Interview: State Legislature Check-In: Tax Priorities in 2021

Paul Jones: Hi, Morgan. Thanks for being here.

Morgan Scarboro: Thanks so much for having me.

Paul Jones: First, I wanted to talk about the elephant in the room. There are some states that are seeking federal assistance given the effects of the pandemic and subsequent lockdowns on states' revenues and the economy. For example, New York Gov. Andrew Cuomo (D) generated headlines by saying that without significant federal assistance for his state, he would have to look into tax increases and cuts.

The Biden administration is looking at providing potentially as much as $350 billion for state and local assistance. Do you think that the federal government is going to provide most or all of that aid? Are states going to need it and should they be depending on it?

Morgan Scarboro: That's a great question. I think that's the question of the hour for states. I'll start by saying I'm not big into predicting federal politics, but if I had to guess, I think that with Democrats in charge states will at least get some aid.

Cuomo's plead to Senate Majority Leader Charles E. Schumer, D-N.Y., and Biden was very much painting a dire picture of what's going to happen if they don't get this federal revenue. That is certainly true for a state like New York.

But I would say when we're talking about what states need right now, I think it's important for us to level set with respect to how states are doing revenue wise. Most states are facing some sort of challenge, but it's not nearly as significant as folks were predicting back when COVID-19 was originally starting to have an impact on state economies.

Back in March and April of last year, experts were predicting that states were going to be down 40 percent to 50 percent of revenue, which would really be catastrophic for states. We haven't seen that play out.

Luckily, this is variable. States like New York have certainly been hit hard by this. But in a lot of states around the country, they're either coming out where they were pre-COVID or they're down maybe three to five percent revenue wise.

I think that there is room to have a conversation on what states need now — not what states needed in March of last year, but how they're actually doing now. I do think that there will be at least some aid package coming to states.

Paul Jones: There is, of course, another issue: the Coronavirus Aid, Relief, and Economic Security (CARES) Act [(P.L. 116-136)]. There were some states, particularly those with rolling conformity, that could be impacted by some of the tax breaks that the federal government included in that legislation.

I know that there are still some states that are discussing what they're going to do in response to that. Oregon Gov. Kate Brown (D) has proposed decoupling from elements of the law. Illinois Gov. J.B. Pritzker (D) sought unsuccessfully in the recent lame-duck session in his state to decouple from the CARES Act's net operating loss provisions.

Do you think that we're going to see more action from states in this session with respect to the CARES Act and how they're going to conform or not conform? What are the stakes there? Do businesses need answers on that quickly?

Morgan Scarboro: I think this is an issue that's largely going to fall along partisan lines. States right now are largely controlled by one party. We've only got a handful of states that have divided government. Most states are operating under a trifecta. But I would say the business community needs certainty fairly quickly on this issue.

It's important to remember that when we talk about the revenue impacts here and in what states are facing, businesses have also taken a hit in a lot of cases. A lot of physical stores closed their doors in order to help protect their employees and customers, and to go along with these government mandates, which was the right answer for public health. But it took a toll on many in the business community.

I think if states are looking to foster an economic recovery, they need to start providing a little bit of assistance. At the very least, they need to start providing some certainty on what businesses can expect in the coming year as far as tax policy and the federal things that have already passed that are uncertain at the state level. They at least need an answer on how that's going to happen.

Paul Jones: Speaking about businesses, a number of measures are being proposed in various states to help facilitate economic recovery. As you mentioned, the revenue situation for a lot of states isn't as dire as was feared early in mid-2020.

But there has been economic harm. I know that in some states they're trying to figure out ways to mitigate the unemployment tax implications of all the people who lost their jobs.

In Washington state, the legislature there just passed a bill to try and prevent a significant increase in unemployment taxes. There are other states like California where Gov. Gavin Newsom (D) has proposed various tax incentives, reductions, and fees, and even funding for businesses to try and help them recover.

Is that something that we're going to see a lot of energy on? In the last year we also saw plenty of deferrals and extensions. Do you think that's going to continue?

Morgan Scarboro: It's interesting that in the last year, the response that we saw from states toward COVID-19 was administrative actions. We saw states doing things like extending filing deadlines following the federal lead and modifying requirements. It used to be that many documents when they were filed needed to have a physical signature and allowing people to submit those electronically was a big deal.

But we mostly saw these administrative actions that were focused on easing the complexity of filing when we were all in this digital world. I don't think we're going to see more of that deferral or extensions, though. We've all been living in this online COVID-19 world for about a year now. We understand better how to work on these things in a digital environment. States are allowing more flexibility in that respect.

