State taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ation finally has its own viral sensation—and, unsurprisingly, it’s a CAT.
No, not the feline version, but the Commercial Activity Tax (CAT), Ohio’s 2005 spin on gross receipts taxA gross receipts tax is a tax applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. ation, which is suddenly the model for every other state thinking about bringing back that once-moribund and outmoded form of taxation. No one wants one of those old business and occupation taxes; they belong to the distant past. But a CAT? Why, CATs get shared.
The bad news? Living under the CAT’s foot isn’t a very good thing.
West Virginia came close to adopting a tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. d on Ohio’s CAT earlier this year. Proponents of a gross receipts tax in Oregon leaned heavily on the CAT to defend their proposal. Louisiana considered one. And, most recently, the Missouri Director of Revenue signaled the administration’s interest in a gross receipts tax modeled after the CAT in a speech last week.
Gross receipts taxes (GRTs) used to be everywhere, but most were repealed over the course of the 20th century. By 2002, there were only two statewide gross receipts taxes left standing, in Delaware and Washington. The defects of GRTs were almost universally acknowledged.
By taxing gross income, these taxes were indifferent to profitability and thus to ability to pay, and heavily penalized new firms, those with narrow profit margins, and those posting actual losses. They were imposed at each stage of the production process, meaning that tax was imposed upon tax in what is commonly called “tax pyramidingTax pyramiding occurs when the same final good or service is taxed multiple times along the production process. This yields vastly different effective tax rates depending on the length of the supply chain and disproportionately harms low-margin firms. Gross receipts taxes are a prime example of tax pyramiding in action. ,” the result being that the final product contains multiple layers of taxation. Under gross receipts taxes, businesses experienced vastly different effective tax rates, creating a system widely acknowledged as inequitable and economically destructive. State after state scrapped this outmoded form of taxation.
But everything old is new again (witness the reemergence of Archie and Florence as popular baby names), and through the CAT, gross receipts taxes have a new lease on life.
The Ohio CAT is often held up as a success story, mostly due to the fact that it doesn’t engender the sort of business backlash that other states have experienced. The perceived success of the CAT is a large part of the case for a new gross receipts tax in Missouri, based on documents leaked from the state’s tax commission earlier this year. (A final report is still forthcoming, but based on recent public comments, it is likely to recommend a GRT.)
The problem is that the CAT isn’t anywhere near the success that proponents like to think. To understand why, you need to know the circumstances under which it was introduced, because a significant factor in acceptance of the Ohio CAT is what it replaced. Prior to an overhaul of the tax code which commenced in 2005, Ohio imposed both a corporate franchise tax (a corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. with a capital stock tax component) and a tangible personal property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. . Changes to the tax code adopted that year reduced the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rate and phased out the taxation of corporate income, capital stock, and tangible personal property.
The package represented a significant tax cut overall. In inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. -adjusted terms, it represented a reduction of 23.6 percent in revenue from the affected taxes.
Economists generally regard capital stock taxes, tangible personal property taxes, and gross receipts taxes as more economically harmful than corporate income taxes (though they are distortive as well), so in creating the CAT, Ohio replaced three economically distortive taxes with one, and this in the context of a sizable tax cut.
Ohio is not a clear success story to begin with: since 2004, it has still grown more slowly than all neighboring states except Michigan, which was hit particularly hard by the Great RecessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. . But if the lack of unified opposition to the tax is a success, then this is less an endorsement of gross receipts taxes than a commentary on just how bad the previous system was, and it is not analogous to swapping out a traditional corporate income tax for a gross receipts tax, as is being contemplated in Missouri, or tacking one onto the existing corporate income tax, as Louisiana and West Virginia considered.
For a detailed analysis of the Ohio CAT and why it doesn’t provide a good model for other states to follow, click here to read our new paper on the subject. As we conclude there:
“The resurgence of interest in gross receipts taxation is a throwback in the worst sense, the embrace of an inefficient and inequitable tax long since superseded by more modern revenue tools. Ohio’s experience, at most, offers a cautionary tale about capital stock and tangible personal property taxes, not a recommendation of gross receipts taxes. By learning the wrong lessons from the Buckeye State, other states risk embarking on a perilous course. Proponents hope the CAT has many lives—but for this CAT, even one life is one too many.”Share