Pennsylvania’s employers need to pay close attention to the developing fiscal crisis confronting Pennsylvania policy makers in the months ahead. None of Pennsylvania’s major industries should conclude that they are protected from significant new and/or increased state taxes. Manufacturers and other cyclical industries are at risk of losing the significant progress achieved with respect to Net Operating Loss relief. Oil and gas extraction companies, and their midstream partners, are likely to face a plethora of proposals to create a severance tax and other taxes/fees to be imposed upon pipelines. All corporate taxpayers could be impacted by potential increases to the Corporate Net Income Tax (CNIT), as well as other CNIT-related reforms that purport to make the system “fairer.” Small businesses are also at risk with recent proposals to increase and restructure the Personal Income Tax (PIT), which is paid by most small businesses.

The purpose of this Legislative Alert is to discuss the extent of the current fiscal crisis, as well as various proposals that have been identified as mechanisms to close the gap between current (and desired) spending levels and revenues intended to meet spending demands.

Painting Pennsylvania’s Fiscal Landscape

Pennsylvania’s Independent Fiscal Office (IFO), a statutorily created, non-partisan and impartial office responsible for revenue projections for use in Pennsylvania state budgets, recently estimated that Pennsylvania policy makers will have to confront a $1.85 billion revenue shortfall in fiscal year 2015-16.  Taking into account this nearly $2 billion structural budget deficit, and an additional $1 billion in other mandatory spending increases, before Governor-Elect Tom Wolf can propose any new spending, he must consider current revenues and how to fill the current fiscal gap. The bleak fiscal picture will pose challenges for the new Democratic governor who takes office, as will the reality of a more conservative, Republican dominated General Assembly.

There is an elephant in the room. Public pensions. Newly elected Majority Leader of the Senate, Jake Corman has already publically stated, “We're not going to consider any new revenue until we do pension reform," noting that a pension proposal from new Appropriations Chairman Pat Browne would be introduced as Senate Bill 1 at the beginning of session in January. Public employee pensions are a very big problem and conservatives in the House and Senate will be reluctant to increase taxes until this issue is addressed. According to the Pennsylvania Budget Office, the two pensions system’s debt outweighs assets by more than $47 billion, and the office expects that number to reach nearly $65 billion within the next five years.

Governor-Elect Wolf’s Campaign Promises

During the campaign, Governor-Elect Wolf proposed several tax policy changes. One of his priorities is to “modernize the tax code.” To this end, he has vowed to increase Personal Income Tax revenues by exempting lower income taxpayers and increasing the rate to approximately 5 percent for higher income taxpayers, including and especially small business. There is still a lot of mystery surrounding how exactly he would propose different tax rates for different taxpayers, as well as questions about whether or not this type of proposal would violate Pennsylvania’s Uniformity Clause. Regardless of the specifics of the proposal, Pennsylvania small businesses need to be prepared to have a seat at the table to ensure that policy makers understand the potential impacts on existing jobs from proposals to “modernize” and or increase PIT rates. 

Corporate taxpayers, particularly those with a multistate presence, also need to be prepared to engage with policy makers and the Wolf Administration with respect to Governor-Elect Wolf’s proposal to implement “mandatory combined reporting.” Depending on how it is drafted, this tax proposal could pose a significant threat to current Pennsylvania businesses and could act as a deterrent for any business looking to locate in the Commonwealth.  Discussions in the past regarding combined reporting have often times been in concert with lowering the CNIT rate, but given the current fiscal crisis (i.e., $2 billion structural deficit, plus at least another $1 billion in mandatory spending increases), combined with Governor-Elect Wolf’s commitment to increase spending on Medicaid and Education, it is unlikely that combined reporting would be used to decrease Pennsylvania’s already high CNIT rate. As the new structure of the Administration unfolds, and as we take a look at those who have been chosen so far to lead the new Governor’s transition team, it is hard not to notice specific choices. For example, Sharon Ward, the Director of the left leaning and public sector union funded Pennsylvania Budget and Policy Center (PBPC), has been chosen to work on the Department of Revenue’s transition team. In the past, Ms. Ward has been extremely vocal about the need to move to mandatory combined reporting, and was very critical of the House Republican’s modest “add back” provision adopted in Act 52 of 2013.

