New Study: Gross Receipts Taxes Harmful to State and Local Economies

December 04, 2006

For immediate release Media contact: Brian Phillips (202) 464-5102

Washington, D.C.—Gross receipts taxes are inefficient, unfair, and ultimately lead to complexities that undermine their attractiveness as a simple way to raise revenue. A new study by Tax Foundation economists evaluates the fundamental problems inherent in the gross receipts tax--problems which should cause alarm for many of the states that have or are considering them.

The popularity of gross receipts taxes has grown out of a backlash to the complexities of taxing corporate income. Since defining corporate income can be difficult, lawmakers see gross receipts taxes as a simple alternative. Companies total up in-state revenue, apply the statutory tax rate, and pay the tax.

“There is an inherent unfairness, though,” said Andrew Chamberlain, who co-authored the study with Patrick Fleenor. “Industries that make products that require several business transactions from the time a raw material becomes something sold in a store, all end up paying higher taxes.”

For example, before a piece of timber becomes a two-by-four, there can be half a dozen transactions by the time it gets from the forest to the shelf at Home Depot. But other service-based industries, such as a computer programming or your local barber, do not require as many business-to-business transactions. Since a gross receipts tax is levied on the full value of each transaction, and not adjusted to subtract business expenses, industries with more transactions get taxed more often, which adds up to higher effective rates.

“Invariably, lawmakers will try to mitigate the unfairness. The result is that they end up making the administration of gross receipts taxes just as complicated,” said Chamberlain. “Take your pick: a simple system that is unfair or a fair system that is complicated. Either way, gross receipts taxes are not the magic bullet some make them out to be.”

The report also reveals that gross receipts taxes create incentives that make business more inefficient. Instead of concentrating on what they’re good at, businesses will try to reduce costs by decreasing the number of transactions--a process known as vertical integration.

“Imagine UPS building their own trucks or American Airlines making their own in-flight dinners,” said Chamberlain. “It hurts the overall productivity of the economy since that is not what those companies do best.”

Click here to read the full study.

For media inquires please email Brian Phillips or call 202.464.5102.

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