    [House Hearing, 111 Congress]
    [From the U.S. Government Publishing Office]

       STATE TAXATION: THE ROLE OF CONGRESS IN DEVELOPING APPORTIONMENT
                                   STANDARDS

    =======================================================================

                                    HEARING

                                   BEFORE THE

                                SUBCOMMITTEE ON
                       COMMERCIAL AND ADMINISTRATIVE LAW

                                     OF THE

                           COMMITTEE ON THE JUDICIARY
                            HOUSE OF REPRESENTATIVES

                         ONE HUNDRED ELEVENTH CONGRESS

                                 SECOND SESSION

                                   __________

                                  MAY 6, 2010

                                   __________

                               Serial No. 111-93

                                   __________

             Printed for the use of the Committee on the Judiciary

          Available via the World Wide Web: http://judiciary.house.gov

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                           COMMITTEE ON THE JUDICIARY

                     JOHN CONYERS, Jr., Michigan, Chairman
    HOWARD L. BERMAN, California         LAMAR SMITH, Texas
    RICK BOUCHER, Virginia               F. JAMES SENSENBRENNER, Jr.,
    JERROLD NADLER, New York                 Wisconsin
    ROBERT C. ``BOBBY'' SCOTT, Virginia  HOWARD COBLE, North Carolina
    MELVIN L. WATT, North Carolina       ELTON GALLEGLY, California
    ZOE LOFGREN, California              BOB GOODLATTE, Virginia
    SHEILA JACKSON LEE, Texas            DANIEL E. LUNGREN, California
    MAXINE WATERS, California            DARRELL E. ISSA, California
    WILLIAM D. DELAHUNT, Massachusetts   J. RANDY FORBES, Virginia
    STEVE COHEN, Tennessee               STEVE KING, Iowa
    HENRY C. ``HANK'' JOHNSON, Jr.,      TRENT FRANKS, Arizona
      Georgia                            LOUIE GOHMERT, Texas
    PEDRO PIERLUISI, Puerto Rico         JIM JORDAN, Ohio
    MIKE QUIGLEY, Illinois               TED POE, Texas
    JUDY CHU, California                 JASON CHAFFETZ, Utah
    TED DEUTCH, Florida                  TOM ROONEY, Florida
    LUIS V. GUTIERREZ, Illinois          GREGG HARPER, Mississippi
    TAMMY BALDWIN, Wisconsin
    CHARLES A. GONZALEZ, Texas
    ANTHONY D. WEINER, New York
    ADAM B. SCHIFF, California
    LINDA T. SANCHEZ, California
    DANIEL MAFFEI, New York
    JARED POLIS, Colorado

           Perry Apelbaum, Majority Staff Director and Chief Counsel
          Sean McLaughlin, Minority Chief of Staff and General Counsel
                                     ------

               Subcommittee on Commercial and Administrative Law

                        STEVE COHEN, Tennessee, Chairman

    WILLIAM D. DELAHUNT, Massachusetts   TRENT FRANKS, Arizona
    MELVIN L. WATT, North Carolina       JIM JORDAN, Ohio
    DANIEL MAFFEI, New York              HOWARD COBLE, North Carolina
    ZOE LOFGREN, California              DARRELL E. ISSA, California
    HENRY C. ``HANK'' JOHNSON, Jr.,      J. RANDY FORBES, Virginia
      Georgia                            STEVE KING, Iowa
    ROBERT C. ``BOBBY'' SCOTT, Virginia
    JOHN CONYERS, Jr., Michigan
    JUDY CHU, California

                         Michone Johnson, Chief Counsel

                        Daniel Flores, Minority Counsel

                                C O N T E N T S

                                  ----------

                                  MAY 6, 2010

                                                                       Page

                               OPENING STATEMENT

    The Honorable Steve Cohen, a Representative in Congress from the
      State of Tennessee, and Chairman, Subcommittee on Commercial
      and Administrative Law.........................................     1

                                   WITNESSES

    Mr. John A. Swain, Professor, University of Arizona, James E.
      Rogers College of Law
      Oral Testimony.................................................     3
      Prepared Statement.............................................     5
    Mr. James R. Eads, Jr., Executive Director, Federation of Tax
      Administrators
      Oral Testimony.................................................    15
      Prepared Statement.............................................    17
    Mr. Daniel B. De Jong, Tax Counsel, Tax Executives Institute,
      Inc.
      Oral Testimony.................................................    30
      Prepared Statement.............................................    32

