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States are considering a number of taxes to help raise revenue and close budget gaps, including the gross receipts tax. In this article, the Tax Foundation's Nicole Kaeding discusses the history of gross receipts taxes and their impact on businesses.
By Nicole Kaeding
Nicole Kaeding is an economist at the Center for State Tax Policy at the Tax Foundation.
Gross receipts taxes are rarely used by states. Only five states, Delaware, Nevada, Ohio, Texas, and Washington, have statewide gross receipts taxes, with a handful more using them at the local level, such as Pennsylvania and Virginia. However, a number of states could be joining them to help close budget gaps—and this is the wrong approach for states.
Gross receipts taxes are not a new form of taxation. In fact, they are hundreds of years old. Adam Smith devoted a lengthy passage in The Wealth of Nations to discussing Spain's gross receipts tax, the alcabala, which dates to the 1300s. Smith blamed much of Spain's economic hardships in the 17th century to the tax's flawed structure. Gross receipts taxes were a popular tax in the United States prior to the Great Depression, but states quickly abandoned the tax following the creation of the first retail sales tax in Mississippi in 1930. Retail sales taxes provide the benefits of a gross receipts tax—easier administration and stable revenue—without the harmful economic effects.
Gross receipts taxes violate many of the tenets of good tax policy, including neutrality, transparency, and fairness. They create tax pyramiding, as a product is taxed multiple times as it moves to the market. Instead of just taxing the final purchase of the consumer, as under a retail sales tax, gross receipts taxes levy a tax at every single level of production. Each level of taxation pyramids into the final purchase price for consumers. For firms without the ability to pass the tax forward, they move it backwards to workers, through lower wages and reduced job creation. Firms with longer production cycles are particularly devastated.
Because gross receipts taxes ignore profitability, they unfairly burden businesses with smaller profit margins—or no profits at all. States seeking to reform their tax codes should look elsewhere.
After a long hiatus, a few states created gross receipts taxes in the mid-2000s. New Jersey (2002-06), Kentucky (2005-06), and Michigan (2008-11) briefly adopted gross receipts taxes, but repealed them soon after. Report after report from these states emphasized the non-neutrality of these taxes. The gross receipts taxes led to tax pyramiding, with concentrated impacts on specific industries. In 2003, Arthur J. Maurice, then first vice president of the New Jersey Business & Industry Association, perfectly summarized the impacts during legislative testimony. New Jersey's gross receipts tax hit “low-profit margin firms, service companies, start-ups, firms with extraordinary and unexpected expenses, doing all this by taxing gross revenues without allowance for customary cost of doing business.” Ohio's commercial activities tax (CAT), enacted in 2005, and Texas's Margins tax, enacted in 2006, are the two remaining taxes from this flurry of activity.
But now, a few other states, Louisiana, Oregon, and West Virginia, are reopening the debate on gross receipts taxes, even with hundreds of years of precedent on the economic downsides to this tax type. (A gross receipts tax proposal was introduced in Oklahoma this year, but that proposal is not being considered.)
Governor John Bel Edwards (D) of Louisiana has introduced a gross receipts tax based on the Ohio CAT. Citing the number of corporations with no tax liability in 2015, Governor Edwards has designed the Louisiana CAT to be a minimum tax to its corporate income taxes, with a rate of 0.35 percent of Louisiana-source receipts. Corporations in Louisiana would remit the higher of its income tax or gross receipts tax liability. Pass-through entities would also be subject to the tax. The $800 million to $900 million in new revenue would replace the revenue from an expiring sales tax increase.
Acknowledging the disproportionate impacts to specific industries, such as retailing and manufacturing, Governor Edwards signaled during the announcement of his tax plan that he'd be releasing an alternative calculation method for those firms. Those details are still not available, but enacting different rules for different industries will add complexity to an already poor tax proposal.
Oregon voters defeated Measure 97 at the ballot box in November, which would have created a nearly unprecedented 2.5 percent gross receipts tax (the highest rate in the country, with the exception of Washington state's tax rate for nuclear waste). Even with the overwhelming opposition, the Oregon legislature is continuing to explore creating a gross receipts tax. Earlier in the legislative session, Representative Mark Johnson introduced a gross receipts tax at 0.7 percent, while the Senate Finance committee floated a similar proposal. Senator Mark Hass, chair of Senate Finance, has publicly stated that he'll be releasing an in-depth gross receipts tax proposal modeled on the CAT over the next several weeks. Senator Hass argues that the state needs to limit revenue volatility, which a gross receipts tax would do, but the downsides to the tax outweigh the benefits of stability.
West Virginia is the third state seriously considering a gross receipts tax. Governor Jim Justice (D) included two gross receipts tax proposals. The first one would have a rate of 0.2 percent, which the governor was quick to note was a lower rate than Ohio's 0.26 percent. Since initial release, the governor has backtracked, now suggesting a rate of 0.045 percent. Members of the legislature seem unwilling to back such a proposal, but with the prospects of a special session ever-increasing, the legislature could be in a difficult position to refuse.
In all three of these states, Oregon, Louisiana, and West Virginia, policymakers have argued that Ohio's experience with the CAT shows it's a workable model for each state. But this view is misguided. As discussed previously, gross receipts taxes, even with low rates and fairly broad bases, lead to tax pyramiding, with concentrated effects on low-margin firms. This occurs even under the CAT and its low rate. A study from EY found that effective rates under the CAT varied from 0.4 percent for management of companies to 8.6 percent for construction, compared to the statutory rate of 0.26 percent. Wholesale and retail had effective rates of 8.3 percent and 7.9 percent respectively.
Hundreds of years of economic literature confirm that gross receipts taxes are not a preferable form of taxation. Tax pyramiding leads to higher prices for consumers, fewer job opportunities, and limits wage growth for employees. Despite the overwhelming economic evidence, a few states are looking to resurrect this flawed tax type. States should learn from the experiences of their fellow states and not add this tax to their revenue arsenal.
Copyright © 2017 Tax Management Inc. All Rights Reserved.
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