayers chose to defer is about $1.6 trillion. This takes into account the original $2.4 trillion estimate for the total amount of revenue to be repatriated, as well as the reported fact that 2/3 of taxpayers with repatriated tax liability chose to defer their tax liability on the repatriation (and only these deferrals would be taxed). Note we do not know how much of the repatriation those taxpayers represented.


Based on these reasonable, but rough, assumptions, taxing the repatriation would result in roughly $4.3 billion in taxes paid to California over the next 5 years. Acknowledging the significant uncertainties here, starting with the original estimate of how much revenue there was to be repatriated, a lower bound of figure of $2 billion over 5 years seems reasonable or again discounting by a factor of 2.

A final note on the larger bill. One of AB 71’s core policy insights is that the state needs to provide a stable stream of revenue to combat homelessness. Tying the state’s contribution to the vagaries of how much taxpayers pay on their GILTI income would undermine that stability. What is most important about the revenue estimates is that making a change to California’s corporate tax that should have been made anyway is reasonably likely to roughly pay for the state’s revenue commitment to combat homelessness over time so that these new programs are not taking away from other essential programs.

 

To make this point more concrete, consider that we want taxpayers to have less GILTI because we want them to shift less income. California’s conforming to GILTI could contribute to taxpayers changing their tax structures in this way. Indeed, the Biden Administration is proposing to strengthen the GILTI regime in various ways. Suppose then that there is less GILTI income because less income is being shifted. If that were to occur, then that would mean there is more tax paid on ordinary corporate income and so California would still receive more revenue from GILTI inclusion, but not with the GILTI label.

 

Accordingly, it makes sense to appropriate about $2 billion/year to homelessness mitigation programs, knowing that the GILTI conformity and repatriation provisions are at least reasonably likely to roughly cover these expenditures over time if one takes a broad view of how these provisions are meant to operate.

April 26, 2021

Op-Ed: California Should Pass a Small Tax on Big Wealth

[Cross-posted from the Los Angeles Times]

 

By Darien Shanske, David Gamage and Emmanuel Saez

 

California’s tax system is upside down at the top: Millionaires pay higher rates than billionaires. California’s wealthiest residents — who have partaken in a $4-trillion increase in billionaire wealth in the last year — contribute next to nothing to state coffers. Meanwhile, many less fortunate Californians are suffering.

 

The ordinary rich — say, a well-compensated doctor — pay a lot in California income tax; they do their share to help support the state. Indeed, many working-class individuals, such as nurses, teachers or firefighters, pay tax on a much larger share of their economic gains than do the wealthiest Californians.

So how do mega-millionaires and billionaires escape the state’s Franchise Tax Board?

The answer is that our tax system does not reach large fortunes unless property is sold or money is paid out in salaries or in stock dividends. Playing Wall Street games, the very rich in the state can avoid taxation and still fund their lavish lifestyles.

Consider Elon Musk. He built a fortune in California currently valued at about $180 billion, the largest ever seen in the state. We don’t know exactly how much state income tax he has paid, but because he hasn’t sold his Tesla stock or taken a substantial salary or dividends, we can surmise that he has paid very little. Musk now claims to have moved to Texas, so he will probably never pay income tax to California on the billions he accumulated while benefiting from the services and protections provided by the state.

The state Legislature is now considering a pair of bills — Assembly Constitutional Amendment 8 and Assembly Bill 310 — that would levy a 1% tax on extreme wealth: anything above $50 million, with an additional 0.5% tax on fortunes worth more than $1 billion. With Georgetown University law professor Brian Galle, we helped draft these bills to deter tax avoidance and to restore fairness to California’s tax system.

Under these two measures, a household worth $51 million, for example, would pay a tax of $10,000 a year (1% of $1 million). That would be a small burden for such a household but a big boon to California because about one-quarter of all American billionaires reside in the state. As we lay out in a white paper on the legislation, the reforms would raise about $22 billion a year, and more as wealth increases in the state.

California may be able to weather the pandemic without budget cuts, helped by President Biden’s COVID-19 relief package. But soon enough, the state will again face deficits and a host of unmet needs. Sacramento must invest in climate change resilience, such as power line and power grid upgrades to help prevent catastrophic wildfires. The state’s school systems are facing teacher shortages. Housing and mental health facilities are needed to help those living on our streets.

Most fundamentally, it is time to make the tax system fairer.

We estimate that about 15,000 families would be subject to the new wealth tax — the richest 0.07% of the state. According to Forbes magazine, there are about 170 California billionaires, and their total wealth is now around $1 trillion. It was only $700 billion two years ago, before COVID-19, and $300 billion 10 years ago. During the pandemic, while 7.8 million unemployment claims were filed in the state, the state’s richest people gained $300 billion. About half of the $22 billion the new tax would raise would be paid by these billionaires.

Those opposed to a new wealth tax claim that the very rich would flee California in droves, a la Musk, who has made no secret of his objections to the state’s regulations. Much the same warnings were sounded in 2012 and 2016 when California raised income taxes on millionaires. And yet our research shows that the state has gained millionaires and billionaires, along with added revenue from those earlier taxes on the rich.

Other researchers who have studied the question of whether millionaires leave states when taxes are raised have generally found that such movement is uncommon and that when the rich do relocate, taxes aren’t the main reason.

Think about it: For many of the ultra-wealthy, paying a 1% or even 1.5% tax on their fortunes would amount to less than the usual fluctuations of their net worth because of weekly swings in the stock market. And those who made a lot of noise about departing because of the tax would probably have left anyway, seeking a lower-tax state when they finally sell off some of their holdings.

Don’t buy the scare stories about taxing extreme wealth. We need such a tax so that California’s economy benefits all its residents, not just the rich, and to make sure that the wealthiest in the state pay their fair share.

Darien Shanske is a professor of law at UC Davis, David Gamage is a professor of law at Indiana University Bloomington, and Emmanuel Saez is a professor of economics at UC Berkeley.