                                    APPENDIX
                   Material Submitted for the Hearing Record

    Prepared Statement of the Honorable John Conyers, Jr., a
      Representative in Congress from the State of Michigan,
      Chairman, Committee on the Judiciary, and Member, Subcommittee
      on Commercial and Administrative Law...........................    51
    Prepared Statement of the Honorable Henry C. ``Hank'' Johnson,
      Jr., a Representative in Congress from the State of Georgia,
      and Member, Subcommittee on Commercial and Administrative Law..    52
    Response to Post-Hearing Questions from John A. Swain, Professor,
      University of Arizona, James E. Rogers College of Law..........    53
    Response to Post-Hearing Questions from James R. Eads, Jr.,
      Executive Director, Federation of Tax Administrators...........    57
    Response to Post-Hearing Questions from Daniel B. De Jong, Tax
      Counsel, Tax Executives Institute, Inc.........................    60

       STATE TAXATION: THE ROLE OF CONGRESS IN DEVELOPING APPORTIONMENT
                                   STANDARDS

                                  ----------

                             THURSDAY, MAY 6, 2010

                  House of Representatives,
                         Subcommittee on Commercial
                                and Administrative Law,
                                    Committee on the Judiciary,
                                                        Washington, DC.

        The Subcommittee met, pursuant to notice, at 11:07 a.m., in
    room 2141, Rayburn House Office Building, the Honorable Steve
    Cohen (Chairman of the Subcommittee) presiding.
        Present: Representatives Cohen, Watt, Scott, and Chu.
        Staff present: (Majority) Norberto Salinas, Counsel; Adam
    Russell, Professional Staff Member; and Stewart Jeffries,
    Minority Counsel.
        Mr. Cohen. The hearing will commence here with the banging
    of the gavel. [Commenced.]
        This hearing of the Committee on the Judiciary,
    Subcommittee on Commercial and Administrative Law will now come
    to order. Without objection, the Chair will be authorized to
    declare a recess of the hearing, and there will be votes at
    11:30, so we will have to go and be interrupted at some point.
        I will recognize myself for a short statement.
        In February, this Subcommittee held a hearing on the state
    tax nexus, simply, when a state may impose a tax on an
    individual or business entity.
        Today's hearing will focus on that next step, assuming that
    sufficient nexus is established, how should a state determine
    the imposed tax. States currently follow formulas to apportion
    the tax based on several different factors.
        They include location of the taxpayer's property,
    taxpayer's income, and even the taxpayer's payroll within that
    state. That calculation is simple when the taxpayer only
    conducts business within the state, of course, but becomes more
    complicated when the business' goods and services are
    collected--across state lines.
        States must determine what portion of the total value of a
    multi-state taxpayer's property, and each single state should
    and can tax what they can get away with and what they should
    get away with. These calculations could lead to double taxation
    or possibly, in a very unusual case of somebody who loses their
    job, undertaxation.
        Considering that many states are actively competing for
    business development investment, especially during the current
    economic climate, states may create apportionment formulas
    which favor in-state businesses over multi-state businesses or
    vice versa. Such apportionment formulas may also bring in much-
    needed revenue.
        But do the apportionment formulas burden interstate
    commerce, one of the issues we will deal with. Some contend
    states need to adopt a uniform apportionment standard, however,
    some of the states may not want to be limited by such
    standards. Others claim that businesses have already tax
    planned or have based investment on the differing state tax
    structures and they don't want to interrupt that process.
        It is the role of Congress and this Subcommittee in
    particular to review whether state taxation affecting
    interstate commerce is burdensome. Specifically, we should
    determine whether the differing apportionment formulas utilized
    in this expanding borderless economy are fair and appropriate.
        We should question whether the differing formulas favor in-
    state taxpayers over multi-state taxpayers. We should consider
    whether uniform apportionment standards are a better
    alternative, and would create a competitively neutral playing
    field for in-state and multi-state businesses.
        And we should discuss whether such a standard would lead to
    a more efficient and robust--we haven't heard robust since the
    health-care debate--economy.
        I thank the witnesses for appearing today, and I look
    forward to their testimony. And I will now recognize my
    colleague, Mr. Franks, who is not here. Having done that, I
    will go right along--ah.
        Mr. Coble, would you like to give an opening statement?
        Mr. Coble. [Off Mike.] [Laughter.]
        Mr. Cohen. We are lucky to have you. We are all lucky to be
    here in more ways than one.
        With Mr. Coble's sage advice, comments and observations, we
    will then go onto the witnesses. And the first witness today--
    and I want to thank everybody for participating. Your written
    statements will be placed in the record. I ask you to limit
    your oral remarks to 5 minutes. We have got a lighting system.
    Green means you are in the first 4. Yellow means you are in
    your last 1. Red means you should conclude or be finished.
        Members will be able to ask you questions. The same 5
    minutes prevail.
        The first witness is Mr. John Swain. I almost made you Lynn
    Swann's brother. [Laughter.]
        Mr. John Swain, professor of college at University of
    Arizona, an rival school for Mr. Swann, the Rogers College of
    Law.
        Professor Swain has authored and co-authored numerous books
    including ``The Streamlined Sales and Use Tax,'' and is a
    regular columnist for State Tax Notes Magazine. He is a
    frequent speaker at state and local tax conferences, consults
    with state governments and other entities on tax law.
        Before entering academia, he was with a firm in Phoenix
    where he practiced in the area of state and local taxation.
        Thank you, Professor Swain. And if you would begin your
    testimony, and your 5-minute light is now on.

