Scrimping for Revenues, States Agressively go after Out-of-State Incomes

With five straight quarters of year-to-year losses, plummeting tax revenues have steered many U.S. states toward desperate measures to fill budgetary holes. In a recent article, Catherine Rampell of the New York Times discusses the developing trend by many states to enforce, more diligently than ever, income tax collections on out-of-state workers who conduct business within state lines. Rampell Writes:

Such laws have been on the books for decades, and they vary by state. But it is only recently, accountants and tax lawyers say, that many states appear to have picked up enforcement, expanding it beyond the wealthiest celebrities and athletes.

“The states are all hungry for revenue,” said Alan Clavette, an accountant in Newtown, Conn. “We are certainly seeing states like New York and Connecticut looking more and more for executives and everyday taxpayers who may be spending time across the border.”

While such practices may have been unaffordable in the past, the desperate situation to generate revenue has created a perverse incentive amongst states to enforce the most aggressive tax collection methods upon the employers and employees of their neighboring states:

The bigger burden associated with distributing your taxes to more state governments is the administrative effort it requires, for both employee and employer. Many states require filing a return for a single day’s work. For peripatetic workers like salesmen or consultants, filing a pile of additional state tax returns can become prohibitively expensive, not to mention frustrating…

…So long as there is still a great deal of ignorance about these laws, the states with the most aggressive tax compliance teams have the most to gain. They can siphon off more revenue from their neighboring states than the other way around, all without fear of retaliation from anyone who has the power to vote them out of office.

But as more states catch on and start investing in more payroll auditors and data mining tools to get money back, the end result may be an arms race until every state comes out more or less evenly.

“If everybody goes after everybody, nobody wins,” said Arthur R. Rosen, a New York tax lawyer and partner at McDermott Will & Emery. “In this interstate war of ‘you tax my rich guy and I tax your rich guy,’ it’s just a wash, a preposterous flurry of tax returns.”

As Mr. Rosen points out, this is a situation where nobody wins – particularly the small businesses responsible for the majority of hiring following an economic downturn.