I do think that moving into this year we're going to see some more tax policy conversations. It's hard to say what states are going to do or what they should do. Every state's going to need a different solution because every state has such a different revenue makeup. There needs to be a focus on providing people and businesses the resources that they need to sort of get back to work. But that also, of course, is heavily dependent on a vaccine rollout, which is not so much a tax policy conversation, but will have huge economic impacts for states.

My colleague Ryan Maness did some really interesting research on previous recessions and how states responded. He found a couple of main things that rang true through the previous two recessions.

The first is that states needed time to act. It took about a year for states to really start doing any tax responses to raising revenue in response to a recession.

States last year were just starting to wrap their heads around what this meant for their revenue picture, how they were going to respond. Now they might be ready to have more of those conversations about what they should do about it. I think that was the right call.

As we talked about previously, the revenue picture and estimates changed drastically in the last year. States have a little bit better and more information in which they can operate under now.

The second thing he found was that typically changes to tax revenue fall along somewhat partisan lines. Generally, you'll see Democratic states enacting larger increases and Republican states enacting smaller increases. That's not always the case, but that's a pretty good general rule.

Last, what I thought was most interesting was when I start thinking about, "Oh, how is a state going to respond to a recession?" My instinct was to say, "Oh, well, states are probably just going to look at tax credits and incentives, and eliminate some of those and try to minimize the pain." But that's not exactly what they did. States don't turn to targeted credit eliminations. What they were doing is if they were enacting benefits for taxpayers, the benefit was relatively widespread — think like maybe expanding NOLs or something like that. Increases that were very targeted.

What we saw in the previous two recessions were increased taxes on the telecommunications and healthcare industries. I don't think we're going to see it on the healthcare industry this year. But I think we might continue to see that line on the telecommunications industry with some of the digital advertising conversations we've had.

It's an interesting note that what they tend to do is widespread benefit, but targeted tax increases.

Paul Jones: Before we get into some of the potential revenue measures that states may be discussing, I wanted to ask one more question that was very specific to a challenge that's been raised as a result of the impact of the pandemic. We've seen a significant increase in teleworking by employees.

In a lot of areas, that's resulted in employees who work for an employer in one state working out of their home in a different state. That's given rise to a lot of questions about withholding. States have put out varying guidance on what employers should do.

It seems like there's still going to be some confusion and some outstanding questions for both employers and their employees. We are even looking right now at a major piece of litigation on that issue: New Hampshire v. Massachusetts.

Do you think that states are likely to take any legislative action to try and clarify this issue? Do you think that they should? Do you think that there may be any push for federal intervention on this question?

Morgan Scarboro: Yeah, that seems to be the one time that my friends are interested in tax policy, asking me, "Oh, I have read these things about there might be tax implications for me working from home." I think it's on the minds of a lot of people, not just tax folks.

I'll start with the federal side. Given the current federal makeup, I don't think that we're going to see any federal action on this. There's been a group, the Mobile Workforce Coalition — and I work with some folks who help run that coalition — who've been trying for several years. There's been legislation pending at the federal level that couldn't quite get over the finish line. Given the makeup now, it certainly has a worse chance. I'm not holding my breath for any sort of federal solution there.

The one thing I think states really need to do is provide clear guidance on what their position is. We've seen a lot of patchwork from states. Some have issued guidance, some just giving a comment, and some having regulations. But in a lot of states, it's not clear what the rule is going to be going forward regarding nexus. No matter what the state's position is, they need to be really straightforward about publishing and being very concise in that.

Paul Jones: Do you think that that the legislatures of those states might take any action in that respect? Or is that mainly going to have to be something that is handled administratively?

Morgan Scarboro: I think it's mostly going to be handled administratively. The legislature is going to have so much on their plate, not just with regards to tax, but with so many issues this session. I don't think this is front of mind. It's much easier to handle if you've got that coming from the agency itself, especially if they already have clear rules. They're not going to change those rules, so they just need to make a statement saying, "We're just going to follow what we've always done."

Paul Jones: Let's take a look at what might be some of the revenue options that states have if they're trying to shore up revenue or replace lost revenue. One thing that we at Tax Notes and a lot of other people who focus on state tax policy have been following is what action the states are likely to take on global intangible low-taxed income, foreign income, and worldwide combined reporting generally after the Tax Cuts and Jobs Act.

