States stunt growth by using income taxes to shake down mobile workers

This nation’s founders recognized that an unimpeded flow of workers, capital and goods between citizens generates economic prosperity. Although the 50 states are sovereign, the states ceded to the federal government the power to regulate commerce between the states. As a result, this nation operates as a 2,680 mile free trade zone. Nowhere else on the planet is wealth so widespread amongst so many people situated across such a wide expanse of land. Entrepreneurs and employees are free to crisscross the country seeking opportunity, establishing business outposts and cementing deals.

Unfortunately, a maze of state income tax codes ensnares an increasing proportion of the increasingly mobile American workforce. An assortment of mainly high tax states demands income tax payment from nonresidents working in or travelling through another state for a few short hours or days. These requirements saddle businesses and their employees with new and burdensome compliance costs.

{mosads}In many cases, compliance costs exceed the actual tax burden imposed. For instance, consider a company with 15 employees who each spend just two work days every month in other states. If a person earning $100,000 per year spends 10 percent of her time working elsewhere, or two work days out of 20 work days in a month, roughly $10,000 of the $100,000 salary is possibly taxed by another state.

Using a 5 percent income tax rate for simplicity, this tax on mobile working would total $500 for each employee or $7,500 in aggregate. Shockingly, the compliance costs may meet or exceed the actual tax burden imposed. Just three hours of payroll department time at $50 per hour each week devoted to sifting through paperwork and various state tax codes amounts to another $7,500 annually in addition to the wasted hours of records keeping incurred by the individual employees.

Of course, compliance costs can rocket far higher quickly if a state decides to audit an employee or company. In this situation, phone records, emails, and travel receipts may be subpoenaed. In effect, the burden of proof lies with the entity under investigation to show the proper tax amount was paid. In the case of the prior example, an employee owing $500 to nonresident states over the course of one year may owe just $50 to any individual state. Just 15 minutes of fees from a tax attorney incurred in response to an audit would dwarf the $50 owed.

Legislation has been proposed to remedy this situation, specifically the Mobile Workforce Simplification Act of 2017, sponsored by Sen. John Thune (R-S.D.) in the Senate and Rep. Mike Bishop (R-Mich.) in the House, which passed the bill by voice vote in June. A bipartisan group of 56 senators have cosponsored the legislation, which “prohibits the wages or other remuneration earned by an employee who performs employment duties in more than one state from being subject to income tax in any state other than the state of the employee’s residence, and  the state within which the employee is present and performing employment duties for more than 30 days during the calendar year.”

Potentially of even greater importance, the bill “exempts employers from state income tax withholding and information reporting requirements for employees not subject to income tax in the state under this bill.” So long as evidence of employee fraud or collusion in tax evasion does not exist, the employer is permitted to rely on an employee’s attestation in determining whether an exemption applies. This 30-day threshold eliminates for most companies and employees nearly all the compliance costs in time and money stemming from current requirements.

Of course, that brings up an important question. What counts as a day worked outside one’s home state? Under current New York law, simply travelling through Kennedy Airport or Penn Station and making a business call counts as working a full day in the state, even if just there for a few hours. First, the proposed legislation ensures that hours worked while in transit do not count. Second, if present in more than two states in one day, the work day is considered to have entirely occurred where the employee performed more of his work duties than in any other state on that day. Third, if the employees worked just his home state and just one other state during a day, he is considered to have worked the entire day in the nonresident state. These three guidelines greatly simplify and standardize the existing law.

Without a doubt, the plethora of income taxes and applicability of these taxes are impacting interstate commerce. The commerce clause of the Constitution authorizes federal action to resolve this problem. As the American Legislative Exchange Council’s Principles of Taxation articulate, the tax code should “facilitate commerce” and “minimize the cost of complying with the tax laws.” To this end, a Mobile Workforce State Income Tax Simplification Act has been our model policy since 2011. Absent a legislative remedy, a myriad of state tax codes will continue diverting capital and brainpower away from opportunities to create wealth. Restoring the promise of a continental zone brimming with opportunities requires simplification and standardization of how states tax mobile workers.

Joel Griffith is director of the Center for State Fiscal Reform at the American Legislative Exchange Council. Jonathan Williams is chief economist at the American Legislative Exchange Council.