How Pennsylvania Can Transform Its Tax Code

Pennsylvania’s state and local tax structure is an illogical patchwork of punitive and nuisance taxes, administrative inefficiencies, and special interest carveouts.

A new report from the Tax Foundation highlights these problems in detail and offers numerous solutions to fix the state’s uncompetitive tax climate. Here are several state-level tax reform ideas lawmakers could pursue.

• Reduce Pennsylvania’s corporate tax rate. At 9.99 percent, Pennsylvania’s corporate net income tax (CNIT) rate is one of the highest in the country. It is a barrier to job creation and higher wages and should be reduced to incentivize entrepreneurs to start and grow their businesses in the state. The Tax Foundation recommends reducing the rate to 6.99 percent, which would push the rate closer to that of other states.
• Gradually increase the cap on the net operating loss (NOL) deduction. Pennsylvania is one of only two states that cap the amount of losses a business can carry forward to reduce its tax liability. This harms entrepreneurs who are unable to use robust NOL deductions to mitigate tax obligations over time. This is a serious problem for businesses with “cyclical income,” as they’re required to pay more—relative to other businesses—in the absence of a NOL deduction. The table below illustrates:

• Reduce tax credits for businesses. The Tax Foundation recommends reducing business tax credits to help lower the CNIT for all businesses. This is an idea CF has offered in the past and one that should merit discussion moving forward. However, the Tax Foundation includes the Educational Improvement Tax Credit and Opportunity Scholarship Tax Credit in its list of business tax credits that could be reduced. But these tax credits aren’t offered to encourage economic development. Their primary purpose is to provide quality educational options for students, and therefore, they should not be reduced or eliminated.
• Eliminate classes of income. As the Tax Foundation points out, Pennsylvania is unique in the way in treats income. It is the only state that separates income into distinct classes and taxes each class without allowing for losses to carry over from class to class. This arbitrarily penalizes some taxpayers, raising questions about the personal income tax’s constitutionality. Lawmakers should move to eliminate these unnecessary class distinctions.
• Broaden the sales tax base. The foundation’s report offers policymakers approximately 25 different goods or services that could be added to expand the sales tax base. Broadening the base would raise additional revenue, which should be used to lower the overall sales tax rate. The new revenue should not be used to increase spending. The purpose of comprehensive tax reform is to reduce the overall tax burden across the board for families and businesses, not to grow the size and scope of government.
• Repeal the inheritance tax. Pennsylvania is just one of six states that imposes an inheritance tax. The tax rate ranges from 4 to 15 percent, depending on the share of the inheritance and the relationship between the inheritor and the deceased. As the foundation points out, this tax could potentially force inheritors to downsize, or even sell, their business to cover their tax liability. This liability also forces many people to structure legacies in a way that avoids the inheritance tax liability, which is a needless waste of time and money.

The Tax Foundation’s report is a great starting point for a larger discussion about tax reform. However, it’s just one part of the equation. Policymakers need to ensure that any overhaul of Pa.’s tax code is coupled with spending restraint to avoid future financial challenges.