     TESTIMONY OF JOHN A. SWAIN, PROFESSOR, UNIVERSITY OF ARIZONA,
                     JAMES E. ROGERS COLLEGE OF LAW

        Mr. Swain. Okay. Thank you, Mr. Chairman, and Members of
    the Committee. And I want to thank you for inviting me to
    testify today.
        As the Chairman noted, there is a problem in state
    taxation, and that problem is how do we divide the income of a
    taxpayer who does business in more than one state. And for
    example, let us imagine a business that has customers all over
    the United States, does manufacturing in Michigan, has
    distribution facilities in Tennessee, maybe does R&D in
    California. How do we determine how much income is earned in
    each of those jurisdictions? It is a thorny problem. The states
    have a clever and generally good solution to that problem. It
    is called formula apportionment.
        And what the states do is they compute an apportionment
    ratio for that business, and that is computed by the average of
    three ratios. The first is the sales factor, and we take the
    sales in state over the sales everywhere; that is one ratio.
    Then we take the payroll in state over payroll everywhere. And
    we take the property in state over the property everywhere. We
    get those ratios. We average them. And then we come up with an
    apportionment formula. We apply that to the total income of
    that business to determine what income is taxed in that state.
        I think it is--whenever you are dividing a pie, I believe
    it is good to have uniform rules otherwise you run into problem
    of overallocating or underallocating that pie. For example, let
    us assume that Iowa has an apportionment formula that relies
    only to sales which, in fact, is true. And then let us say
    Illinois has a formula that employs the traditional three
    factor formula I just mentioned.
        And then assume there is a business with all its property
    and payroll in Illinois that is making sales into Iowa--all its
    sales are into Iowa. What is going to happen?
        Setting aside nexus questions, what is going to happen is
    Iowa will tax all the income of that business because Iowa only
    relies on sales, and all the sales are in Iowa. But then when
    Illinois goes to compute that taxpayer's income, sure, there
    are no sales in that state, so the sales factor is zero, but
    all the property and all the payroll are in Illinois, and that
    matters to Illinois. So Illinois is going to tax two-thirds of
    that business' income. And that business will pay tax on one
    and two-thirds of its income.
        So that is the problem when we have inconsistent rules.
    Now, the opposite can happen. Assume the same facts but the
    business is located in Iowa and making all of its sales into
    Illinois. Iowa won't tax that business at all even though it
    has payroll and property in Iowa because Iowa doesn't care. It
    only relies on a sales factor.
        Illinois will only have--the sales factor will be one
    because all the sales are in Illinois, but there is no property
    or payroll in Illinois. So that ratio will be one-third. And in
    that case, that business will only be taxed on a third of its
    income. So we can undertaxation as well.
        In the 1960's and 1970's, there was relative peace in the
    valley. There was relative uniformity among the states, and
    they used the three-factor formula I described. More recently,
    the lid has been blown off of uniformity, largely, because of
    economic development pressures.
        States and taxpayers realizes that every time the business
    adds property, makes a capital investment, adds payroll in a
    state, their tax bill goes up. And so in the name of economic
    development, states have begun to overweight their sales factor
    which, in effect, lowers the weight of the property and sales
    factors--excuse me--property and payroll factors to attract
    business, to have a more favorable business environment.
        But in this period where some states are changing and some
    aren't, we have a lack of uniformity and the risk of
    overtaxation and, actually, undertaxation.
        In my view, there is a predicate for intervention that has
    been met because of the compliance burdens of non-uniform
    rules, because of the risk of double taxation. It is a burden
    of interstate commerce. On the other hand, as I mentioned in my
    example earlier, there is the opportunity for tax planning and
    undertaxation which I suppose is less of a concern to Congress.
    Unless the states come to Congress, you know, hat in hand and
    say please save us from ourselves, I don't know that they are
    going to do that. But that would be the other possibility.
        Thank you very much.
        [The prepared statement of Mr. Swain follows:]

                      Prepared Statement of John A. Swain

                                   __________

        Mr. Cohen. Thank you for your testimony.
        And we now recognize Mr. Jim Eads. Mr. Eads has been with
    us before, executive director of the Federation of Tax
    Administrators since September where he kept capping a 30-year
    career in state tax work. He leads the FTA staff in D.C., and
    he represents the 50 states, the District, and New York City.
        Previously, he was director of public affairs for Ryan, a
    major tax consulting company, where he represents their clients
    regarding state tax policy and legislative proposals. Past
    president of the National Tax Association, former chairman of
    Electronic Commerce Task Force on the Council on State
    Taxation.
        Thank you, Mr. Eads. The light begins.