With respect to oil and gas producers, and the many industries that support and/or benefit from robust production within the Commonwealth, the PBPC has also taken the position that the impact fee passed in 2012 on natural gas wells drilled into Pennsylvania’s Marcellus Shale generates a “relatively small” amount of revenue from the gas industry. To date, the impact fee has resulted in an estimated $600 million in revenues. Governor-Elect Wolf as part of his platform intends to advocate for a new 5% severance tax and wants to invest the revenues into education. This policy initiative could prove to be very destructive to the gas industry and to the Pennsylvania economy as a whole.

The Threat Runs Deeper

Pennsylvania’s current fiscal situation jeopardizes favorable tax changes that have been recently enacted.

• Net Operating Losses (NOLs). Pennsylvania has increased relief for NOLs from $2 million annually to 30 percent of income, which has been a significant victory for Pennsylvania businesses. This success is in serious jeopardy this year and proponents - especially manufacturers and other cyclical industries - need to be prepared to ward off any attempts to go back and try to recoup revenues associated with this allowance. 
• Phase out of the Corporate Stock and Franchise Tax (CSFT). Under current law, the CSFT is slated to phase out by 2016. This phase out would result in a tremendous savings for business. However there could be a willingness among lawmakers and Governor Elect Wolf to halt the phase out which would mean a significant tax increase for businesses in 2015-16.
• Vendor Discount.  Currently businesses who remit Sales and Use Tax in a timely fashion are afforded a vendor sales discount of 1%. Discussions revolving around capping and or eliminating the vendor sales discount would again mean a tax increase for businesses that rely on receiving this discount.

The Will of the Legislature

Typically, one might assume that the overwhelming Republican majorities in the House and Senate, and the more conservative legislative leaders elected by an influx of fiscally conservative Republicans, might provide a sufficient insurance policy against new or increased taxes likely to be proposed by Governor-Elect Wolf during his budget address in early-March. While it is fair to say that the increasingly conservative legislature is likely to be hostile to an aggressive tax increase package, it would be a mistake to ignore the potential for budget negotiations to produce any or all of the tax increases identified above as part of a “global compromise” that addresses policy and fiscal priorities collectively, and which could also rely upon a large number of Democratic votes.

Even some of the most conservative Republicans within both chambers of the General Assembly have indicated support for a PIT increase and a “broadened” sales tax base; albeit in an effort to use those revenues to reduce or eliminate property taxes. For instance, in the 2013-14 legislative session, Senate Bill 76, called “The Property Tax Independence Act.” would attempt to raise the Personal Income Tax from 3.07% to 4.34%, increase the Sales and Use Tax from 6% to 7% and, to make matters worse, would propose to eliminate the following Sales and Use Tax (SUT) exemptions: food and beverages; clothing and shoes; personal hygiene products; gum and candy; magazines; textbooks; and non-prescription drugs. In addition, under SB 76, there would be a host of newly taxable services including: legal services; architectural/engineering services; accounting services; and, advertising services. These changes would result in an overall higher cost to conduct business in Pennsylvania. The strong desire of conservatives within the General Assembly to increase PIT and SUT revenues for property tax reform, paired with the fact that Governor-Elect Wolf has previously demonstrated support for increasing Sales and Use Tax under the Governor Rendell Administration, further underscore that the Pennsylvania business community must be fully engaged within the political and legislative processes surrounding budget negotiations over the next two years.

January will reveal a lot of outstanding missing pieces to the puzzle. The General Assembly will reorganize and members will be placed into standing committee posts. Governor-Elect Wolf will appoint his cabinet, as well as other Administration officials, and will immediately begin on the work of crafting a proposed budget. One constant throughout the next six months will be the discussion over revenues and the need to meet current budgetary demands in order to pass a constitutionally mandated balanced budget. The newly elected and now more conservative House and Senate leadership will be the ones holding the Governor accountable as they wrangle with Pennsylvania’s budget deficit. It remains to be seen if the Governor can bridge a political gap with the legislature to accomplish the task of balancing this coming year’s budget, and it is inevitable both chambers as well as the Governor will be seeking to find revenue raisers to meet their priorities.

Uncertainty breeds hesitancy when it comes to business planning. K&L Gates recognizes the importance of predictability for its clients and is committed to having a voice and a seat at the table as discussions unfold.