March 5, 2021

Local Taxes Have Lots of Untapped Potential

[Cross-posted from The Recorder]

By Darien Shanske and David A. Carrillo

Help may be coming at long last from the federal government, but California local governments are likely to face fiscal challenges as a result of the pandemic and recession for a long time. After all, many of those local governments faced major issues before the current crisis. It turns out that a 2017 decision by the California Supreme Court might offer some communities the ability to help themselves.

When the California Supreme Court decided California Cannabis Coalition v. City of Upland (2017) 3 Cal.5th 924, we — and others — argued that the court opened the door for local initiative measures to adopt special taxes by majority vote rather than the supermajority that ordinarily applies to taxes. The issue of whether local tax initiatives can be passed by majority vote has now been litigated in three court of appeal decisions, and our prediction is coming true: All three decisions expressly adopted a majority vote rule for local special tax initiatives.

In City and County of San Francisco v. All Persons Interested in Proposition C (2020) 51 Cal.App.5th 703, 61% of the local voters approved a proposed initiative tax. Opponents argued that California constitution Article XIII A, Section 4 and Article XIII C, Section 2(d) (Proposition 13 and Proposition 218, which require special taxes proposed by local governments to be approved by two-thirds of the voting electorate) applied to special taxes adopted by local initiative. Following Upland’s reasoning, the court of appeal relied on the electorate’s reserved initiative power to reject that argument and held that local voters may exercise their initiative power to adopt a special tax by a simple majority. The same issue was presented in City of Fresno v. Fresno Building Healthy Communities (2020) 58 Cal.App.5th 884, and Howard Jarvis Taxpayers Association v. City and County of San Francisco (A157983). Both decisions adopted the reasoning in San Francisco and adopted the majority vote rule for local special tax initiatives.

All three decisions were unanimous, and the court of appeal published all three decisions. That makes them the only controlling law on this issue, so Superior Court judges have little choice but to follow them. And absent an appellate division split, the California Supreme Court is unlikely to disturb these rulings. Indeed, the state high court denied review in San Francisco; a review petition is pending in Fresno; and the court of appeal denied rehearing in Howard Jarvis.

These rulings are correct; they are natural extensions of Upland and properly build on doctrine that preexisted Upland. Courts have long held that the initiative power is not subject to the same constraints that apply to local governments or the legislature and have historically been skeptical of two-thirds vote requirements.

The San Francisco decision noted that two-thirds requirements must be “strictly construed” in the initiative context due to the “fundamentally undemocratic nature of the requirement for an extraordinary majority.” That principle derives from City and County of San Francisco v. Farrell (1982) 32 Cal.3d 47—a decision that was overturned by Proposition 218. Relying on Farrell now shows both how skeptical courts are of supermajority requirements, and how compelling the judicial imperative to jealously guard the initiative power is. Look for this skepticism of supermajority voting rules in future initiative cases.

The concern about supermajority requirements partly flows from the fact that the simple majority rule for initiatives has been in effect from direct democracy’s inception. Since then California voters have permitted just three modifications to their direct democracy powers—and none of those changes reduced their powers. It would be a significant departure from that history for the initiative power to be limited by the voters, which is another reason we think the court in Upland was correct to hold that such a limitation “require[s] clear evidence of an intended purpose to constrain exercise of the initiative power.”

This trend is also consistent with the California Supreme Court’s treatment of local control over taxation. Unlike many states, the California Supreme Court has interpreted a charter city’s home rule power to extend to taxation. Our state high court has also interpreted the initiative power broadly in the taxation context. Though it would not be an outright contradiction to apply a supermajority rule to local tax initiatives, it would be at least incongruous for the courts to take away the local electorate’s power over taxation after recognizing the importance of local control over finances in these related contexts.

We think the more interesting question is not whether a court should or would depart from these three decisions, but how their implications can be harnessed to make life better for Californians. The initiative power is explicitly granted to counties and cities, but not to school district electorates. Yet there is a strong argument that school district voters retain the initiative power and could pass tax measures by majority vote. It would be even better, of course, if the legislature gave school district voters this power by statute. It would be better still if the legislature also expressly permitted local governments to impose tiered parcel taxes so local voters could approve measures that do a better job of spreading the tax burden.

We understand that extending the Upland reasoning has already stirred up some opposition, even a threat of a constitutional amendment imposing a supermajority rule on local voters. But, as we have argued, it’s not clear that Upland can be undone that way. Upland’s clear statement rule is, we think, predicated on the notion that certain powers are reserved for the local electorate. And thus the state electorate could not change the power of local voters unless the change resulted from a constitutional revision. As a result, we think the power of local voters to impose taxes on themselves by majority vote using the initiative power is here to stay.

March 1, 2021

This is a good time for the Legislature to invest in California by taxing large, profitable corporations

[Cross-posted from CalMatters]

By Reuven S. Avi-Yonah, David Gamage and Darien Shanske

A year into the COVID-19 crisis, the gap between corporate profits and economic security for the average American is wider than ever. Since March 2020, 45 out of 50 of America’s largest companies have made a profit and in some cases the profit has been quite substantial

Meanwhile, unemployment in California increased dramatically in 2020, from 5.5% in March to 9% in December. Many more Californians have been thrown into housing instability, worsening an already urgent issue. 

Reversing the housing crisis and addressing homelessness in particular will require large and regular investments. Assembly Bill 71, introduced by Democratic Assemblymember Luz Rivas, is a bold step to making these investments and takes into consideration that California has a lot of needs, and its current budget surplus is not expected to last. Hence, AB 71 funds itself by means of a targeted tax increase that will be paid for only by the largest corporations best able to pay.

This is an appropriate revenue source, as corporations have paid an ever smaller share of their profits in taxes over the last several decades. Some of this decline was the result of deliberate decisions: Between 1980 and 1997 California lawmakers cut the corporate tax rate from 9.6% to 8.84% – and it hasn’t changed since then. 

Bottom of Form

This decline in taxes paid by large corporations was also because the state failed to act as certain very profitable corporations got cannier about exploiting major loopholes that allow them to avoid paying taxes even further.  