    TESTIMONY OF JAMES R. EADS, JR., EXECUTIVE DIRECTOR, FEDERATION
                         OF TAX ADMINISTRATORS

        Mr. Eads. Thank you, Mr. Chairman, and Members of the
    Committee. Thank you for opportunity to appear before you
    today.
        As the Chairman said, my name is Jim Eads. I am the
    executive director at the Federation of Tax Administrators. The
    Federation is an organization of the state tax agencies of all
    50 states as well as the District of Columbia and New York
    City.
        As you know, Navjeet Bal, the commissioner of revenue for
    the Commonwealth of Massachusetts was scheduled to present this
    testimony at the hearing in March which was rescheduled today.
    She could not be here today, and I am honored to be here
    representing her and the Federation of Tax Administrators.
        We gather at a difficult time for state governments. The
    recession has taken its toll on our citizens and creates the
    demand for state services and caused record declines in state
    tax revenues. States have responded by cutting services, laying
    off state workers, drawing down rainy-day funds, and, in some
    cases, raising taxes.
        The Federal Government has been a vital partner to the
    states, providing financial assistance, which has allowed the
    states to meet their balanced-budget requirements without even
    deeper budget cuts. As the states prepare their budgets for the
    upcoming fiscal year, it appears that state revenues are no
    longer in freefall, but state budgets still face enormous
    challenges as Federal assistance ends, demand for state
    services remains strong, and state revenues are well below pre-
    recession levels.
        You asked that we discuss the general issue of
    apportionment of corporate income for state tax purposes and
    specifically to address the question of what role the Congress
    has or should have in developing apportionment standards.
        This hearing follows on a hearing in February that the
    Chairman mentioned on nexus issues. You heard then from Utah
    Tax Commission Chairman Bruce Johnson, and I repeat now, a
    respectful request that Congress continue to refrain from
    Federal legislation in areas of state taxation, including
    apportionment, that are best left to the states. An honest and
    healthy respect for our Federal system requires no less.
        For the better part of 50 years now, the states have found
    a workable solution to the issue of determining a corporation's
    taxable income through the application of formulary
    apportionment. It has served as a stable and widely accepted
    means to approximate the extent of a business' activity within
    a state and has proven sufficiently flexible to address a
    changing economy.
        As that economy has evolved toward a service and
    information economy, states have responded by adjusting their
    apportionment formula and also by adopting alternative
    apportionment regulations for particular industries such as
    financial institutions, telecommunications, airlines,
    railroads, trucking companies, television and radio
    broadcasting.
        Despite business' opposition, the multi-state tax
    commission is undertaking an effort to modernize and
    standardize the sales factor for services and intangibles to
    better reflect today's economy and to promote uniformity
    amongst the states with respect to this important sector of the
    economy.
        We believe that the states are the best laboratories for
    the evolution of apportionment structures that significantly
    affect their own fiscal destiny. State tax administrative
    agencies are confronted daily with issues related to state
    corporation taxation. They have the knowledge, the experience
    and expertise to craft what we believe are workable solutions.
        Given the diversity and complexity of the American economy
    and the rapid changes that it is undergoing, it is imperative
    for both the business community and the states to maintain
    their flexibility to adjust the apportionment formula to
    address particular industries and to respond to particular
    needs of that state.
        Any type of Federal intervention in this effort would have
    a deleterious effect on the flexibility that is in the current
    apportionment structure and would, in all likelihood, have
    unintended consequences. Given their expertise, their
    motivation, and their on-the-ground relations with the business
    community, the states are best positioned to revise formulary
    apportionment as it applies to state taxation of interstate
    commerce.
        Thank you for your time and for your consideration of this
    important issue, and I will be glad to respond to questions at
    the appropriate time.
        [The prepared statement of Mr. Eads follows:]

                    Prepared Statement of James R. Eads, Jr.

                                   __________

        Mr. Cohen. Thank you, sir.
        We are approaching a record, two witnesses who have not
    gone to the red light.
        You are on the spot, Mr. De Jong.
        Mr. De Jong is a tax counsel at Tax Executives Institute,
    Inc. He focuses primarily on state and local tax issues,
    drafted several Supreme Court amicus briefs, written advocacy
    pieces on issues ranging from economic nexus is to state add-
    back statutes and penalties.
        Prior to joining TEI, he worked in the McLean, Virginia,
    office of Ernst and Young. The majority of his time was spent
    on state and local tax practices, assisting clients with a
    broad variety of issues.
        Thank you, Mr. De Jong. Don't feel any great, you know,
    burden, but it is all on you. [Laughter.]

             TESTIMONY OF DANIEL B. DE JONG, TAX COUNSEL,
                     TAX EXECUTIVES INSTITUTE, INC.

