Connecticut's capital base tax, essentially a tax on corporate savings accounts, has never made much sense, but in today's economy it is strikingly counter productive.
It actually incentivizes technology companies—the cutting-edge, new age firms that Connecticut wants to claim—to start up outside of Connecticut.
This is why a budget amendment enacted at the end of the last General Assembly session phasing out the capital base tax made a lot of economic development sense.
The Lamont administration now plans to reverse course and delay commencement of the phase out for four years, as outlined in the governor's proposed budget adjustments for the current fiscal year.
Not phasing out the capital base tax would generate only $5.7 million in tax revenue next year—in a $43 billion budget.
Nineteenth Century Holdover
The capital base tax was enacted in the 19th century as a means to encourage corporations to spend—not sit on—their retained earnings.
The concept was to tax money sitting idle in bank accounts to spur companies to deploy it for more productive ends—facilities, equipment, higher wages, etc.
But when the modern corporate tax structure was put into place, it nearly made the capital base tax irrelevant.
Corporations are taxed on the higher of a $250 flat fee, a 0.31% tax on their capital base, or 7.5% on income (plus a "temporary" 1.5% income tax surcharge the governor proposes to make permanent).
Since corporations are in business to generate revenues, and most do, they easily qualify for the corporate income tax.
Few have little or no income and a sizable bank account to trigger the capital base tax.
Except, that is, technology companies, especially biotech companies.
Tech Companies 'Unique'
Tech companies are unique in the amount of money they must raise to conduct years-long research and development to bring innovative products to market.
It takes, for example, $2.7 billion and 12 years for a biotech company to develop a laboratory concept into one Food and Drug Administration-approved medicine available on pharmacy shelves.
Thus, biopharma companies typically hold millions of dollars in their corporate bank accounts. They spend a lot of money—pump a lot of money into the economy—while not generating any revenue, in the hopes of one day having a successful product.
They expect to pay income tax someday. But they're surprised and disheartened to learn that along the way to profitability all the money they raise from friends, family, and other investors, Connecticut will tax their bank account annually.
Since, again, it takes $2.7 billion to bring a medicine to market, a biotech company can easily have tens of millions of dollars in its bank account at any one time.
A $30 million balance means an annual Connecticut capital base tax of $93,000—enough to fund the salary and benefits of an additional scientist.
Lack of Predictability
Unfortunately, the lack of predictability around state tax policy is all too familiar.
Connecticut, for example, routinely establishes one R&D tax credit rate and later adds provisions reducing that rate and limiting the dollar amount any one company can take.
The state's budgetary and fiscal woes are well known to cause uncertainty.
This undermines confidence that an incentive in place today will still be available when a company is ready to use it.
It's not surprising that the founders of and investors in start-ups, emerging from academic labs, ask themselves, "will an R&D tax credit or phase out of the capital base tax really, truly, be in effect if we move to Connecticut?"
If the answer is, at best, "hard to tell," then the odds of recruiting such companies surely are not good.