Corporate tax avoidance is so rampant that even the 2017 tax bill, which was loaded with breaks for large corporations and the wealthy, included several provisions meant to combat these loopholes. In particular, the Trump tax bill established a methodology to both identify and tax income improperly shifted out of the U.S. tax base.  This income is known by the acronym “GILTI,” which stands for Global Intangible Low-Taxed Income.

Restoring California’s corporate tax rate to 9.6% on corporations making more than $5 million in profits per year, as well as taxing the shifted income known as GILTI, are two sensible tax reforms that on their own are projected to provide sufficient funds for AB 71’s robust approach to reversing the cycle of homelessness.  

Don’t buy the scare tactics of multinational corporations threatening to move their headquarters from California because of this bill. California’s corporate income tax is based on sales made in California and applies regardless of whether a corporation has its headquarters in California or elsewhere. Thus, bolstering California’s corporate income tax would not create any incentives for California-based corporations to move out of the state.

Even before the pandemic, it made excellent sense to ask our largest and most profitable corporations to pay as much as they did in the 1980s. Given the state’s current urgent needs, what was once a good idea is now vital for the future health of our state.

December 10, 2018

Auctioning the Upzone: A New Strategy for Inducing Local-Government Compliance with State Housing Policies

By Christopher Elmendorf and Darien Shanske

[Cross-posted from Legal Planet]

California’s housing policies–a topic that for years received precious little attention from state officials–has suddenly become the Golden State’s hottest political and policy issue.  The California Legislature passed no fewer than 15 new housing bills in 2017, and then doubled down on that accomplishment by enacting 16 more laws in its just-concluded 2018 session.  Taken together, they represent incremental (if not sweeping) progress in addressing California’s chronic housing shortage.

With California Governor-elect Gavin Newsom about to take office, attention turns to if and how he will deliver on his campaign pledge to create 3.5 million new housing units by 2025.  Legal Planet colleagues Ethan Elkind and Meredith Hankins have recently weighed in on the topic.  Here’s a slightly different take on these same housing issues, courtesy of U.C. Davis academics:

In January of 2018, California State Senator Scott Wiener shocked the political firmament with a bill that would have zoned every tract of land in the state near a bus, rail, or ferry stop for 8-10 story buildings. His bill, SB 827, was soon watered down and then defeated, but not before launching a national debate about housing costs, “NIMBYism,” and the critical importance of increasing residential density near mass transit.

Though SB 827 was uniquely far-reaching, it was not a one-off. Sen. Wiener has introduced a very similar successor bill, SB 50, for the 2019-2020 legislation session, and a state senator in Washington has floated a proposal to establish density minimums around transit stations in the greater Seattle region. Out of the limelight, state housing agencies and to some extent state courts are also pressing local governments to allow denser housing.

The debate thus far about state-mandated upzoning has centered on questions about the proper balance between statewide vs. local interests. An equally if not more important question has received too little attention: what will it take to get local governments—the entities that actually issue building permits—to comply with the state’s policy? SB 827 did nothing to displace local control over permitting, design standards, demolition restrictions, impact fees, affordable-housing requirements, and more. SB 50 is no different. If the bill passes, localities that don’t want tall buildings near a transit station could make them incredibly difficult to build.

The history of state efforts to make local governments allow more housing is a history of mostly minor interventions that were met, swamped, and defeated by local champions of the status quo. A bold, state-led upzoning program is unlikely to achieve very much unless it is paired with an equally bold mechanism to secure local governments’ cooperation.

Two of us have just posted a new white paper proposing such a mechanism. We argue that states should confer on local governments a right to auction the new development rights created by upzoning pursuant to state policy. Local governments that comply with state policy (and whose upzone-plus-auction plan is approved by a state agency) would recoup the development value thereby created. This is akin to a state subsidy for local compliance, but it comes at no cost to the state’s budget, and, critically, the size of the subsidy—that is, the revenue generated for the local government through the auction—would depend on the credibility of the local government’s commitment to allowing development in the upzoned area. Our proposal would also facilitate state monitoring of local land-use regulation, as the price at which development-allowances trade would provide a forward-looking signal about otherwise hidden or obscure local barriers to development.

Though the notion of auctioning the right to develop housing may seem strange, our proposal has a near analogue in existing transferable development rights (TDR) programs. The principal difference is that TDR programs reallocate development value among landowners, whereas our model would reward local governments for upzoning and permit streamlining.

Our proposal also resembles California’s cap-and-trade regime for greenhouse gas emissions. Just as the owner of a power plant who wishes to burn fossil fuels must purchase emissions allowances for the carbon dioxide that would be released, so too would a landowner who wishes build in the expanded zoning envelope have to acquire and redeem “development allowances.” Each development allowance would permit its owner to build, say, 100 square feet of housing in excess of the baseline, up to a maximum defined by the new zoning map. To illustrate, imagine a parcel of 2500 square feet that had been zoned for a floor-to-area ratio of two, i.e., two square feet of housing for every square foot of lot size. Let us stipulate that after upzoning, the maximum floor-to-area ratio is eight. This means that the owner of the parcel, who previously could build no more than 5000 square feet, may now construct as many as 20,000 square feet. But to obtain a permit to build 20,000 square feet, she would have to acquire and redeem 150 development allowances ([20,000 – 5000]/100 = 150).

To protect landowners’ reasonable expectations, the state legislature should carefully define the development baseline—that is, the minimum level of development for which local governments maynotdemand development allowances. A landowner who seeks only to build something similar to what most others have already built should not have to pay for the privilege. Nor should local governments make landowners pay for the density allowed under longstanding zoning classifications. Accordingly, we recommend defining the baseline as the greater of (1) the typical density of parcels that have already been developed for housing within the local government’s territory, and (2) the locally permitted density for the parcel in question as of the date of the state law authorizing the auctions.