        Mr. De Jong. Thanks for taking away that burden. Is this
    working for you?
        Mr. Cohen. Your time started.
        Mr. De Jong. Okay. [Laughter.]
        Good morning, and thank you for your invitation to Tax
    Executives Institute to participate in this hearing and to
    provide the business perspective on issues related to the
    apportionment of income for state corporate tax purposes.
        Founded in 1944, TEI is the preeminent worldwide
    association of in-house tax professionals with more than 7,000
    members representing over 3,000 of the world's largest
    businesses located in the United States, in Canada, Europe, and
    Asia.
        My testimony today will focus on two areas. First, I will
    discuss the practical effects of the current patchwork of state
    apportionment rules and how they affect multi-state businesses.
    Second, I will describe the challenges that exist to achieving
    consensus in this area.
        But before jumping into apportionment, I think it is also
    important to note that complexity exists in determining the tax
    base, the pie that Mr. Swain described, that must ultimately be
    divided among the states. This includes determining which
    entities must be included in a tax return which can be
    complicated, in part, because of the general lack of uniformity
    among the states.
        After identifying the entities to be included in each state
    tax return and the tax base of those entities, businesses must
    apportion that income to the various states in which they have
    nexus. For the reasons outlined by Professor Swain, many states
    have moved away from a standard formula based on a
    corporation's property, payroll, and sales and have used their
    apportionment formulas to benefit and encourage in-state
    investment.
        For example, by moving the payroll and property factors out
    of the apportionment calculation, the state can benefit in-
    state businesses by eliminating the ratios tied to the
    production of a taxpayer's goods and services. The resulting
    lack of uniformity increases the compliance burden on multi-
    state business.
        Perhaps the most striking example of this disconnect is the
    manner in which receipts from the sale of services and
    intangibles are sourced for purposes of the sales factor. Under
    many state statutes, taxpayers must source those receipts to
    the state in which the income-producing activity is performed.
    Many other states, however, have begun to source sales to the
    location where the customer receives the benefit of those
    services.
        Inconsistent application of these rules can result in both
    double taxation and taxation of less than one hundred percent
    of a taxpayer's income. TEI's written statement includes an
    example of a taxpayer that provides computer help desk services
    and ultimately paid tax twice on half of its income as a result
    of the varying sourcing rules applicable to multi-state service
    providers.
        The example also shows that these inconsistent rules can
    work in favor of the taxpayer. By moving its headquarters from
    one state to another, the taxpayer in that example would pay
    state income taxes on only half of its income. While the
    example may seem only an interesting hypothetical, situations
    of a similar nature are not uncommon for businesses across the
    country.
        This brings us to the question: ``Is it possible to achieve
    consensus on a uniform apportionment standard?'' Based on
    experience across the country, the challenge will be
    significant. Some degree of complexity is inherent in any
    multi-jurisdictional tax system. Changes in one area would
    likely benefit some businesses and disadvantage others.
        This occurs because the facts and circumstances of each
    business can vary by industry, geographic location, and other
    factors. Over the years, there have been repeated efforts to
    promote state and local tax consistency and uniformity. These
    efforts have, for the most part, met with limited success for a
    variety of reasons--state economic and budgetary pressures,
    concerns about state sovereignty, geographic and demographic
    considerations, and interstate or international competitive
    concerns.
        A one-size-fits-all approach to apportionment may not be
    uniformly supported by the business community. For example, a
    uniform apportionment formula that includes a payroll or
    property factor would increase the state tax burden on
    businesses that located production facilities in states that
    offered single-sale-factor apportionment formulas in order to
    attract in-state investment. That may also run contrary to
    policy decisions made by states to promote in-state
    investments.
        In conclusion, Tax Executives Institute thanks the
    Subcommittee for the opportunity to share our perspective on
    the complexities of our multi-state tax system in general and
    apportionment matters in particular. And with 25 seconds to
    spare, I welcome the opportunity to answer any questions.
    [Laughter.]
        [The prepared statement of Mr. De Jong follows:]

