David Stewart 0:01

Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: state level status. Across the country, many state legislatures have gaveled in their 2021 sessions, albeit virtually for some. With coronavirus still widespread in the U.S. and the vaccine rollout just hitting its stride, the hallowed halls of some state capitols remain quiet as legislative leaders opt to convene online instead of in person . Despite the setting of their session, state legislatures appear ready to tackle a number of tax issues ranging from COVID-19 relief to digital advertising. Here's to talk more about this is Tax Notes senior reporter Paul Jones. Paul, welcome back to the podcast.

Paul Jones 1:40

Thanks, David. It's always a pleasure.

David Stewart 1:42

So, you recently spoke to somebody about the 2021 legislative session. Who did you talk to and what issues are coming up?

Paul Jones 1:48

We spoke with Morgan Scarboro of MultiState, and we discussed a range of revenue and tax policy priorities for state legislatures this year. These range from federal relief for state and local governments to wealth tax proposals and digital ad tax proposals.

David Stewart 2:04

All right, let's go to that interview.

Paul Jones 2:07

H,i Morgan. Thanks for being here.

Morgan Scarboro 2:09

Hi. Thanks so much for having me.

Paul Jones 2:11

First, I wanted to talk about the elephant in the room, which is obviously that there are some states that are seeking federal assistance, given the effects of the pandemic and the lockdowns on states' revenues and the economy. And there are some, for example, Gov. Andrew Cuomo (D) of New York generated headlines by saying that without significant federal assistance for his state, he would have to look into tax increases and cuts. And the Biden administration is obviously 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? And are states going to need it and should they be depending on it?

Morgan Scarboro 2:55

That's a great question and 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. You know, you're exactly right. Governor Cuomo's sort of plead to Senator Schumer and President Biden was very much painting a dire picture of what's going to happen if they don't get this federal revenue. And that is certainly true for a state like New York. But I would say when we're talking about what states are needing right now, I think it's important for us to level set with respect to how states are doing revenue-wise. So, most states are facing some sort of challenge, but it's not nearly as significant as folks were predicting back when COVID was originally starting to really 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 to 50 percent of revenue, which would really be catastrophic for states. We haven't seen that play out. Luckily, like I said, this is variable. So, 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 sort of where they were pre-COVID or they're down maybe three to five percent revenue-wise. So, I think that there is room to sort of have a conversation on what states need now. Not what states needed in March of last year, but how they're actually doing now. But I do think that there will be at least some aid package coming to states.

Paul Jones 4:17

So, the situation isn't necessarily as dire as it has been presented. There is, of course, another issue, which is the CARES Act. And 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. And I know that there are still some states that are discussing what they're going to do in response to that. I know that Oregon's 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 NOL provisions. Do you think that we're going to see more action from states in this session with respect to the CARES Act and then how they're going to conform or not conform to that? And what are the stakes there? Do businesses need answers on that quickly?

Speaker 4 5:07

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.

Morgan Scarboro 5:23

It's important to remember, you know, 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 sort of 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 a lot in the business community. So, I think if states are looking to sort of foster an economic recovery, they need to start providing a little bit of assistance. And at the very least, providing some certainty on what businesses can expect in the coming year as far as tax policy and these sort of federal things that have already passed, but were unsure how they're going to be treated at the state level. They at least need an answer on how that's going to happen.

Paul Jones 6:06

Also, speaking about businesses, a number of measures are being proposed in various states to help facilitate economic recovery. I think as you mentioned obviously the revenue situation for a lot of states isn't as dire as was feared early in mid last year. But of course there has been economic harm like you said. I know that in some states they're trying to figure out ways to sort of 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. And there are other states like California, where Gov. Gavin Newsom (D) has proposed various tax incentives, reductions, and fees, et cetera, 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? I know that in the last year we also saw plenty of deferrals and extensions. Do you think that's going to continue?

Morgan Scarboro 6:58

So, it's interesting that, I think in the last year, the response that we saw from states toward COVID was administrative actions . So, we saw states doing things like extending filing deadlines , following that federal lead, 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 with e-signatures was a big deal. But we saw mostly 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 . You know, we've all been living in this online COVID world for about a year now. So, we understand better how to work on these things in a digital environment and how to submit them and things like that. And I think that states are allowing more flexibility in that respect. So, 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. I do think 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, I think, for states. One thing that's interesting to note when we start thinking about how states might respond — 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 last couple of recessions— the previous two. 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. So, I think states last year were sort of just starting to wrap their heads around what this meant for their revenue picture, how they were going to respond. And now they might be ready to have more of those conversations about what they should do about it. And I think that was the right call, right? Like, as we talked about previously, the revenue picture and estimates changed drastically in the last year. So, 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. So, generally you'll see Democratic states enacting larger increases and Republican states and enacting smaller increases. That's not always the case, but that's a pretty good general rule. And then 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 just eliminate some of those and try to minimize the pain." Right? But that's not exactly what they did. So, states don't turn to like these sort of 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. But increases that were very targeted. So, what we saw in the previous two recessions were increased taxes on the telecommunications and healthcare industry. 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. But just sort of an interesting note that what they tend to do is widespread benefit, but targeted tax increases.

