The Effects of Pennsylvania’s Capital Stock and Franchise Tax

The Effects of Pennsylvania’s Capital Stock and Franchise Tax

ALEC members request this brief on the scheduled phase-out of Pennsylvania’s Capital Stock and Franchise Tax (CSFT), which has been the subject of recent debate in the legislature. Under a plan adopted by the legislature in 2000, the CSFT was originally scheduled to be phased out completely by 2009. This plan was subsequently altered to delay the final phase-out date on four separate occasions in 2002, 2003, 2009 and 2011.  While the CSFT is currently scheduled to be eliminated entirely by January 1, 2014, some remain skeptical as to the detrimental effects of the tax on business and economic growth.

Generally speaking, capital stock taxes are taxes levied on the net worth of a corporation. The Capital Stock Tax is a property tax applicable to all domestic corporations and limited liability companies in Pennsylvania. Similarly, the Franchise Tax is levied on all non-Pennsylvania corporations operating in Pennsylvania. Both taxes are imposed on a corporation’s capital stock value, or its net wealth.

For a number of reasons, taxes on the net wealth of corporations can serve as major impediments to business attraction and growth in Pennsylvania. First, taxes such as the CSFT impose significant tax burdens on businesses even during years in which the business has struggled, earned little or no profits, or incurred a loss. By requiring firms to pay taxes on their overall value regardless of their earnings during a particular year, capital stock taxes can be a major hardship for struggling businesses during difficult economic times. This burden inhibits capital accumulation and hiring, and adversely impacts the competitiveness of Pennsylvania businesses 

Second, the CSFT is redundant, adding an additional layer of taxation on top of the Commonwealth’s high corporate income tax rate of 9.99 percent (the second highest in the nation). Requiring business owners to pay taxes on both the value of their business and on their income is an excessive practice which has not been embraced by the majority of states.  

Finally, the tax effectively punishes business growth, deterring investment and entrepreneurial activity. By levying taxes in proportion to a firm’s value, the CSFT is directly at odds with the most common goal of the entrepreneur—growth and expansion of the enterprise and its value. This disincentive deters entrepreneurs at a time when the state should be doing all it can to attract them.

According to the Tax Foundation, of the 20 states that maintain a CSFT, Pennsylvania’s CSFT burden ranks in the top half. Many of these states have realized the negative effects of the CSFT and have moved to eliminate it.  West Virginia is in the middle of a 10-year phase-out, with full repeal taking effect in 2015. Kansas completed the phase-out of its CSFT in 2011.

The empirical evidence presented in ALEC’s annual Rich States, Poor Statesreport demonstrates that states that retain a low overall tax burden experience higher rates of growth. This year, Pennsylvania ranks 34th in the report, demonstrating that the state has room for improvement. As Pennsylvania’s CSFT progresses towards a complete phase-out in 2014, policymakers would do well to consider the aforementioned consequences of high taxation, as well as Pennsylvania’s competitive position relative to other states.

Please do not hesitate to contact us with any questions.

Sincerely,

Fara Klein, M.P.P.

Research Analyst, Center for State Fiscal Reform

American Legislative Exchange Council

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