                    Prepared Statement of Daniel B. De Jong

                                   __________

        Mr. Cohen. Thank you, Mr. De Jong. What a great panel. I
    think we should give them applause. [Applause.]
        That was very special.
        I am going to yield to Mr. Watt for first questions.
    Normally--Mr. Watt, you are recognized for 3 minutes.
        Mr. Watt. Three minutes?
        Mr. Cohen. Well, I think we have votes at 11:30. I would
    like to give everybody a shot.
        Mr. Watt. Okay. That is fine. I will try to stay within my
    time. My green light is not on, though. So you better start the
    clock.
        Mr. Eads, you are with this multi-state task force that is
    doing some work in this area. To what extent will they address
    coming up with some uniformity on the definition of ``nexus''?
        Mr. Eads. I alluded in my testimony to the multi-state tax
    commission, which is working on an issue with regard to
    apportionment. I represent the Federation of Tax Administrators
    which includes all the states' tax agencies.
        Right now, the issue of nexus is governed by two United
    States Supreme Court decisions based on the Constitution.
        Mr. Watt. I understand that. I am trying to figure out
    whether anybody in this task force or any of the multi-state
    discussions are trying to come up with some kind of uniformity
    in that area.
        Mr. Eads. There is an effort, yes, among the states to--
    particularly at the multi-state tax commission--to address the
    issue of nexus as well as issues with regard to apportionment.
    As you might well imagine being a participant in the
    legislative process, getting everyone in a particular group to
    agree about something, sometimes, can be problematic.
        Mr. Watt. Are they anywhere in the neighborhood of having
    some kind of consensus about what the definition of ``nexus''
    is?
        Mr. Eads. Well, it depends on which state--I am sorry--
    which tax we are talking about, Mr. Watt. In the area of sales
    taxes, there is going to be some legislation and has been
    legislation introduced in the Congress in the past which would
    establish a universal definition of nexus for sales taxes.
        There is also, pending before this Committee, a bill which
    would also define nexus in the corporate income tax----
        Mr. Watt. I think you may be missing it. You are lobbying
    for the states to work this out, and then you are telling me
    about legislation that has been introduced here. So what I am
    trying to get a sense is whether there is any possibility of
    whether the states, if we stay out of this, can resolve this
    without legislation.
        Mr. Eads. The states can make some progress, but when--as
    we have in the sales tax area, the Supreme Court has ruled
    based on the Constitution. There may not be a whole lot that
    the states can do. The states can act collaboratively, and they
    probably can even act collaboratively within the Constitution.
        But it is very difficult to get there.
        Mr. Watt. Mr. Chairman, I will yield back before my red
    light comes on, too.
        Mr. Cohen. Thank you, sir. I appreciate it.
        Mr. Coble has left the building, like Elvis.
        Mr. Scott, you are recognized.
        Mr. Scott. Thank you.
        Professor Swain, you mentioned a situation where people in
    Iowa could, if you run a business out of Iowa which just has a
    sales--if they were in Illinois selling in Illinois taxed at a
    hundred percent and moved their corporate headquarters across
    the street as Mr. De Jong has indicated, would they cut their
    corporate taxes?
        Mr. Swain. Yes. I think--I mean, my scenario was----
        Mr. Scott. If you move a company that is doing business in
    Iowa, selling in Iowa, property in Iowa--if you just pick up
    your corporate headquarters, move--excuse me--in Illinois--and
    pick up just the corporate headquarters and move it to Iowa
    where all your customers all still in Illinois, you could be
    taxed on one-third----
        Mr. Swain. Yes. You could reduce your tax liability
    substantially----
        Mr. Scott. You have got population places like Bristol,
    Tennessee; Bristol, Virgini; Kansas City; Illinois; Kansas
    City, Missouri. Do people locate across state lines to try to
    save some money? Does that actually happen?
        Mr. Swain. Oh, certainly. Certainly. And you have to move
    your operations, not just your headquarters because they count
    your property and your payroll. But if you move your
    operations, you can--you find a tax haven if you can.
        Mr. Scott. Now, we are just talking--we are talking about
    corporate income tax. How many people use all three? Sales,
    payroll, and property? How many just use sales? How much
    variation is there?
        Mr. Swain. It is a moving target. It is in my written
    testimony. I am thinking maybe 11 to 14 or somewhere--15'ish--
    use the traditional formula. I think it is up to about 14 or so
    that use sales only. And the rest are using a superweighted
    sales factor. It is somewhere in there in my testimony.
        Mr. Scott. Now, if you pay your corporate tax in one state,
    do you necessarily get a credit in the other state?
        Mr. Swain. No. The interesting thing about the state system
    is it is not a credit system. It is just--each state determines
    the slice of the pie it is going to tax, end of story. No
    credits for taxes paid in other jurisdictions.
        Mr. Scott. And how continuous a nexus do we have to have to
    trigger all of this apportionment?
        Mr. Swain. Well, that is an open question for income tax,
    but the trend with state courts is that you just need what we
