Tax panel seeking both economic growth and effective tax collections

Shortly after being tapped as commissioner of the Department of Revenue Services, Kevin Sullivan insisted he was not Connecticut’s latest “tax man,” calling it a misnomer that represented only half of his job.

Now one of the leaders of a new policy group expected to issue its first progress report next month, Sullivan will have an opportunity to show that effective revenue collection and tax policy that promotes a healthy business climate can go hand-in-hand.

“For too long these two worlds have not been in sync, have not been in communication,” Sullivan said Wednesday, praising Gov. Dannel P. Malloy for recognizing that revenue services is about more than just gathering the dollars. “We have a collection function to perform, but Connecticut is better off if it has businesses to tax than if it does not have businesses to tax.”

Since the Governor’s Business Tax Policy Review Task Force was launched earlier this spring, the panel Sullivan co-chairs has begun to review corporation, sales and property taxes, various fees, credits and exemptions. But it’s also looking at wider issues, such as how complexity and uncertainty in tax policy affects business growth, or how effectively does state government measure the economic footprint of its tax system.

“For policymakers, tax discussions usually begin and end with the question, ‘How much?'” Sullivan wrote in the summer edition of The Connecticut Economy, the University of Connecticut’s quarterly economic journal, which was released last week. “Rarely does the debate get around to questions of economic purpose.”

For example, the state’s corporate income tax covered the largest share of state operating expenses — the $801 million raised represented 14.4 percent — in 1989. Last fiscal year, the tax took in $684 million, which represented 3.8 percent of General Fund operating expenses.

What’s changed?

Though it can’t be boiled down to just one factor, the traditional “C” corporation — a U.S, tax law term that refers primarily to major corporations that are taxed separately from their owners — are “a vanishing breed,” according to one report from the Department of Revenue Services.

And it’s these “C” corporations, about 37,800, that pay the state’s corporate income tax.

By comparison, limited liability corporations (LLC’s) and other companies that don’t pay the corporation tax are on the rise. Many instead face the business entity tax — a modest $250 fee due once every two years. And even though many of their principals report business earnings on their personal income tax filings, the arrangement is more cost-effective than paying the corporation levy.

In the four years before the last recession, from 2004 through 2007, more than 96,800 LLCs were formed here, compared to under 8,900 “C” corporations, according to DRS.

“If you don’t have tax policy, how do you match business as it evolves?” Sullivan said.

The tax policy group also is taking a close look at e-commerce, another area Connecticut — and many other states — have struggled to resolve.

The General Assembly enacted a statute last year to attempt to force online retailers, such as, to collect and remit sales taxes from Internet purchases to Connecticut.

That legislation hinges on sales affiliates, local companies that receive a small commission for redirecting customers to a retailer’s website. Any online firm with sufficient sales generated through its Connecticut affiliates effectively has a “nexus” or physical presence in the state, and therefore must collect and report sales tax.

Many online retailers responded by terminating their affiliates, leading those local companies to complain they had lost crucial income.

A second example of an evolving economy that challenges state tax policy to be equally dynamic involves the controversial roll-you-own cigarette smoke shops.

Connecticut imposes an annual fee on cigarette manufacturers, a cost that affects the price of cigarettes sold in hundreds of convenience stores, gas stations and other retail outlets.

But over the past few years, more than a dozen smoke shops began offering machines that allow patrons, armed with rolling papers and tobacco, to roll their own cigarettes.

DRS tried to impose the annual fee on these shops until a Superior Court judge ruled earlier this year that the state’s definition of cigarette manufacturer didn’t apply.

The legislature responded in special session this week by adopting a revised definition, meaning these smoke shops will face the $5,250 annual fee starting Oct. 1.

Smoke shops called the change unfair, arguing they are small businesses, not manufacturers, and may be forced to close because of the new expense.

Sullivan said he understands the objections, but noted that these shops enjoy a “huge profit margin” by not paying the fee while “down the street there could be 25 stores selling cigarettes” at a much higher price. “It’s a question of fairness.”

The commissioner added that the most frequent complaint he hears from businesses “is not so much the level of taxes in Connecticut, it’s the complexity or the uncertainty.”

Another focus of the task force are the sales taxes imposed on a variety of business services decades ago. Sullivan said he suspects research will show that many of these are among “the dumbest things you can do” if the goal is to raise necessary revenue without cramping the economy.

The task force, which plans to hold its next meeting at 2 p.m., Thursday, in the Legislative Office Building, will submit its final report to the governor in October.

But Sullivan added that the group, which includes representatives of the governor’s budget office, Comptroller Kevin P. Lembo, Treasurer Denise L. Nappier and the business and academic communities, might be more valuable reviewing state tax policy on a recurring basis.

Sen. Gary D. LeBeau, D-East Hartford, co-chairman of the legislature’s Commerce Committee, said he thinks the panel’s work will be an important resource for lawmakers in the next legislation session, which begins in January.

Lawmakers have long had concerns about whether the shrinking role of the corporation tax in the state budget is tied to a bigger problem with tax equity. As more entities register only as LLCs, “how much of this is tax avoidance and how much of this is about ease of business operations? I believe we want to stimulate business and maintain balance and fairness in our tax structure,” he said. “I think this group can help find the answers.”