On April 15, Texas Governor Rick Perry called for substantial cuts to the state’s “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. , a complex tax partially based on gross receipts that we have been critical of since its inception. According to State Tax Notes (subscription required), the plan would:
- “reduce [margin] tax rates by 5 percent;
- provide a $1 million deduction for businesses with revenue up to $20 million;
- lower the rate for EZ Form filers; and
- give companies relocating to Texas from out of state a one-time deduction of moving expenses in the first year they pay the [margin] tax.”
When the tax was originally put in place, the exemption was set at $300,000; but after an outcry from businesses, it was raised to $1 million and has stayed there since. Perry would make this higher exemption permanent at $1 million.
Some legislators have criticized the move, which would take money out of the state’s rainy day fund. The fund currently has $7.9 billion in balances, and the worry is that if the fund is too low, they will be forced to raise taxes or cut spending in a fiscal crisis (check out CBPP’s paper on rainy day funds). On the other hand, if the fund reaches its statutory limit of 10 percent of total revenue (around $13 billion), additional revenues will flow into the general fund, where they will ostensibly be spent.
Those caveats aside, this reform is a step in the right direction. Moreover, I’m happy to see that Governor Perry recognizes that the margin tax should be the focus of reform in Texas’ tax code. Past years have seen quixotic calls to eliminate property taxes in the state, which may need reform, but are nowhere near as distortionary or complex as the margin tax. Cutting property taxes may be popular, but property taxes are also generally found to be the least destructive taxes to growth.
|State Gross Receipts Taxes as of January 1, 2013
|Name of Tax
|Range of Rates
|Manufacturers’ & Merchants’ License Tax
|0.1006% – 0.7543%
|Commercial Activities Tax (CAT)
|0.5% – 1%
|Business/Professional/Occupational License Tax (BPOL)
|0.03% – 0.58%
|Business & Occupation Tax (B&O)
|0.13% – 3.3%
|(a) Virginia’s tax is locally levied and rates vary by business and jurisdiction.
Source: Commerce Clearing House; state revenue departments; Tax Foundation.
The problem with the margin tax is that it is fundamentally a gross receipts taxA gross receipts tax, also known as a turnover tax, is 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. , which is like a sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. that is problematically levied at all stages of production. These types of taxes pyramid as products move through production stages. For example, if you build a car under a gross receipts tax regime, the rubber in the tire would be taxed when it came out of the tree and was sold to the tire company, then again when the tire company sells the tire to the car manufacturer, then a third time when the car manufacturer sells to the consumer.
With each additional transaction, the tax becomes imbedded in the price of the product, a feature which is an affront to the principle of transparency. Gross receipts taxes are also not neutral in that they have lower effective rates on industries with fewer stages of production and higher effective rates on industries with more stages of production. Sometimes businesses will vertically integrate their production processes just to reduce their tax burden, even if doing so doesn’t make any economic sense. These are just some of the reasons that gross receipts taxes only comprehensively exist in five states (table above).
The margin tax is a very poor part of Texas’ otherwise very stellar tax system. While full repeal should be the goal, virtually any move to limit the tax is desirable.
More on Texas here.
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