Business Tax Burdens Possibly on States’ Chopping Block

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By Jennifer McLoughlin

State efforts to carve out business personal property from taxation are gaining steam amid continuing calls for states to remove business inputs from the sales tax base.

According to consulting firm Multistate Associates, states are increasingly motivated to pull away from taxing businesses’ tangible personal property (TPP). More than 20 bills have been introduced this year to reduce or remove the property tax.

This legislative shift aligns with a long-standing view held by several organizations that including business personal property in the tax base is bad tax policy. Task forces with the National Conference of State Legislatures and the American Legislative Exchange Council adopted 2016 papers that decried the taxes for distorting markets by “discouraging capital investment, expansion and replacement.” The organizations encouraged states to eliminate or limit such taxes, and if repeal isn’t feasible, suggested administrative simplification.

As states migrate away from the tangible personal property tax, tax groups have reiterated requests for states to exempt business inputs from sales tax liability as well. A Feb. 10 report from the Tax Foundation disagrees with the inclusion of business inputs in the sales tax base. And the Council On State Taxation this week offered support for Utah’s S.B. 197, which would expand manufacturing exemptions to select machinery, equipment and materials.

Joe Henchman, Tax Foundation vice president of state and legal projects, told Bloomberg BNA that taxation of business inputs wasn’t an issue during the early sales tax era in which the economy was predominantly local, goods-based transactions, with few or no intermediaries in the process.

The laws were never updated, and “it’s just the autopilot that resulted,” he said.

Economic Distortion

Opposition to taxation of business inputs often points to the pyramiding effect in which taxes pile on other taxes through the supply chain, forcing businesses to embed those costs in the final consumer price or cutting economic activity in a state.

In its report, the Tax Foundation echoed criticism of the distortive impact of taxing inputs that aren’t final consumption.

“Consumers end up paying the tax in the form of higher prices—they just do so in a nontransparent way,” according to the report. It further noted that “taxing business inputs disproportionately harms industries with long production chains, and consequently can encourage vertical integration for tax reasons even if it makes no business sense.”

COST has similar concerns with increased consumer prices and competitive disadvantages. The association will be issuing next month its first Sales Tax Administrative Scorecard, which will factor in business input exemptions.

“As a result of the choices businesses are forced to make, the economic burden of taxes on business inputs inevitably shifts to labor in the State (through lower wages and employment) or consumers (through higher prices),” according to a policy statement.

No Blanket Exemption

Michael Mazerov, with the Center on Budget and Policy Priorities, explained that it’s not always clear if consumers shoulder the burden from taxation of business inputs.

For example, businesses may face competition from out-of-state companies not subject to taxation for specific inputs. In that case, the business may not be able to pass through the input tax—rather than burden the consumer, however, the tax incidence would fall on the business.

But a blanket exemption for all business inputs may present risks.

In a 2009 report, Mazerov counseled against states expanding their sales tax base by targeting business-to-business services. However, he told Bloomberg BNA that an exemption for all business services may facilitate tax evasion.

“We’d have people claiming that their cell phone bill was entirely for business use, when it’s probably substantially for personal use,” said Mazerov, a senior fellow with the center’s State Fiscal Project. “So you have to weigh practical enforcement issues, real-world enforcement issues against what theory would say about the inappropriateness of taxing business-to-business services.”

Recovering Revenue

A sizable revenue impact from exempting business inputs may be tough for several states to stomach.

In conjunction with COST and the State Tax Research Institute—COST’s affiliated research foundation—Ernst & Young LLP prepared a December 2016 report that found “general sales and use tax revenue derived from businesses on purchases of inputs, including capital equipment, totaled $150.6 billion, or 21.3% of all state and local business taxes” for fiscal year 2015.

“Replacing that revenue would be very difficult, and the revenue is badly needed,” said Mazerov, who noted that he is a “little skeptical” of some estimates underlying claims that business-to-business transactions represent as large a share of total sales tax. But he agreed the number is significant.

Reservations Over Revenue Impact

Moreover, uncertainty over the combined effect of multiple sales tax measures may also have a deterrent effect for lawmakers.

Joe W. Garrett Jr., Alabama’s deputy co-commissioner of revenue, told Bloomberg BNA that the state already exempts some business inputs, and several inputs are taxed at a lower rate—such as manufacturing machinery and farm equipment.

“If you eliminated all the taxable business inputs, then you started taxing other categories of services, what would the revenue balance be there if you tried to do both of those things?” he said. “I don’t think we know. I don’t think anybody has a real good idea of that trade.”

Add changes to sales tax exemptions for other goods, and Garrett noted “there is a lot of uncertainty as to what the outcome is when you start making all those changes.”

“Which makes it difficult for people to go out on a limb and make those changes when they don’t know exactly what the outcome will be in terms of impact to revenue,” he said, adding that many economists have acknowledged a lack of information needed to provide states with precise estimates with a high level of confidence.

To contact the reporter on this story: Jennifer McLoughlin in Washington at jmcloughlin@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

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