We acknowledge that courts and legal commentators have often resisted the idea of putting zoning up for sale. A generation ago, the economists William Fischel and Robert Nelson argued that local governments should have more or less unfettered discretion to sell rezoning for cash. Their proposals went nowhere. Liberals generally regard the sale of zoning as corrupt, and conservatives see it as extortionate. If local governments could profit from selling development rights, wouldn’t they just ban all development everywhere to obtain maximum leverage for negotiating upzones?

Our proposal sidesteps the usual zoning-for-sale objections, because it vests authority to approve the rezoning (plus auction) in a different government than the one which profits from it. Local governments could only sell those development rights created by upzonings that advance the state’s policies, and with the approval of the state’s housing agency. The state policy of promoting dense development near transit would continue to be shaped by environmental, economic, and equity goals, not the prospect of filling state-budget holes with auction revenues (the state wouldn’t pocket the revenues). Moreover, state lawmakers could easily allay concerns about “exploitative downzoning” by setting a development baseline that precludes local governments from requiring landowners to redeem allowances if they merely seek to develop at previously-allowed densities. In a legal challenge, the public-profit aspect of our scheme could be defended not as a way of raising revenue, but as a rational means by which the state fosters local-government compliance with its policies.

This is not to say that the right to auction development rights is an absolutely surefire bet for wrangling local governments into compliance with state housing policies. Our white paper considers various legal and policy objections. But new tools are clearly needed if existing residential neighborhoods are to be rezoned and repurposed for substantially denser housing. The development-rights auction belongs in the mix.

September 18, 2018

Blue State Republicans Fret Over 'Tax Reform 2.0' -- rightly so

By Darien Shanske and Dennis Ventry

[Cross-posted from The Hill]

The new tax bill, “Tax Reform 2.0,” is here, and it makes permanent the $10,000 cap on the state and local tax deduction (SALT) created by the Tax Cut and Jobs Act (TCJA) in December 2017.

Meanwhile, Republican politicians from districts where high percentages of taxpayers will be affected by the cap are wary of making the cap permanent. A deeper dive into theories of taxpayer psychology and tax policy indicates these politicians are right to be concerned.

First, consider how the cap will shrink refunds or increase tax bills for millions of taxpayers.

Early next year, Jane fills out her tax return using her preferred commercial tax prep software. She enters her property tax information, expecting, as in prior years, that her federal tax liability will drop considerably. But she surpassed the SALT cap of $10,000 when she previously entered her $12,000 in-state income taxes paid.

Under prior law, and when added to her $8,000 in property taxes, Jane would have received a $20,000 federal tax deduction. But the new law caps her deduction at $10,000, and so she loses the value of the additional $10,000 deduction.

How much does she lose? If she’s in the 24-percent tax bracket, Jane is worse off by $2,400, either resulting in a smaller refund or more tax.

And it gets worse for higher-income taxpayers. If Jane had a total of $110,000 in SALT paid rather than $20,000, she would lose the value of the additional $100,000 deduction. Since Jane would likely be in the top tax bracket of 37 percent, she’d owe $37,000 more in taxes.

Beyond the sting of owing more in tax, Jane also may feel that she is being punished for doing the right thing: opting to pay more in state and local taxes in exchange for better state and local public goods.

Research indicates that dismay at this tax change might be quite politically salient to the taxpayer when making voting decisions. Compare the large — and explicit — jump in tax liability described above to an increase in withholding taxes from periodic paychecks.

Moreover, millions of taxpayers are likely to react negatively to their higher-than-expected tax liability even if some of those same taxpayers pay lower taxes in the aggregate due to other changes in the law.

Indeed, the SALT cap is arguably already impacting property owners in jurisdictions whether they itemize or not because itemizing home buyers understand that their future property taxes will no longer be deductible over the cap and are accounting for that change in their home-buying budgets.

Homes are typically a taxpayers’ largest asset and voters can be aggressive in voting to protect the value of that asset.

Retaining the SALT cap is also fraught with political peril because taxpayers are sensitive to the reality and perception of procedural and substantive fairness. It is unlikely that the partisan, rushed, secretive and demonstrably flawed processes that produced TCJA and now Tax Reform 2.0 are going to be perceived as fair.

As for substantive fairness, Republicans have claimed repeatedly that most taxpayers will receive lower tax bills. But it is hard to explain why two-earner families in a handful of states should not get a tax cut on account of the SALT cap, to say nothing of the unequal political valence of the jurisdictions targeted by Congress with a tax increase.

It is possible for voters to be convinced by more abstract tax policy arguments. And politicians are to be commended when they pursue the correct policy and endeavor to persuade their constituents. But the policy arguments for the SALT cap are feeble.

One argument is that the cap is progressive in that wealthier taxpayers are affected by it. But the cap was embedded in a very regressive bill. A tax change that only subjects a small sliver of wealthier taxpayers — though not the wealthiest — to higher taxes is not fair.

Another unpersuasive argument is that the SALT cap corrects for the fact that low-tax states were subsidizing high-tax states through the deduction. For starters, this kind of inter-state accounting is corrosive to our polity.

Worse, it leaves out a key piece of information. Specifically, the states that have the most taxpayers affected by the cap are among the wealthiest states and thus are net “givers” to our common government. Capping the SALT deduction makes these states’ relative contribution even higher.

Another argument is that a full deduction for state and local taxes might not be appropriate as a matter of tax principle. Fair enough, but it’s incongruous in the context of a tax bill loaded with tax policy blunders and deviations from income tax principles, most notably new code section 199A, the so-called passthrough deduction, which is a bacchanal of unprincipled and regressive income tax policy.

Phase 2.0 will make this blunder permanent, so the claim that the SALT cap is a principled change rings quite hollow.

In any event, a more typical approach to situations where it is uncertain how much of a deduction is proper would have involved using a percentage cap, like 50 percent. Limiting the SALT deduction in such a way would have been unpopular as well, but it would have been principled. Other principled options exist.

Perhaps the biggest political danger posed by the SALT cap is that it could create millions of apostles carrying a simple message: Ultimately, very few taxpayers will receive their promised tax cut from Republican tax changes.