Paul Jones 10:13

So, before we get into some of the potential revenue measures that states may be discussing, I wanted to ask one more question that was really very specific to a challenge that's been raised as a result of the impact of the pandemic. And that is, we've seen a significant increase in teleworking by employees. And 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. And that's given rise to a lot of questions about withholding. States have put out varying guidance on what employers should do. But I— it seems like there's still going to be some confusion and some outstanding questions on the part of both employers and their employees. And we are even looking right now at a major piece of litigation on that issue, New Hampshire versus 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? And if you have any thoughts on this, do you think that there may be any push for federal intervention on this question?

Morgan Scarboro 11:12

Yeah, that seems to be the one time that my friends are interested in tax policy, asking me like, "Oh, I have read these things about there might be tax implications for me working from home." So, 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, and they've been trying for several years. There's been legislation pending at the federal level that just couldn't quite get over the finish line. And it certainly, given the makeup now, has a worse chance. So, 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. Maybe some issuing guidance, some just giving a comment, some having regulations. But in a lot of states, it's not clear what the rule is even going to be going forward with regard to nexus. So, no matter what the state's position is, I think they just need to be really straightforward about publishing that and being very concise in that. I would just say, I feel pretty bad for the accountants this year. I think that's going to be sort of a mess. Particularly, like I said, [it's] February and several states have not even said if they're going to be changing things or anything like that. So, I think states just need to be really clear about what their position is.

Paul Jones 12:29

Right. So, they should be providing clarity. And 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 12:41

I think it's mostly going to be handled administratively. Just because I think 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. And it's much easier I believe to handle if you've got that coming just from the agency itself. Especially if they already have clear rules, and they're not going to change those rules and they just need to make a statement saying, "We're just going to follow what we've always done."

Paul Jones 13:06

So, moving along from that, 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, replace lost revenue, et cetera. One thing that I know we at Tax Notes have been following, 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 GILTI and sort of foreign income and worldwide combined reporting generally post-Tax Cuts and Jobs Act. There's a lot of states, I think, that have sort of not made clear if they're going to try and move to capture some of that income. I think it's sort of 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 14:44

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 A.B. 71. So, 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, looking at foreign income I think is going to be a popular thing that states are doing. So, I think there's sort of two categories of people that might be looking at this: states that maybe have not acted on the Tax Cuts and Jobs Act and haven't said yet. Because there are still a handful of states that have not done anything really. And 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. So, 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 and states have already done so again this year. I have not seen a state introduce it this year, though, that I feel competent will actually enacted. So, for example, there is legislation to impose mandatory worldwide in New Hampshire, but that's a Republican-controlled state. So, 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 STAR partnership, and we do a lot of work on foreign income. And what we've found is that the majority of states have decoupled from these Tax Cuts and Jobs Act provisions . So, 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. But I think sort of, as we talk about this tax and budget conversation is 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. So, obviously public health vaccine rollout are going to be big issues. Responses to social justice movements that we saw over the summer. It's just important, I think, for us to remember that tax isn't the only thing and a lot of states have short legislative sessions, so thinking about maybe what tax issues states are going to prioritize is an important thing, too.

Paul Jones 17:18

You've obviously got a bandwidth issue, particularly in light of the fact that we're still in this pandemic. And so, getting legislators together remains challenging. But just to pursue some other possible tax policies that I know were getting some discussion and I wanted to take your temperature on. So, we just talked honestly about potential interest in foreign income, but 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. But also, as has been noted by a lot of people in this current recession, people with sort of 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. And 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. And 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? And do you think there'll be any action on that? So, maybe the foreign income is a little bit too heavy of a lift or maybe not even a desirable policy, but what about just more progressive taxes overall?