    call an economic nexus. You don't need a physical presence in
    order to trigger income tax liability. That hasn't been
    determined by the Supreme Court, but the clear trend with state
    courts is to allow what we call economic nexus for income
    taxes.
        Mr. Cohen. Ms. Chu from California, an expert on this as
    many other topics.
        Ms. Chu. Thank you, Mr. Chair.
        Mr. Eads, Professor Swain argues that, without uniform
    apportionment rules, there is a risk of both overtaxation and
    undertaxation of multi-state businesses. How do you respond to
    that?
        Mr. Eads. There is a risk. Professor Swain is correct that
    there is a risk. It is not a perfect system. It is a system
    that, on a case-by-case basis, has been to the U.S. Supreme
    Court and been found to be constitutional. There is a good body
    of case law from the Supreme Court about what the states have
    done and what is constitutional and what is not.
        The struggle that the Congress would have would be if it
    wanted to craft a piece of legislation to find something that
    would please everyone. And as Mr. De Jong said in his
    testimony, even among the business community, that would be
    hard to do.
        So is it a perfect system? No. Is it a working system that
    achieves--I hesitate to use this term but--rough justice? Yes.
        Ms. Chu. And how about the issue of double taxation in
    services? Of course, we know that tangible goods. It is very
    clear where that tangible good comes from.
        But with services, there is the risk of being double taxed
    because it has to do with where the service is rendered versus
    where it is being received.
        Mr. Eads. Representative Chu, certainly, the evolving
    nature of the economy has put some stresses and strains on the
    tax system. Many state tax laws were drafted in an era when we
    were a mercantile system. People went to stores and bought
    things. There wasn't nearly as much service in the economy when
    many tax laws were adopted.
        And so there are some stresses and strains that need to be
    worked out to try to address that segment of the economy to
    make the tax system work and to be fair to taxpayers.
        Ms. Chu. Okay. Thank you. I yield back.
        Mr. Cohen. Let me ask a question or two about maybe--first,
    Mr. Eads.
        You said that you think that we should respect the
    sovereignty of the states and refrain from Federal legislation
    in the area of apportionment for state taxes purposes. You
    don't see any benefit at all from any kind of uniformity?
        Mr. Eads. Mr. Chairman, I do. I think the devil is in the
    details. That is--as Mr. De Jong alluded to in his testimony,
    even amongst the business community, it would be hard to find a
    consensus about what the standard should be. That would also be
    true among my members.
        So is there a role for Congress to try to alleviate some
    burden? Yes. As I indicated in my testimony, however, what the
    Congress would have to do is try is avoid those unintended
    consequences that would just create a new set of problems or a
    new burden that business would have to confront.
        The fact of the matter is----
        Mr. Cohen. And do you not think Congress can do that in its
    infinite wisdom and its ability to craft, you know, meaningful
    and reasonable and rational legislation devoid of political
    considerations and special influences?
        Mr. Eads. I am a hundred percent confident of the Congress'
    ability to do that, Mr. Chairman. [Laughter.]
        Mr. Cohen. This Congress too? [Laughter.]
        Thank you for your endorsement.
        Do either of you gentlemen feel that Congress should do
    anything in this area? Or are you laissez-faire as well?
        Mr. Swain. Well, I live--go ahead. I mean, I have kind of
    the ivory-tower perspective. I mean, conceptually, it is a good
    idea. It is what should be done. I understand the politics is
    difficult. And I don't have much of an opinion on that.
        But, you know, first, do no harm. I think that is what the
    states are worried about; that if Congress tried to do
    something, it might do some harm rather than some good even
    though, conceptually or in the abstract, uniformity makes
    complete sense.
        Mr. Cohen. And Mr. De Jong?
        Mr. De Jong. My perspective--our members would probably--to
    answer a question of should there be uniform apportionment
    standards with a yes, and then you asked each one of them what
    that uniform standard would be, they would probably give you a
    hundred different answers to what it would be.
        So I think it would be difficult to build up a consensus
    behind a single solution to that problem. It is very complex.
        Mr. Cohen. I want to thank the Members of the Committee for
    attending, and I want to thank the witnesses very much for your
    testimony and time.
        I wish we had more time, but we have to vote--we have the
    healthy--a bill that would help provide for--cash for clunkers
    is what it is. It is called Home Start, a very important bill.
    And then we have to vote for motherhood, literally, voting for
    Mother's Day. So we all want to get up there and do that to
    precede apple pie.
        So we thank the witnesses today. Without objection, Members
    have 5 legislative days to submit any additional written
    questions which we will forward to the witnesses and ask you to
    respond as promptly as you did your testimony.
        Without objection, the record will remain open for 5
    legislative days for submission of any other additional
    materials. I thank everyone for their time and patience. The
    hearing is adjourned.
        [Whereupon, at 11:38 a.m., the Subcommittee was adjourned.]