This is because borrowing trillions of dollars (with interest) to reduce taxes does not a tax cut make. While taxpayers at the very top of the income ladder will realize huge tax savings both now and in the future, the rest of us will ultimately face higher tax bills and/or fewer vital services.

The millions of taxpayers paying more in taxes next year due to the SALT cap are just the harbingers.

Darien Shanske and Dennis Ventry are professors at the University of California, Davis, School of Law. Shanske's areas of academic interest include taxation, particularly state and local taxation, local government law, public finance and political theory. Ventry is an expert in tax policy, tax practice and tax filing and administration.

 

 

July 30, 2018

States Should Conform to -- and Improve -- the New Federal Tax Provisions Meant to Counter Base Erosion

By Darien Shanske

[Cross-posted from Medium]

The United States used to tax multinational corporations (MNCs) on the basis of their worldwide income, except that most foreign source income would only be taxed when actually repatriated to the United States. This structure naturally created considerable incentive to strip income out of the United States and then not to repatriate it.

Now, thanks to the TCJA, the United States is ostensibly only going to tax MNCs on their US source income. This shift to a so-called territorial system means, of course, that MNCs will continue to have incentive to shift income abroad in order to avoid US tax. The TCJA has two separate provisions meant to counter this: GILTI and BEAT. One question for the states is whether they should conform to these provisions. I think the answer is yes. I also think it is clear that states should improve these provisions when they adopt them.

There is a preliminary question as to whether states can — as a matter of federal constitutional law — conform to these provisions. I think the answer is again yes, but the details of the state law will matter a great deal.

Not everyone agrees. For instance, the STAR Partnership, argues here that:

“Under the prior federal tax system, States generally did not include foreign income in their own tax bases, for both policy reasons and Constitutional limitations. States should continue to respect these policy and Constitutional rationales and avoid taxation of foreign income by excluding these provisions from their business tax bases.”

In short, according to a group of top state and local tax lawyers and policy wonks — who are quite explicitly representing the “business community” — states should not and cannot conform to the federal provisions meant to prevent base erosion. It is true that states do not tax foreign source income (in general) and that it is a tricky policy and constitutional question whether they can and/or should, but is it true that this is what states would be doing if they tax the repatriation or conform to GILTI or BEAT?

Consider some well-known and curious facts about the income of MNCs. First, there are some jurisdictions that are just unbelievably profitable for corporations. As Torslov, Wier and Zucman put it: “Foreign corporations . . . have extremely high profitability ratios in tax havens, e.g., 800% in Ireland. . . . By contrast, and strikingly, in almost all non-haven countries foreign firms are less profitable than local firms. Thus, there is a clear trace in global macro data of shifting from high- to low-tax affiliates, in such a way that profitability is systematically over-stated in tax havens and under-stated elsewhere.”

Many of those some super-profitable jurisdictions also house profits worth many multiples of their GDP, which would seem to be a real head scratcher. For example, the profits of US controlled subsidiaries in the Cayman Islands represented over 1000% of that island’s GDP in 2014. It is of course not possible for firms to earn profit in a jurisdiction many times the size of the jurisdiction’s economy.

We know why this money is taking a Caribbean vacation and we also know which legal structures got it there — see here for example.

In short, there was already a great deal of base erosion, and the two new provisions of federal law we are discussing are meant to counter it. (Indeed, there is a good argument that these provisions are roughly consistent with the anti-base erosion principles championed by the OECD.)

If a state were to conform to these base protection provisions or tax the repatriation, then a state is not — counter to the STAR Partnership — trying to tax “foreign” income, but trying to protect domestic income from being stripped out of their tax base.

This fact has an important legal implication. Again, it is true that the legal questions would be trickier for states looking explicitly to tax foreign income. Matters are different if a state is trying to tax domestic income and is simply trying to craft rules that lead to a better reflection of domestic income. As to designing their own tax systems to tax domestic income, states have a lot of leeway.

So, states can conform to these federal backup taxes and they should, but it is important to note that they should and could also improve these taxes. For more on how states should tax the repatriation, see here and kudos to NJ for doing so.

Here are a couple of examples of possible improvements to the backup provisions that are drawn in particular from Rebecca Kysar and Dan Shaviro. GILTI stands for “global intangible low taxed income” and the intuition behind the provision, consistent with the evidence above, is that certain low-tax jurisdictions are suspiciously profitable. Therefore, GILTI income is income that is earned beyond the normal expected return on an investment. There are numerous complexities involved in GILTI, many of which are not resolved, but for our purposes we can note that GILTI assumes a normal rate of return of 10%, which is rather high. A straightforward fix that a states could adopt would be conform to GILTI but use some lower rate tied to actual normal returns — perhaps a long-term corporate bond rate +2%. That would make the rate 6% at the moment.

As for the BEAT, the “Base Anti-Erosion Tax,” this is a minimum tax much like the Alternative Minimum Tax (AMT) for individuals. The idea is that a primary way of shifting income abroad is for MNCs to take large deductions for payments to related foreign corporations — say a US corporation paying a foreign affiliate in a low-tax jurisdiction for the use of intellectual property. The BEAT requires an MNC to add such payments back into the tax base; that broader base is then subject to a 10% rate. If the resulting tax liability is greater than the regular liability, then the taxpayer pays the minimum. As with GILTI, the BEAT has many design flaws. For instance, the BEAT only kicks in for relatively large corporations ($500 mn plus in gross receipts); it would make a lot of sense for states to adopt the BEAT, but at a lower threshold.

The TCJA emerged from such a flawed process that even its most reasonable ideas, like GILTI and the BEAT, are deeply flawed. (Again, don’t take my word on it, ask Kevin Brady.) And the states will be negatively impacted if the TCJA encourages MNCs to strip out even more income because the GILTI and the BEAT are ineffective. So, at a minimum, states should conform to these provisions and ideally they should improve them, but it should be remembered that improvements need not be through tinkering with the mechanics of these provisions.