There are a lot of states that have not made clear if they're going to try and move to capture some of that income. It's always an outstanding question if they might be tempted to do that.

Do you think that 2021, given the pandemic, given some of the challenges, might be the year that some states decide to take a serious look at that?

Morgan Scarboro: That's a great question and one that I follow very closely. I think there's going to be a lot of interest in how states tax foreign income this year. One that comes to mind very quickly is California's A.B. 71. That would include some of GILTI and repatriated income as taxable income for a company. It also includes a number of other things, but for purposes of this conversation I think looking at foreign income is going to be a popular thing that states are doing.

There are two categories of people that might be looking at this: states that maybe have not acted on the TCJA and haven't said yet. There are still a handful of states that have not done anything really. Then you have to think we've had a lot of new legislators that were just recently elected, and they might be coming in wanting to take another look at these issues.

I think there will be some surprise though, when you get down into sort of the gritty details of taxing foreign income. It's difficult to do so and constitutionally apportionate. I think at first it's sort of this shiny object of, "Oh, we can tax this foreign income." But once you really get into the fine points of this, it's more challenging than it appears.

I also think mandatory worldwide combined reporting is going to be an issue. It always has been, but it will continue to be proposed. States have already done so again this year. For example, there is legislation to impose mandatory worldwide [combined reporting] in New Hampshire, but that's a Republican-controlled state. It's more than likely not going to happen there. There's not one state yet where I'm looking at it saying, "Oh, that really might happen in this state this year." But I think foreign income in general is going to be a big conversation for states.

In the interest of full disclosure, I work with the State Taxes After Reform and Recession Partnership, and we do a lot of work on foreign income. What we've found is that the majority of states have decoupled from these TCJA provisions. Whether that's through just straight up decoupling or applying the dividends received deduction, the majority of states are not taxing this income. But I think some states might want to take another look.

As we talk about this tax and budget conversation in legislatures, it's easy for us tax wonks to think, "Tax, tax, tax," all the time. But there are a lot of other really significant policies that legislatures will want to take up this year. that will also take a lot of time and energy out of the legislature. Obviously public health and the vaccine rollout are going to be big issues, as will responses to social justice movements that we saw over the summer.

It's important for us to remember that tax isn't the only thing. A lot of states have short legislative sessions, so thinking about what tax issues states are going to prioritize is an important thing, too.

Paul Jones: You've obviously got a bandwidth issue, particularly in light of the fact that we're still in this pandemic. Getting legislators together remains challenging. 

We just talked about potential interest in foreign income. There's also been an increase in interest in things like wealth taxes and higher taxes on higher earners, partly because some states are looking for additional revenue. As has been noted by a lot of people in this current recession, people with lower income have been hit pretty hard, but people who have stocks and investments seem to have done fairly well. It's sort of unusual, I think, in that respect.

We're seeing now in Washington state a bill to create a wealth tax. We saw a similar proposal in California and a different type of wealth tax proposal in New York in 2020. There are other tax proposals being floated to increase taxes on higher earners.

Do you think that we're going to see more talk of that? Do you think there'll be any action on that? Maybe the foreign income is a little bit too heavy of a lift or maybe not even a desirable policy, but what about more progressive taxes overall?

Morgan Scarboro: Yeah. It's hard to get your constituency base riled up by going out and saying, "Hey, let's tax [GILTI]." That's not a great campaign line. There's a strong sentiment among progressive legislators that the wealthy are not paying their fair share. That is a strong campaign headline and something that nontax people, regular citizens and constituents, seem to understand and be interested in.

I think that you're exactly right. Particularly with an influx of new legislators, we're going to see more of those wealth taxes and increased taxes on regular increases to the individual income tax rate. We're also seeing several CEO pay bills that are gaining in popularity.

For folks who aren't familiar, there are different forms of them. But the premise says if your CEO or your top paid executive makes more than a certain ratio to their median worker, we're going to impose a surcharge or a surtax. One state's doing it where you're not going to be able to deduct that salary as a business expense. We're seeing those gain in popularity as well. We even saw an introduction for a CEO pay bill in Iowa this year, which is not a place that was on my radar to be looking out for that.

I think we've seen these on the local level, but it will be interesting to see how, or if, that works on a statewide level. It's clearly a disadvantage for large corporations who often bring lots of jobs to your state to do something like this. I don't know how practical it is for states.

