April 30, 2018
Much of the attention this legislative session has been on the state budget and school finance – not on the effects of the federal tax law changes on our state. As the Legislature begins week two of the veto session, we thought we’d take this opportunity to define some key terms in this discussion:
- Tax Cuts and Jobs Act (TCJA): Federal tax law passed in December that included numerous changes to the federal tax code. Many of these changes will affect state revenue because of how state tax codes link to the federal code. Federal income tax rate changes don’t affect state revenues, but other changes, like those made to calculate the amount of income subject to federal income taxes, can.
- Rolling conformity: As in most states, the calculation of Kansas personal and corporate income taxes begins by taking information from the federal return, a link to federal tax law referred to as “coupling” or “conforming.” When the federal government passes tax law changes, states with “rolling” conformity (like Kansas) generally adopt the changes automatically and immediately and must specifically “de-couple” from changes they don’t want to adopt.
The federal tax law included a number of changes that affected corporations with overseas operations. One of the major shifts in the federal tax code was to a “territorial” corporate income tax. Moving to a territorial system means that, going forward, “most profits that a U.S. parent company earns from its foreign subsidiaries . . . [won’t be] subject to U.S. tax if they meet certain conditions.” To transition to this new system, the TCJA established a tax on:
- Deemed Repatriation: Under current law, the profits of foreign subsidiaries are subject to tax when they are actually paid as dividends back to their U.S. parent corporations (“repatriated”). The Tax Cuts and Jobs Act includes a one-time tax on profits held by foreign subsidiaries regardless of whether they are actually paid as dividends; that is, they are “deemed” to have been repatriated in tax year 2017. The tax on deemed dividends can be paid in installments over an eight-year period.
Moving to a territorial system could encourage U.S. multinational corporations to shift profits and investment offshore, since once they are moved offshore they will never be subject to tax in the future – even if they are eventually repatriated. The TCJA includes a few provisions to try to limit the damage of this incentive, one of which is a new tax on:
- Global Intangible Low-Taxed Income (GILTI): This provision effectively establishes a “minimum tax […] to ensure that U.S. companies pay a U.S. tax on foreign profits when the foreign taxes on those profits are sufficiently low.”
We have previously pointed out that the amount and timing of revenue from each of the above provisions is highly uncertain.
The GILTI and Repatriation provisions of the new federal tax law account for most of the presumed “pay fors” in the tax bill passed by the Kansas Senate prior to adjournment of the regular session. As we wrote earlier this month, while it may be wise for Kansas lawmakers to enact legislation to capture this potential revenue in the future, lawmakers should not assume this revenue will be available anytime soon. For that matter, corporations are aggressively seeking to limit any extra tax payments they might be responsible for because of state conformity to the federal law — by legal action if necessary.
It is important for Kansas lawmakers to remember that, as the National Conference of State Legislatures pointed out in a presentation on federal tax law changes earlier this year, “stuff rolls downhill.” The Tax Cuts and Jobs Act will reduce federal revenues by $1.5 trillion over the next decade, and this will “impose fiscal constraints on the federal government and its ability to finance intergovernmental and other programs.”
In Kansas, this means further reductions of federal investments in our state’s core pillars – health care, education, public safety and basic infrastructure – are likely. Reduced federal dollars equals additional demands on our state’s budget as we begin to rebuild our state after years of failed tax policy. This possibility, too, is a further argument against the state giving away revenue it may urgently need in the near future.
Kansas lawmakers should ride out the storm of uncertainty around federal tax reform, tracking the effects of federal tax reform on Kansas taxpayers over the next year. They can return next legislative session ready to examine the impact and consider possible legislation addressing it.