AS U.S. CORPORATIONS have expanded their
operations across international borders, states have found it increasingly difficult to tax profits attributable to corporate activities within their jurisdictions. Last June the states got a helping hand when the Supreme Court decided that, in taxing U.S. companies with foreign subsidiaries, California and other states could use a formula long applied to small businesses or to companies with domestic subsidiaries doing business across state lines. Now the multinationals are pressuring the administration to support a petition for rehearing of the case or to press for legislation overriding the decision.
Under the Constitution, states cannot tax income earned outside their jurisdiction. But the court has long acknowledged--as have many multinationals when it is to their advantage--that in the complex dealings between a parent company and its subsidiaries, it is practically impossible to keep accurate account of the profits attributable to each geographically separate operation. In a 1981 report, the General Accounting Office pointed out how unsuccessful the federal Treasury has been in its efforts to use a separate accounting method, and the IRS has recently been stepping up efforts to crack down on the many types of bookkeeping and transactional maneuvers that allow multinationals to escape or limit taxation on their domestic operations.
The unitary method upheld by the court allows states to treat a corporation and its subsidiaries as a unified operation and to assume that the profits earned within the state are proportionate to the amount of activity--measured by sales, payroll and property--that it conducts within the state. The method isn't perfect, but, as the court pointed out, there are built-in factors that will tend over time to keep it fair. If a state taxes corporations too heavily --and this depends far more on rates than on methods of allocating income--corporations will move their operations elsewhere. And if a company's investments in a given state are not, as the formula assumes, contributing roughly as much to earnings as its other operations, the company should close them down anyway.
Opponents of the unitary method argue that it will discourage foreign investment in the United States and encourage retaliatory taxation of U.S. operations abroad. But a detailed study by the independent Advisory Commission on Intergovernmental Relations found no evidence of either result. If such effects could be demonstrated at a future time, then federal interference might be justified. But for the moment, the conclusion of both the Supreme Court and the ACIR is the right one: states should be given wide latitude in deciding how to meet their tax needs as long as their methods do not threaten strong national interests. That's the position that Ronald Reagan took when, as governor of California, he defended that state's use of the unitary method. He should stick with it.