Next Tuesday, Nevada voters will decide whether or not to give the go-ahead to the margin 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. —an economically damaging tax that falls in the 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. family. Gross receipts taxes (GRTs) only exist in a handful of states across the country (and even that’s too many).
Gross receipts taxes are complex business taxes that are imposed at a low rate but on a wide base of transactions (even intermediate goods and services). This results in 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. as taxes pile up on one another as goods move through the production chain. This is non-neutral, non-transparent, and complicated—the opposite of smart tax policy.
Four states have pure gross receipts taxes (Delaware, Ohio, Virginia, and Washington), and one (Texas) has a “modified” gross receipts tax—basically a combination of the two worst state-level taxes: GRTs and state 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. es. In the words of Indiana University Professor John Mikesell,
[The Texas margin tax] is…a badly designed business profits tax, like those that emerged in the newly independent states of the former Soviet Union…combin[ing] all the problems of minimum income taxation in general—excess compliance and administrative cost, penalization of the unsuccessful business, undesirable incentive impacts, doubtful equity basis—with those of taxation according to gross receipts.
Most states do without a gross receipts tax (see map below). Click to enlarge and share.
But where did these nasty gross receipts taxes come from? The first emerged in West Virginia in 1921, followed by Washington in 1933, which enacted the tax as an “emergency measure during the Great Depression” (unfortunately this tax has stuck around). Several states enacted GRTs for similar reasons. Luckily, the trend reversed as time went on (from our 2006 piece on the topic):
As the fiscal pressures of the Depression waned, interest in gross receipts taxes faded. Most gross receipts taxes enacted in the 1930s ultimately proved to be short lived…By the 1950s and 1960s, gross receipts taxes began to fade from state tax policy debates. During the full second half of the 20th Century, no state would enact a new broad-based gross receipts tax…By the late 1970s state and local lawmakers began yielding to the advice of economists, repealing gross receipts taxes in favor of less harmful revenue sources.
Unfortunately, the 2000s saw a resurgence in interest (see here for more information on this).
We’ve written many times in the past about the issues with gross receipts taxes. Though margin taxes are technically “modified” GRTs, they are still plagued by many of the same issues. As I pointed out last year, there are the two compelling economic reasons that a margin tax is poor tax policy:
First, it’s complicated to calculate and drains economic resources due to high compliance and administrative costs. Second, it isn’t neutral, treating certain business types, industries, and operations differently. Both of these lead to economic distortions that would not be present in the absence of such a tax.
I’ll dig more into these two issues over the next few days in a blog post series on the Texas margin tax experience and what a similar tax could mean for Nevada. Stay tuned!Share