Understanding the Single Sales Factor

Philly.com Blogger Ben Waxman has a post about moving Pennsylvania to a single-sales factor on corporate income taxes, calling it a “big tax break for corporations”, based on a paper from the Pennsylvania Budget and Policy Center. Either Waxman doesn’t fully understand the single sales factor, or chooses to mischaracterize it.

Here is how the sales factor works. Corporations pay a 9.99% tax on profits in PA (the second highest rate in the US), but only based on the percentage of their business in Pennsylvania (since they will be subject to the same tax in other states). The percentage of their business in PA is calculated based on sales, property, and payroll in the state. The current ratio is 70% sales, 15% property, 15% payroll. Here is how the formula works:

Percent of sales in PA x .70 + Percent of property in PA x .15 + Percent of payroll in PA x .15 = Percent of business in PA.

Moving to a single sales factor would mean corporations use only their percentage of sales to calculate tax liability.

The implication that this hurts local companies is wrong – corporations based solely in PA would have absolutely no change in tax liability (and most small businesses pay the Personal Income Tax, which has little bearing on the sales factory). There would be some winners and losers under this change:

  • Businesses with a higher percentage of their operations, but a lower percentage of sales in PA would see a tax cut.
  • Business with a higher percentage of sales in PA, but more of their operations in other states would see an increase.

There are a couple very good reasons to move to a single-sales factor

  1. It simplifies tax compliance
  2. It would stop punishing businesses that keep or move their base of operations to Pennsylvania.

Perhaps PBPC is correct that this is not the driving forces in business location decisions, but their evidence for that is weak at best (i.e. manufacturing employment has declined almost everywhere, even in states with a single-sales factor, plus a few anecdotes of companies moving). Furthermore, PBPC cites the Pennsylvania Business Tax Reform Commission support for their proposal – mandatory combined reporting – but ignores that the Pennsylvania Business Tax Reform Commission recommended a single sales factor.

Waxman cites the PBPC estimate that this would be $100 million net tax reduction, but the budget proposal would only be an increase in the sales factor, but not to 100%. The Rendell administration estimates that this, combined with Net Operating Loss changes, would only be a $74 million reduction. This is far outweighed by the retroactive $374 million increase in the Capital Stock and Franchise Tax.

If Waxman and others are concerned about tax “fairness”, they should be concerned about that latter tax hike, which hits manufacturers, while maintaining a $75 million tax break for the film industry, which goes to politically selected Hollywood studios.