The states pioneered an anti-income stripping regime that I would argue is simpler and likely more effective than even an improved GILTI and BEAT: mandatory worldwide combination using the single sales factor. This approach does not require the government to identify a particularly problematic form of income or deduction, which can have unexpected and undesired consequences. Instead, all income is income, and income is apportioned according to where an MNC makes its sales. We know that it is unlikely that an MNC makes many sales to final consumers in tax haven jurisdictions. Currently, no states require mandatory worldwide combination, but many permit taxpayers to choose it. If a state is unwilling to require worldwide combination, then an appealing option would be to conform to GILTI and the BEAT, with improvements, and then permit MNCs to choose if they would not prefer the simplicity of worldwide combination.

 

July 23, 2018

Maryland’s Generic Drug Pricing Law Is Constitutional: A Recent Decision Misunderstands The Structure Of The Industry

By Darien Shanske and Jane Horvath

[Cross-posted from Health Affairs]

Maryland’s price gouging law, a first-in-the-nation state law, would protect consumers from egregious price hikes of certain generic and off-patent brand drugs made by three or fewer manufacturers. Bills based on the Maryland template are moving through a number of other state legislatures. On April 13, 2018, a split three-judge panel of the US Court of Appeals for the Fourth Circuit ruled that the Maryland law, HB 631, enacted in 2017, is unconstitutional based on the court’s interpretation of case law concerning the Dormant Commerce Clause (DCC).

However, the decision is wrong for numerous reasons, many of which were very cogently explained in a lengthy dissent. The Maryland attorney general has requested an en banc review, which is when all judges in the circuit review a decision made by a single three-judge panel. With luck, the entire circuit will get it right.

We will focus here on how this decision is based on a misunderstanding of how the US drug market and supply chain operate.

The Constitutional Doctrine At Issue: Dormant Commerce Clause

The Commerce Clause of the Constitution gives the US Congress the power to regulate commerce between the states. The DCC places limits on a state’s ability to disrupt interstate commerce. The primary focus of DCC doctrine is preventing state discrimination against out-of-state businesses. A secondary concern is preventing state laws that unduly burden interstate commerce. A tertiary concern is preventing states from regulating activity occurring out-of-state—extraterritorially. (For more information about these, the DCC, and state drug cost policy, please see this white paper.)

The Maryland price gouging law (HB 631) addresses generic and off-patent brands that are on the World Health Organization list of essential medicines and manufactured by three or fewer companies. When a drug is produced by only a few manufacturers, the producers can easily launch drugs at high prices, maintain high prices, and increase prices dramatically. High prices of important essential medicines that become unaffordable leave consumers with few, if any, treatment alternatives. This deeply problematic scenario is not just imagined, as both the Government Accounting Office and the US Senate Special Committee on Aging wrote reports detailing the problem. This is the problem the Maryland law addresses.

The generic drug industry sued based on two DCC issues. The first is that the HB 631 law violates the DCC by regulating industry financial transactions outside of Maryland—that is, the charge is that Maryland is regulating extraterritorially. Second, the industry claims that the Maryland law places an “undue burden” on interstate commerce.

Note that there was no argument that the Maryland law would somehow protect the Maryland drug industry, preventing such protectionism is the core concern of the DCC. Nevertheless, the majority of the Fourth Circuit panel found that the Maryland law failed on the secondary and tertiary aspects of the DCC—undue burden and extraterritoriality, respectively. As we will now explain, the court decision seems to have not considered how the pharmaceutical market works.

The Maryland Law Does Not Impose An Undue Burden On Interstate Commerce

The majority opinion found that the Maryland law placed an undue burden on interstate commerce. In the classic cases of undue burden, a state places a heavy burden on interstate commerce of a company or industry for a trivial reason. For instance, in one case, a state required trucks to use an unusual type of mud flap when driving in the state. The Maryland law is nothing like this. First, most obviously, the law is regulating something extremely important—namely generic drug prices—when no one else is doing so, and there is clearly a consumer health and safety issue.

Second, what Maryland is asking the generic drug industry to do is nothing as burdensome as stopping their trucks at the border and making them change their mud flaps. Rather, drug prices are already a product of an enormously complicated set of financial transactions that cross geographies. These financial transactions already vary based on where the product is made and the geography into which it will be sold.

For example, drug manufacturers will negotiate discounts with specific hospitals, health systems, or health plans. Who negotiates with whom depends on the importance of the payer/purchaser in the national or regional market, the product market competition, the importance of the product to company revenue, and other factors. If the negotiation with a hospital results in an on-invoice discount, the manufacturer has to have a financial process to ensure that the wholesaler does not lose money since the wholesaler buys the product from the manufacturer and distributes it nationally or regionally to different buyers (including more local distributors that would get the product to the hospital).

So manufacturer discount negotiations at a very local level—the hospital for instance—drive multiple financial transactions in distant geographies. Manufacturer discount rebate agreements (as distinct from on-invoice discounts) with a health plan also result in financial transactions in a state other than the corporate office of the health plan. This is all part of the business model, and these are only some of the interstate financial transactions required for individual companies to compete in the market. The necessity of working directly in many markets would be particularly important for products with three or fewer competing manufacturers—these are the products subject to the Maryland law—because this is a scenario in which price competition can move market share and profits.

Thus, given the structure of the pharmaceuticals market, and particularly the market for the regulated products, the Maryland law would hardly impose a burden, much less an undue one.

The Maryland Law Does Not Regulate Extraterritorially

The Fourth Circuit also found that the Maryland law violated the extraterritoriality doctrine. This doctrine is a bit variable, but the core rule is simple: A state cannot regulate conduct in another state. Clearly, Maryland was not trying to do this but trying to secure essential drugs at a reasonable price for its citizens. It is true that in so attempting to protect its citizens, there would possibly be a small impact on current transactions wholly out of state, but if this is the test for whether a state can regulate in our interconnected economy, then states cannot regulate much of anything. And, indeed, the decision was wrong on the law of extraterritoriality for just this reason, namely that it would undermine virtually all state regulations. For more on the doctrine, see here.

