Gross Receipts Tax: Wrong Way to Finance Illinois Government

March 07, 2007

In his state of the state address today, Illinois Governor Rod Blagojevich proposed a new business gross receipts tax to raise $6 billion for general fund expenses (largely education and health care). While Illinois may need more money for public services, imposing a gross receipts tax to raise revenue is far worse than raising the state's sales or income taxes.

The chief economic problem with gross receipts taxes is the pyramiding nature of the tax. That is, since the tax applies each time a business sells its goods or services, the tax "pyramids" on products as they move through the production process. The longer the production chain, the higher the effective tax rate on the final product.

Thus, a gross receipts tax badly distorts and interferes with business investment decisions, leading to lower economic growth and job growth. Sales, income and property taxes do not have the same tax pyramiding feature, making them more economically efficient taxes. A $6 billion increase in any of those taxes would cause far less economic harm than a gross receipts tax that raises the same amount of revenue.

Governor Blagojevich, undoubtedly aware of the problems of gross receipts taxes due to a report we released on them, will apparently try to fix the tax by:

  • Providing a lower tax rate for manufacturers, wholesalers and retailers-industries that will suffer from the pyramiding nature of the tax
  •  Exempting companies with less than $1 million in gross receipts from the tax altogether 

These "fixes" are, of course, acknowledgments of the flawed nature of gross receipts taxes. These fixes also narrow the base of the tax and increase the rate needed to raise revenues, moves which contrast sharply with those who claim that a gross receipts tax would be good because it is a low-rate, broad-based tax.

Incidentally, the claim that a gross receipts tax is good because it is "broad-based" is completely refuted by Professor John Mikesell in this study we co-published with the Council on State Taxation.

We are particularly interested in whether Blagojevich (like Ohio two years ago) will adopt the so-called "economic nexus" theory to require out-of-state firms to pay the gross receipts tax on their Illinois sales. If he does so, Illinois companies would likely face an across the board increase in the cost of their purchases, making Illinois a more expensive (and less competitive) place to run a business.

As more details come out, we will offer more analysis and commentary. It is fair to say, however, that a new gross receipts tax that raises $6 billion in tax revenue will have a significant (and negative) impact on Illinois' rankings in our state and local tax burdens (currently 14th worst) and State Business Tax Climate Index (currently 25th worst).

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