Morgan Scarboro 18:35

Yeah. It's hard to get your constituency base riled up by going out and saying like, "Hey, let's tax global intangible low-taxed income." That's not a great campaign line. But a lot of these other things of there's a strong sentiment among progressive legislators that the wealthy are not paying their fair share. And that is a strong campaign headline and something that non-tax people and just regular citizens and constituents seem to understand. Right? And be interested in. So, I think that you're exactly right. Particularly with an influx of new legislators, we're going to see more of those wealth taxes, increased taxes on just regular increases to the individual income tax rate. And then, also we're seeing several CEO pay bills that are gaining in popularity. And for folks who aren't familiar what that essentially says there's different forms of them. But the premise says if your CEO or your most top paid executive makes more than a certain ratio to their median worker, we're going to impose a surcharge or a surtax or something like that. One state's doing it where you're not going to be able to deduct that salary as a business expense. So, we're seeing those gain in popularity as well. It's interesting. We even saw an introduction for a CEO pay bill in Iowa this year, which is just 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. I mean, it's clearly a disadvantage for large corporations who often bring lots of jobs to your state to do something like this. And I don't know how practical it is for states. But I think it's definitely something that folks will be interested in. And especially, you know, if you think about legislators who might not be on the revenue committee, so might not be really deep into a lot of these tax issues. This is not one that's particularly complex. So, it's easy to just sort of have this idea and say, "OK, this is what I want to do." And then, like I said, you've got a base that might rally behind that.

Paul Jones 20:21

So, obviously, maybe that just has more political appeal and given the moment. Speaking of things that are potentially complex, we're also seeing increased interest in discussion in the tax policy community of potential digital ad taxes. And I even recently covered a bill introduced in Washington state that would focus on taxing the sale of personal data. So, in addition to sort of looking at higher income earners, I think there's an increased interest in sort of looking at these tech companies. And particularly this portion of sort of the new online economy that's very focused on data and collecting and selling it and sort of 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? And that's going to make it difficult for states to move on it quickly?

Morgan Scarboro 21:13

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. So, when we think about digital advertising taxes, the point, and supporters of this are not shy about it, particularly those who bring it up or introduce it who are Democrats, will say, "This is meant to be punitive." Right? Their idea is that big tech is not regulated enough or is doing something bad and they need to face this tax. The point is to be punitive. 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. So, I think that there's a chance that you get this just really interesting coalition of legislators who are pursuing this policy. But I also think that you're exactly right that this is an issue that sounds like an easy one, like, "Oh, tax digital advertising." 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. So, 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. And one, too, that's sort of, I would say, starting to separate into two different conversations. So, you've got this conversation about taxes on digital advertisement. And then you've also got states who are interested in taxing the collection or the usage of consumer data. So, 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. So, Maryland was sort of 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. However, I recently found out from some of my colleagues that live in Maryland, 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. So, I think that just by the very nature that these taxes are so broad, that it's going to be difficult to pass them because you have a very large, strong contingency of people who this would affect in a negative way.

Paul Jones 23:36

So, it could be an example of something that is going to require a longer sort of gestation period for people to chew it over. You know, I've got one specific question that's not as generally applicable. Most states have taken some action in response to the Wayfair decision of 2018, but the state of Missouri has sort of held out against that. And now we've got the governor of that one state saying to lawmakers, "Let's pass a remote online sales tax bill this year." So, 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? Because it's been a couple of years now and obviously they've yet to move on it.

Morgan Scarboro 24:16

Yeah, that's a great question that makes me wish I sort of had a crystal ball. Obviously, the governor this year is calling for the state, the legislature, to actually pass it. And 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. And 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. And 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." So, some bad blood there right now, which also makes it much more difficult generally for states to move sort of cohesively on a policy like this, especially one that they'd been dragging their feet on for so many years.

Paul Jones 25:05

So I guess maybe we'll have to see, but maybe we'll wait another year or two or more before Missouri moves on this. I think those are all of our questions, Morgan, and obviously we really appreciate your taking time to speak with us about all of these varied issues. But 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 sort of what adjustments and changes they're going to pursue and really makes a serious effort at that . Does that sound right to you?

Morgan Scarboro 25:39

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

Paul Jones 25:43

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

Morgan Scarboro 25:47

Thanks so much for having me.

David Stewart 25:49

And now, instead of coming attractions, we're joined by Tax Analysts CEO and President Cara Griffith to tell us about an upcoming event.

Cara Griffith 25:58

Last year was a major anniversary for Tax Analysts. 2020 was our golden year as the organization marked 50 years of fighting for transparency in tax. Tax Analysts has gone from humble beginnings to becoming a leading provider of tax information and a forum for even-handed debate. And while we had hoped to see you all in person, I am excited to announce that to celebrate our 50th anniversary, we will be hosting a virtual gala on February 10 at 7 p.m. EST. We will honor former IRS Commissioner and longtime leader in the tax world Larry Gibbs, and discuss the future of tax policy with the former U.S. Treasury Assistant Secretary David Kautter. We hope that you will join us in celebrating our first half century. To purchase tickets, visit events.taxanalysts.org.

David Stewart 26:49

That's it for this week. You can follow me online @TaxStew, that's S-T-E-W. And be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts .org . And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.