But I think it's definitely something that folks will be interested in, especially if you think about legislators who might not be on the revenue committee and who might not be really deep into a lot of these tax issues. This is not one that's particularly complex. It's easy to have this idea and say, "OK, this is what I want to do." Then, like I said, you've got a base that might rally behind that.

Paul Jones: Speaking of things that are potentially complex, we're also seeing increased interest in discussion in the tax policy community of potential digital advertising taxes. I recently covered a bill introduced in Washington state that would focus on taxing the sale of personal data.

In addition to looking at higher income earners, I think there's an increased interest in looking at these tech companies, particularly this portion of the new online economy that's very focused on collecting and selling data, and monetizing information about people in a new way.

Do you think that we're likely to see some action on this? Or is it going to be complicated? Is it a little bit more complicated than it might appear at first blush? Is that going to make it difficult for states to move on it quickly?

Morgan Scarboro: I think both of those things are right. I'm actually fascinated to watch this area right now because I think you might get some really strange bedfellows this year as you go through this.

When we think about digital advertising taxes, the point is to be punitive. Supporters of this are not shy about it, particularly those who bring it up or introduce it who are Democrats. Their idea is that big tech is not regulated enough or is doing something bad and they need to face this tax.

But now you've got this really interesting contingency on the right as well that thinks that conservatives are being targeted by these big tech industries. I think there's a chance that you get this really interesting coalition of legislators who are pursuing this policy.

I also think that this is an issue that sounds like an easy one, but it's really complex when you get down to how you actually do it. How do you source it? Is it legal? Does it violate the Internet Tax Freedom Act? There are a lot of questions there. Even the folks who advocate for these taxes talk at length about the complexity of them.

I also think that if any of them pass, we're going to see litigation. But it is an interesting idea. One, too, that's starting to separate into two different conversations. You've got this conversation about taxes on digital advertisement. You've also got states who are interested in taxing the collection or the usage of consumer data.

I think those conversations are starting to diverge a little bit. The point is the same, the punitive nature is the same, but I think that they might end up being functionally different. But the fact that these taxes are so broad, the way that they have currently been introduced at least, I think it's going to be very difficult to pass them.

Maryland was the big example that we saw last year that tried to pass a digital advertising tax. That was vetoed by the governor, but the legislature is still interested in overriding that veto. I recently found out from some of my colleagues that live in Maryland that there are commercials constantly on TV saying, "Oppose the override." That this is going to be damaging for small businesses. That this is complicated, and that folks should oppose the override.

You hardly ever see commercials about state tax policy on TV. I think just by the very nature that these taxes are so broad that it's going to be difficult to pass them. You have a very large, strong contingency of people who this would affect in a negative way.

Paul Jones: It could be an example of something that is going to require a longer gestation period for people to chew it over.

I've got one specific question that's not as generally applicable. Most states have taken some action in response to the South Dakota v. Wayfair Inc. decision of 2018, but the state of Missouri has held out against that. Now we've got the governor of that one state saying to lawmakers, "Let's pass a remote online sales tax bill this year."

We've been talking about things that apply to states generally, but just with respect to Missouri, do you think that they're likely to actually finally take action on this question? It's been a couple of years now and obviously they've yet to move on it.

Morgan Scarboro: That's a great question that makes me wish I had a crystal ball. Obviously, the governor this year is calling for the state legislature to actually pass it. Given that they are one of the very few holdouts — I think it's just Missouri and Florida at this point — it might happen this year. It's hard to know for sure this early on.

It's really interesting to note that right now the governor and the Legislature have a little bit of tension. There was some issue where the Legislature had the governor move, where he gave the State of the State and they couldn't have the audience that they wanted.

The governor returned to the Legislature with a letter that said, "It was hard to see this as anything other than a purposeful and disgusting scheme to embarrass me and the office of the governor." There's some bad blood there right now, which also makes it much more difficult generally for states to move cohesively on a policy like this, especially one that they'd been dragging their feet on for so many years.

Paul Jones: I guess we'll have to see. Maybe we'll wait another year or two or more before Missouri moves on this. 

It seems like after the hectic 2020, if people were expecting a calmer year in 2021 from a tax policy standpoint, they're likely to be disappointed. It seems like maybe this is the year where everybody figures out what adjustments and changes they're going to pursue and really makes a serious effort at that. 

Morgan Scarboro: Sounds very correct to me. A lot of stories for y'all to write.

Paul Jones: Excellent. Well, we shan't want for work then. Thanks again, Morgan.

Morgan Scarboro: Thanks so much for having me.