Shanske writes this timely symposium piece as part of the aftermath of the Tax Cuts and Jobs Act (TCJA) as states are forced to respond to significant federal tax changes on conformity issues, namely whether and how to adapt to the changes made to federal tax law. The gist of Shanske’s argument is that as a matter of state tax policy, states do not need to conform to the TCJA. Rather, they should view conformity as an opportunity to be strategic and adopt only some federal law but not all in a particular area.
Nevertheless, states acting strategically may disincentivize behavior by taxing it thus undermine national goals. For example, if a state chooses to levy a sufficiently high tax on an activity that the federal government incentivized (like a railroad system) as to thwart that activity altogether it could be very problematic. So Shanske is looking to draw the line that divides state autonomy and federal sovereignty. He outlines fiscal federalism in theory and practice and incorporates comparative constitutional perspectives to inform the appropriate – and actual – approach that constitutional law takes as to the preemption of state taxes.
Shanske begins his analysis by claiming that federal tax law does not generally preempt state tax law, explicitly and implicitly. He analyzes fiscal federalism by arguing that Congress cannot implicitly preempt the states when it could not explicitly preempt the states. Second, the federal government cannot preempt through its taxing power any farther than it can with its spending power. It cannot exercise its taxing power in a way that undermines states too much under the anti-coercion doctrine that requires proportionality analysis. This doctrine means that Congress can generally not preempt broad tax bases on which the states rely but may narrowly intervene to prevent specific problems relating to interstate commerce.
In his opinion, given the structure of U.S. fiscal federation (providing little central fiscal support for states) and the rationale of interjurisdictional competition, it would not make sense for the federal constitution to require states to follow the federal lead as to tax policy. Under explicit preemption doctrine, congressional rules regarding railroads, air transportation, mobile telephones, or requiring states to use a standardized apportionment formula for corporate income taxes, are all justified as they narrowly address a specific burden on interstate commerce and states broad discretion. As a matter of federal constitutional law, the federal government need not provide the states with any financial assistance and so it would be perverse to permit the government to force states to advance federal initiatives without federal funding. According to Shanske, if the federal government could hamstring state revenue collection instead of paying, however, then the federal government could pay a bargain price and undermine the sovereignty of the states. While there is no case where the implicit preemption is a result of federal tax law, the Supreme Court has stated that regular federal tax statutes do not preempt state law. To the extent that the federal government is not providing adequate fiscal support, state self-help is justified. Accordingly, Shanske claims, left on their own to compete with one another on the basis of tax policy, states can and should act strategically.
Shanske then proceeds by discussing strategic options as to the kinds of reforms states should generally undertake. He claims states should pursue tax reform that makes sense for regardless of federal reform actions but taking in mind the exponential growth of wasteful tax planning and lost government revenue. Here, I would have liked to see a broader discussion of how states non-conformity to federal tax laws increases tax complexity and in turn escalates tax avoidance. Instead, Shanske focuses on the fact that different taxes can be evaded in different ways. When a state adds a tax on top of a federal tax, then the states is giving taxpayers a lot more reason to avoid paying the income tax to both sovereigns, say by deferring gain. When a state instead taxes property, it does not increase the incentive to defer gain to avoid the income tax, nor does the federal income tax encourage the taxpayers to evade the state property tax. But what if it states do tax differently the same base?
If the federal government seeks to encourage firms to capitalize their equipment purchases, can states act to undermine such ostensive federal goals? Shanske doesn’t think so and argues that by the mere fact of having state or local income tax imposed on the same income taxed by the federal government, it is undermining the federal base and distort federal incentives. Moreover, conforming to federal choices (such as faster depreciation schedule) automatically consequently cost the states a great deal of revenue. The doctrine may call into question, whether Congress could preempt state capital expensing rules. But in such a case, Shanske concludes, Congress could impose some standardization on terms, but could not force states to require immediate expensing of capital projects as it would undermine states corporate income tax base.
In what manner should states conform strategically? Shanske provides three illustrations. First, the new expensing rules created by the TCJA that permit 100% depreciation for investment in capital assets through 2023. Many states choose not to conform to such rules as a matter of sound tax policy of better matching tax with real economic depreciation. Yet, Shanske calls for further action by slowing down state-level depreciation and taking advantage of this new Federal supercharged incentive for firms to invest in capital equipment. Such slow down, he claims, will better approximate real economic decline, raise revenue, and reflect good tax principles. Moreover, due to state income taxes being much lower than federal income tax, the additional state tax burden will be much smaller than the federal incentive and thus is not likely to hamper capital expenditures or the benefits of the TCJA.
The new Section 199A offers another illustration. The federal government delivers incentives for profitable non-corporate business by providing a 20% deduction for Qualified Business Income (QBI). Shanske claims that adding a small state surcharge on QBI is unlikely to change taxpayer behavior. This result also makes sense according to Shanske, in light of the state corporate income tax currently not imposed on businesses organized in a different way. This left me wondering how much of his arguments would hold in a tax system whereby state tax rates are more aligned with federal tax rates.
Lastly, TCJA changed tax rules concerning multinational corporations by switching the corporate tax base from a worldwide to a territorial system along with anti-abuse rules such as the Global Intangible Low-Taxed Income (“GILTI”) regime. Should states conform to GILTI? Shanske thinks they should in order to protect their tax bases. When multinationals shift income out of the federal corporate tax base, they are shifting it out of the state corporate tax base as well. He further argues states should take this opportunity to improve GILTI rules. Currently, GILTI design is inefficient by placing too high rate of return but thus states can improve the provision by using a lower rate tied to market conditions while also raising state revenues because of changed taxpayer incentives.
Shanske concludes that based on current case law, federal tax policy on expensing, qualified business income (QBI) or certain nominally foreign income (GILTI) cannot bind the states. While it is not clear if the federal government could preempt the states on these decisions explicitly, he notes, it certainly cannot do so just by virtue of its choice of tax structure.