But perhaps one could defend the Fourth Circuit decision by noting that an effect on interstate pricing was especially likely because of the structure of the drug industry. This analysis, though superficially appealing, has to be rejected because, once again, Maryland is not creating a new or unique effect on interstate pricing. Even in the absence of the HB 631 law, the industry responds to the various limits that different payers put on reimbursement to generic drug dispensers. For example, each and every health plan and all Medicaid programs set their own maximum allowable costs (MACs) for generics and off-patent brands. MAC is just a term for setting dispenser reimbursement limits; it is the average of the prices among the competitors. Maryland health plans and Maryland Medicaid each set their own MACs for their own set of generic products. Furthermore, these various payment limits in Maryland are different from what each health plan in Virginia and Delaware set, all of which can require manufacturers to adjust prices for any one geography through financial transactions that likely occur out of state. This is day-to-day activity in the industry, indeed, it could be very difficult to sort out any small impact of the Maryland law because it would be completely in the mix of the current interstate pricing activity in response to payer limits on pharmacy and provider drug reimbursements—limits that can change weekly or monthly at a payer’s discretion.

So, if the Fourth Circuit’s analysis were correct, then any industry with a complicated business model that crosses state lines could not be regulated by the states. Even more peculiar, if an industry were not so organized, all an industry would need to do is tie itself in knots to escape regulation by the states. It can’t be that the constitutional power of states to protect the health of its citizens diminishes because a firm’s business model produces interstate ripples whenever a state tries to regulate its actions.

In the analogous area of state taxation, it is well-established that a state cannot subject an interstate business to double taxation (relative to an instate business) on account of how the state organizes its own tax system. However, if an interstate firm suffers from double taxation because of permissible decisions made by two states individually, then that is just a necessary byproduct of living in a federation where subnational units have substantial taxing and regulatory power.

But perhaps it makes a difference that part of the complexity here is a result of federal law? If the argument is that a federal law relating to generic drug prices preempts state regulation of prices charged to its citizens, then that is indeed a serious argument. The generic drug industry did not raise this issue precisely because there is no such federal law. Therefore, the court’s finding must rest on the argument that when a federal regulatory regime that does not regulate the prices of drugs that are available in Maryland and other states (because there is no federal law regulating generic drug prices) but does indirectly create possible interstate price linkages (because of federal programs such as Medicaid), then the states are not allowed to regulate those drug prices as if the federal government had preempted state regulation directly. Stating the argument clearly is to reveal how little sense it makes and also, not coincidentally, why it is not the law. There is an entire body of law—preemption—that considers when a federal law preempts a state law, and there is a presumption against preemption. Federal courts are not supposed to be in the business of finding creative ways to prevent states from protecting their citizens.

The structure of the pharmaceuticals market is opaque, as is US Supreme Court case law about the Dormant Commerce Clause. However, knowledge of the market is absolutely key to assessing state laws relative to the DCC. We do not think their decision will stand the test of time once it is understood how this complex market actually functions. 

 

July 23, 2018

Wayfair as a Federalism Decision

By Darien Shanske

[Cross-posted from Medium]

Some first impressions, including pondering how this decision intersects with NCAA v. Murphy

In the end, not a single justice would stand up for the rule of Quill, which rule was that a state can only impose a use tax collection obligation on a vendor if it has a physical presence in the state. All the justices agreed that it was the wrong rule, even apparently, when first imposed in 1967. So then why was this a 5–4 decision?

The four dissenters argued that stare decisis should protect the Quill rule nevertheless because it is an old rule that Congress can change. I take the key part of the majority response to be the following:

While it can be conceded that Congress has the authority to change the physical presence rule, Congress cannot change the constitutional default rule. It is inconsistent with the Court’s proper role to ask Congress to address a false constitutional premise of this Court’s own creation. Courts have acted as the front line of review in this limited sphere; and hence it is important that their principles be accurate and logical, whether or not Congress can or will act in response. It is currently the Court, and not Congress, that is limiting the lawful prerogatives of the States.

This seems exactly right to me and I have argued as much (see here and here). And it is of course not surprising that Justice Kennedy is arguing that federalism values establish a pro-state power default and that it is untenable for a federal court to erect a barrier to state power based on a mistake.

But note that the dissent in Wayfair was written by Chief Justice Roberts, who, in another context wrote: “The dormant Commerce Clause is not a roving license for federal courts to decide what activities are appropriate for state and local government to undertake …” The issue in that case, United Haulers, was whether a public utility could force local users to use its services, and Chief Justice Roberts held for the majority that it could. Justice Alito wrote a powerful dissent in that case and was joined by Justice Kennedy. Justice Alito again joined Justice Kennedy in Wayfair. Thus, according to these two justices, a pro-state constitutional default does not protect local flow control ordinances, but does protect the ability of states to impose a use tax collection obligation. For Chief Justice Roberts, the reverse is apparently true, though in his case he would note that stare decisis was what weighed against the states in the use tax context. (The counter to this is that United Haulers also essentially overturned a precedent, a point well made by Justice Alito in his dissent.)

So Wayfair did hinge on federalism values, I believe, but in a quite complicated way that will require additional unpacking, especially in light of NCAA v. Murphy. This decision, authored by Justice Alito, and joined by Justices Roberts, Kennedy, Thomas, Kagan and Gorsuch, struck down a federal law that made it unlawful for states or their subdivisions to authorize betting on sporting events. The majority thought that this decision followed from the anti-commandeering principle, namely that Congress cannot “issue orders directly to the States.”

As was immediately noted, a broad interpretation of NCAA v. Murphy puts into question numerous federal laws that also restrict the kinds of laws that state legislatures can pass. Such laws are particularly numerous in the field of taxation, where Congress has imposed special rules relating to mobile phones, railroads, pensions etc. And yet both sides in Wayfair seem to agree that Congress could step in and regulate how states can impose a use tax collection obligation. But would not the relevant federal law be, in effect, a prohibition on state legislative power?

