Pennsylvania: A 21st Century Tax Code
for the Commonwealth
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September 10, 2018

The Tax Foundation recently published a tax reform guide entitled Pennsylvania: A 21st Century Tax Code for the Commonwealth . The Pennsylvania Chamber of Business and Industry commissioned the Tax Foundation to prepare a review of the Pennsylvania tax system and recommend possible solutions. The following outlines some of the recommendations the Tax Foundation made:

Corporate Net Income Tax
Pennsylvania’s 9.99 percent Corporate Net Income Tax rate is the second-highest in the country, and the tax is beset by structural shortcomings which impose particularly high burdens on certain industries. The Tax Foundation’s corporate tax solutions would make Pennsylvania more competitive by moving to a lower rate and broader base while reducing disincentives for corporate investment.

  • Improving the treatment of net operating losses. Pennsylvania is one of only two states to cap the amount of net operating losses which can be claimed in a given year. This policy undermines tax neutrality and results in particularly heavy tax burdens for companies with longer business cycles. We propose the prioritizing of continued increases in the percentages of net operating losses businesses may carry forward.

  • Making the corporate rate more competitive. While many companies only pay a fraction of the statutory tax rate, for others, Pennsylvania’s 9.99 percent Corporate Net Income Tax rate, combined with structural shortcomings which increase their overall liability, can result in prohibitively high tax burdens. The Tax Foundation recommends targeting a rate reduction to 6.99 percent or lower, bringing the Commonwealth more in line with its peers, with reductions funded by tax credit reform and base broadening elsewhere.

  • Reforming corporate tax credits. Pennsylvania does better than most peer states in avoiding substantial carveouts of its corporate income tax base through targeted credits, but the state still forgoes an estimated $265 million a year due to Corporate Net Income Tax credits. The state should enhance its review of these credits and consider paring them back.

Personal Income Tax
The Tax Foundation’s individual income tax solutions begin with the recognition that there is already much to commend the state’s Personal Income Tax, which is levied at a low, flat rate on a broad definition of income. Where the Personal Income Tax falls short, however, is its substantial carveout for retirement income, its use of distinct classes of personal income, and the large rate differential between individual and corporate income taxes owing to Pennsylvania’s anomalously high corporate rate. The Tax Foundation’s solutions seek to address these concerns.

  • Taxing retirement income. Though difficult politically, any long-term rebalancing of Pennsylvania’s tax code cannot ignore the complete exemption from taxation of all retirement income, an exemption that is far more generous than the tax treatment in peer states. As the Commonwealth’s population continues to age, a policy which already turns away $3.4 billion in annual revenue cannot go unexamined forever.

  • Eliminating distinct classes of income. Pennsylvania divides income into eight classes and does not allow taxpayers to carry losses over from one class to another, or from one spouse to another. This outmoded tax structure introduces complexity into an otherwise straightforward income tax code and penalizes some taxpayers on a largely arbitrary basis. The Tax Foundation recommends its elimination.

  • Rolling back business incentives. Policymakers should eliminate most or all business credits (which can be claimed by pass-through businesses against Personal Income Tax liability), using them to pay down reforms which benefit Pennsylvanians more broadly. Fortunately for taxpayers, Pennsylvania’s reliance on incentives is already modest.

Sales Taxes
Pennsylvania’s sales tax is an important source of revenue for both the state and for Allegheny County and Philadelphia, but it has one of the narrowest tax bases in the country. Currently, many goods and services are unnecessarily exempted, while some business inputs are subject to tax, which can lead to multiple layers of taxation being imposed on the same final product at different points along the production process. The Tax Foundation urges that steps be taken to avoid the taxation of business inputs and offer a range of base-broadening options.

  • Broadening the sales tax base. A well-structured sales tax applies to all final consumer transactions, both goods and services, but Pennsylvania’s tax code exempts many goods and most services. Accordingly, The Tax Foundation offers a range of options for expansion to services. Any base broadening provides an opportunity to pay down reductions in the rate of the sales tax or other taxes. The Tax Foundation’s base broadening options are as follows:

  • Modest expansion to personal services, amusements, candy and gum, and similar goods and services ($900 million);
  • Broader expansion to also include clothing, nonprescription drugs, household utilities, and motor fuels, and similar goods and services ($3.58 billion);
  • Broad-based expansion to further include groceries and personal use of legal and accounting services ($5.39 billion); and
  • Inclusion of nearly all final consumer transactions in the sales tax base, including medical services, financial institution fees, and private educational expenditures ($11.00 billion).
  • Revenue projections are given for each line item considered, allowing policymakers to design their own base expansion options, modernizing the state’s sales tax code while generating revenues which can help offset improvements elsewhere.

  • Exempting business inputs. Pennsylvania taxes relatively few services. Nevertheless, it does manage to tax 27 categories of services (as defined by the Federation of Tax Administrators) which count as business inputs and lead to tax pyramiding. We offer suggestions for removing business inputs from the sales tax base.

The Pennsylvania: A 21st Century Tax Code for the Commonwealth explains the Tax Foundation’s recommendations in detail. Included are suggestions to reform several other areas of the tax code.

Please keep in mind that this document expresses the opinion of the Tax Foundation, not the Commonwealth. These recommendations are not part of the Pennsylvania tax law nor is there any indication that they will be adopted.  

Feel free to call any member of our team at 610-828-1900 with questions. You can also contact me at . We are always happy to help.
Martin C. McCarthy, CPA, CCIFP
Managing Partner
McCarthy & Company, PC

Disclaimer This alert is for informational purposes only and does not constitute professional advice. Information contained in this communication is not intended or written to be used as tax advice, and cannot be used by the recipient to avoid penalties that may be imposed under the Internal Revenue Code. We strongly advise you to seek professional assistance with respect to your specific issue(s).