                                A P P E N D I X

                                  ----------

                   Material Submitted for the Hearing Record

    Prepared Statement of the Honorable John Conyers, Jr., a Representative
      in Congress from the State of Michigan, Chairman, Committee on the
     Judiciary, and Member, Subcommittee on Commercial and Administrative
                                      Law

        Nearly 50 years ago, the House Judiciary Committee established a
    special subcommittee on State taxation affecting interstate commerce,
    known as the ``Willis Committee,'' to study these complicated issues
    and to make recommendations.
        Unfortunately, State taxation affecting interstate commerce has
    become even more complex in the Age of the Internet.
        The Subcommittee on Commercial and Administrative Law has conducted
    a series of hearings--both legislative and oversight--examining these
    issues, including a hearing it conducted last February that focused on
    defining nexus.
        Today's oversight hearing considers how States calculate tax
    liabilities for multistate businesses in light of the fact that
    different States utilize different formulas.
        Given the potential for taxation formulas to burden interstate
    commerce, it is critical for Congress to understand them.
        Accordingly, I welcome today's hearing. As we hear testimony from
    today's witnesses, we should consider the following three points:
        First, to help our Nation lift itself out of the current economic
    climate, we should work to lessen unnecessary burdens on interstate
    commerce. As our businesses thrive and increase production, more jobs
    are created. As more workers get back on their feet, they create a
    market for more goods and services that further helps our businesses to
    thrive.
        But to foster our country's economic revival, businesses need
    clarity and fair tax policies to operate. They need simple and clear
    tax structures to know what activities will trigger tax liability in a
    State.
        Accordingly, we should urge the creation of State and local tax
    policies that are clear and fair and that will not burden interstate
    commerce.
        Second, many State and local governments across the United States
    are also suffering during this three-year-long economic downturn.
        With reduced revenues and looming fiscal obligations, State and
    local governments are having to make tough choices to spur economic
    growth while balancing their budgets.
        My home State of Michigan has been hit especially hard as its tax
    base continues to dwindle. In response, Michigan has had to cut
    spending and tweak its tax policies just to stay afloat.
        It's important, however, that State and local governments create
    tax policies that not only pay for providing essential services, but
    also spur economic development, and in turn, job creation.
        For example, State governments often formulate tax policies in
    hopes of attracting investments and businesses to the State.
        Within these tax policies, State governments have to determine how
    to tax multistate companies.
        We should not at this hearing question the effectiveness of such
    tax policies. Instead, we should focus on whether these tax policies
    burden interstate commerce.
        Nonetheless, Congress should take seriously the plight of State and
    local governments. In fact, last month, this Subcommittee held a
    hearing on how pending legislation could affect State and local
    government revenues, especially during the current economic downturn.
        Third, we should encourage State and local governments--together
    with the relevant taxpayers--to work together to establish tax policies
    that eliminate over-taxation of multistate taxpayers, while ensuring
    that there is no under-taxation.
        And we should encourage the parties to work together to lessen the
    administrative burdens for both businesses and governments.
        To the extent that there are issues involving over-taxation and
    under-taxation--as we know from the creation of the Uniform Division of
    Income for Tax Purposes Act, and its widespread adoption--the
    interested parties should work collaboratively to achieve a tax policy
    that is mutually beneficial.
        They can choose to follow a uniform standard, or tweak the current
    differing standards, or do nothing at all.
        Although Congress can provide a legislative solution if the
    relevant parties cannot agree upon one, I would hope the interested
    parties could try to develop their own solutions before involving
    Congress.
        We are interested in how, for instance, the Multi-state Tax
    Commission will approach the apportionment issue.
        Of course, if there exists a problem that cannot be solved through
    mutual agreement, then Congress may need to intercede.
        If Congress later chooses to provide a solution, the legislative
    record from today's hearing should provide us with a basis for creating
    meaningful legislation.
        I thank Chairman Cohen for holding this very important hearing. And
    I encourage him and this Subcommittee to continue its review of State
    taxation issues to ensure that State tax policies do not burden
    interstate commerce.

     Prepared Statement of the Honorable Henry C. ``Hank'' Johnson, Jr., a
       Representative in Congress from the State of Georgia, and Member,
               Subcommittee on Commercial and Administrative Law
        Thank you, Mr. Chairman, for holding this hearing today.
        Today we will examine the general issue of apportionment of
    corporate income for state tax purposes. Specifically, this hearing
    will give Members the opportunity to hear from witnesses about what
    Congress should do, if anything, in regards to apportionment standards.
    I hope the witnesses will be able to shed some light on this issue.
        Apportionment is a means to attribute a business entity's income to
    and among the various states in which the entity conducts business.
        When an entity conducts businesses in multiple jurisdictions, it is
    necessary to determine which of the entity's activities, and how much
    of the income derived from those activities, should be attributed to
    each jurisdiction in which it conducts business. States currently set
    their own corporate tax formulas.
        Given the tumultuous economy, and record unemployment, states are
    hurting. States are struggling to create budgets to provide essential
    services, such as public education, police, and fire personnel, for
    their citizens. Therefore, this is an issue that should not be taken
    lightly.
        As I think about apportionment, several questions come to mind.
    Should Congress step in and legislate? If so, how should Congress
    proceed? How would federal legislation affect multistate businesses?
    How would it impact interstate commerce?
        Hopefully, the witnesses can enlighten us on these and other
    questions.
        I thank the Chairman for holding this hearing today, and I look
    forward to hearing from the witnesses.

       Response to Post-Hearing Questions from John A. Swain, Professor,
             University of Arizona, James E. Rogers College of Law

          Response to Post-Hearing Questions from James R. Eads, Jr.,
              Executive Director, Federation of Tax Administrators

          Response to Post-Hearing Questions from Daniel B. De Jong,
                  Tax Counsel, Tax Executives Institute, Inc.