By most measures of the economy, Oklahoma shouldn’t have a budget shortfall this year. At a time when the economy is improving nationwide and most states are debating what to do with budget surpluses, Oklahoma lawmakers are looking at creating a budget with $188 million less than last year.
Part of the reason for the shortfall is skyrocketing tax refunds going to corporations. Through January 2014 of this fiscal year, Oklahoma paid out $75.0 million in corporate income tax refunds. That’s more than double the refunds paid over the same period last year ($31.4 million). Corporate income tax revenue going to Oklahoma’s General Revenue Fund is down $100.1 million, or 33.9 percent from this time last year. It’s a symptom of a larger problem — numerous tax loopholes for corporations that shift the burden onto individuals and small business.
Where’s the money going?
One possibility is that profits made in Oklahoma are being shifted to tax shelter states. When someone mentions a tax shelter, most people think of exotic locales like Switzerland or the Cayman Islands. The state of Delaware may not come to mind. Yet for Oklahoma and other states that have not adopted a reform to prevent it, shifting profits to subsidiaries in Delaware is a common way for corporations to avoid taxes.
Delaware has gained notoriety as a state with very little corporate regulation. That’s why many large corporations have subsidiaries in Delaware, no matter where the parent company actually does business. A New York Times investigation found a small office building in the state was the legal address of more than 285,000 separate businesses. The state has more registered corporations than it does people.
Companies sometimes use these subsidiaries to avoid taxes. Delaware assesses no corporate income tax on profits from intangible assets, such as trademarks, so corporations transfer ownership of their trademarks to Delaware subsidiaries, pay the subsidiary to use them, and then deduct those payments from taxable profits. Companies known to use this loophole include Circuit City, The Gap, Home Depot, Ikea, Kmart, Kohl’s, Limited Brands(which owns Bath & Body Works, Victoria’s Secret, and other chains), Payless Shoes, Staples, and Toys ‘R’ Us.
Another especially flagrant example of tax avoidance is a loophole used by Wal-Mart. A Wall Street Journal investigation showed that Wal-Mart had transferred ownership of all its stores to a company that is owned 99 percent by another Wal-Mart subsidiary and 1 percent by 100 Wal-Mart executives. Wal-Mart can then effectively pay rent to itself and deduct the rent from its taxable income.
Evidence points to major Oklahoma-based companies that may be taking advantage of this loophole. According to the U.S. Securities and Exchange Commission, ONEOK has dozens of subsidiaries in Delaware and one in the Cayman Islands. Most of Chesapeake Energy’s subsidiaries are based in Oklahoma, except for one in Texas, two in Arkansas, one in Pennsylvania, and six in Delaware. Devon Energy has one subsidiary in Oklahoma, several in Canada, and four in Delaware. The Williams Company is incorporated in Delaware and has dozens of subsidiaries there, in addition to several in the Cayman Islands, even though its executive offices are in Tulsa.
Not all of these subsidiaries were created to avoid taxes, but some of their names are suggestive of being passive investment companies whose sole purpose is as a tax shelter (many are listed as “holdings” or “financing” companies). So it’s possible that Oklahoma companies are taking advantage of the loophole, and we know many out-of-state companies are doing so for their profits made in Oklahoma.
Because of this loophole and others, large corporations pay far less than the state’s 6 percent corporate income tax. A report by Citizens for Tax Justice found that from 2008-2012, Devon Energy paid an average annual state income tax rate of 0.5 percent, ONEOK paid 1.0 percent, and Williams paid 1.4 percent. Out-of-state subsidiaries aren’t the only way these companies reduce their taxes. For oil and gas companies, the intangible drilling cost deduction is even more lucrative. But by reigning in tax shelters, we can keep make sure a fair share of the profits earned in Oklahoma by multi-state companies stay in Oklahoma.
What can we do?
Oklahoma can address this problem with combined corporate reporting. This simple reform requires companies to add together all of the profits of the parent and subsidiaries in one report. They would then pay taxes on all of the profits earned in Oklahoma, which is determined by a formula that takes into account the activities in Oklahoma of the entire corporate group.
Combined reporting has multiple benefits. Companies shouldn’t be able to reduce their taxes just by changing their organizational structure. This reform would prevent several tax avoidance strategies used by the largest corporations. It also levels the playing field for small business by taking away a tax break that’s only available to multi-state corporations with large teams of lawyers and accountants. This reform has already been adopted in more than half of the states with a corporate income tax, including three of Oklahoma’s border states - Kansas, Texas, and Colorado.
That’s why combined reporting is one of OK Policy’s recommendations to fix our budget hole. Based on a variety of fiscal notes from states that have considered combined reporting bills, plus analyses of actual tax return data, a conservative estimate is that adopting combined reporting would lead to a 10 – 20 percent boost in corporate tax collections, or some $50 – $100 million for Oklahoma services.
Just as importantly, it would make our tax system fairer for all businesses and individuals in the state. Oklahoma’s lack of combined reporting creates an uneven playing field where small businesses who can’t afford the lawyers and accountants necessary to make these tax schemes work end up paying a higher rate than big business.
If state lawmakers want to represent the citizens of Oklahoma more than multi-state companies, they should adopt this common sense reform as soon as possible.