This question has been very ably debated by Daniel Hemel, Brian Galle, Rick Hills, Jeff Schmitt and Ilya Somin among others. It seems to me Wayfair is a pretty strong indication that the Court did not mean to undermine the ability of Congress to restrict state taxing power — within limits. Still, Murphy says what it says and so I will add one more way that the Court — and first courts — can reasonably limit Murphy.

In Murphy, Congress was weighing in on a contentious policy matter involving regulating individual conduct on which there is a limited federal interest. The majority in Murphy signals as much in its first line: “Americans have never been of one mind about gambling…” I think that Justices like Kennedy and Alito, relative hawks in other dormant Commerce Clause cases, would argue that preventing balkanization of the national marketplace is a very different matter from imposing a one-size fits all rule about sports betting. Protecting the national marketplace is a core concern of the Commerce Clause and indeed of our whole constitutional order, a point made particularly well by Brain Galle. I know that this kind of analysis is mushy and that the Court in Murphy instead focused on the issue of whether or not the federal government is regulating a private actor, but that rubric does not work to explain how and why Congress can act to limit state taxing power post Wayfair.

Focusing on the importance and centrality of the federal interest means, in effect, that the Court is applying a kind of proportionality analysis, a very common method of deciding constitutional cases, though not in our tradition (at least not explicitly). I think applying some form of the proportionality principle is the right answer not only to the question posed by Murphy, but also to the question posed by Quill/Wayfair. The Court in Wayfair does not explicitly shift to a kind of balancing test (in particular, Pike balancing), but its retention of a “substantial nexus” standard without much further guidance seems to invite the states to engage in balancing. Clearly, a remote vendor can now be asked to collect the use tax even without a physical presence, but, just as clearly, remote vendors can only be asked to do so if there is sufficient nexus. Thoughtful balancing of the legitimately opposing interests is therefore the way forward.

July 23, 2018

State Options After Wayfair


By Darien Shanske (with David Gamage and Adam Thimmesch)

[Cross-posted from Medium]

In Wayfair, the Supreme Court overturned the bright-line physical presence rule imposed by Quill. A state can now require an out-of-state vendor to collect the use tax even if that vendor does not have a physical presence within the state. The underlying standard governing when states can impose a use tax collection obligation remains the same: there must be a “substantial nexus.” But what constitutes a substantial nexus? The Court does not give any general guidance, but does make it clear that this standard was satisfied in this case. Alas, the Court’s reasoning as to this case is reasoning is ambiguous. Here is the key paragraph:

Here, the nexus is clearly sufficient based on both the economic and virtual contacts respondents have with the State. The Act applies only to sellers that deliver more than $100,000 of goods or services into South Dakota or engage in 200 or more separate transactions for the delivery of goods and services into the State on an annual basis. S. B. 106, §1. This quantity of business could not have occurred unless the seller availed itself of the substantial privilege of carrying on business in South Dakota. And respondents are large, national companies that undoubtedly maintain an extensive virtual presence. Thus, the substantial nexus requirement of Complete Auto is satisfied in this case.

The first sentence of this paragraph suggests that two inquiries are relevant to nexus: (1) a taxpayer’s economic returns from a state and (2) its activities directed toward a state. The second and third sentences of this paragraph suggest that the South Dakota thresholds require sufficient “economic contacts” for substantial nexus. The fourth sentence, emphasizing the size of respondents, focused on the so-called “virtual contacts” that large, national e-commerce vendors create through their extensive marketing and web presences.

What this paragraph does not do is to address precisely when small sellers have a substantial nexus. What if a small seller has exactly 200 sales, worth $20,000? Given this uncertainty, our advice for states at the moment would be to put in place thresholds similar to South Dakota’s. If they wanted to be better insulated from challenges from very small sellers, and likely at minimal revenue loss, we would suggest adopting even higher thresholds. This would be especially true for non-SSUTA states.

Alas for states looking for guidance, there is more ambiguity in the next paragraph of the opinion. The Court remanded the case to the lower courts to consider other possible challenges to the South Dakota law, including, apparently Pike balancing, which is odd considering that the substantial nexus test is a test for taxes and Pike balancing is a test for regulations. Here is the paragraph:

South Dakota’s tax system includes several features that appear designed to prevent discrimination against or undue burdens upon interstate commerce. First, the Act applies a safe harbor to those who transact only limited business in South Dakota. Second, the Act ensures that no obligation to remit the sales tax may be applied retroactively. S. B. 106, §5.Third, South Dakota is one of more than 20 States that have adopted the Streamlined Sales and Use Tax Agreement. This system standardizes taxes to reduce administrative and compliance costs: It requires a single, state level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules. It also provides sellers access to sales tax administration software paid for by the State. Sellers who choose to use such software are immune from audit liability.

Though we agree that Pike balancing should apply, we wish the Court would have explained why it should apply. Furthermore, and more importantly for states, the Court does not offer any guidance as to which of these aspects of South Dakota’s law is the most important. Crucially, it may not be too difficult for a state to emulate South Dakota’s thresholds, but it might be very difficult for a state to join the SSUTA or otherwise simplify its tax system in a comparable manner.

Our advice here is that states that cannot engage in substantial simplification — and perhaps even states that can — should offer meaningful vendor reimbursement for compliance costs and/or offer free compliance software that immunizes vendors who rely upon it. (One of us discussed this first approach at length in a prior article here; and two of us discussed this second approach in a prior essay here.)

We do not think that these approaches are necessarily required by the Court’s opinion; substantial enough simplification of a state’s sales and use tax, roughly equivalent to that required by the SSUTA, should suffice. But we do think that adopting one of these approaches makes for good, sensible policy. If, for whatever reason, a state wants to retain a more complicated sales and use tax system or simply does not wish to conform their sales and use tax system with that of other states, then it is only fair that states compensate vendors for the costs they incur in collecting sales and use taxes.