Near the conclusion of a legislative session focusing on what Texas Governor Greg Abbott (R) characterized as the “meat and potatoes” of policy, the governor signed into law SB 2, a bill intended to help rein in 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. es. In addition to addressing the concerns of many Texans, the bill addresses the core 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. issue of property taxation so that the legislature can focus future sessions on the least competitive component of Texas’ business tax code: the Margin Tax.
Because Texas forgoes an 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. , it relies more heavily on other sources of revenue, which means local governments in Texas are comparatively more important than in many other states. This yields property taxes that are higher than average, a frequent source of complaints in a generally low-tax state, even if high property taxes are part of the reason other taxes are low.
SB 2 is a levy limit, which is one of three categories of property tax limitations. This means it limits how much revenue the school district can collect, in this case to an annual growth factor of 3.5 percent (down from a previous cap of 8 percent). If a district wishes to impose property taxes at a rate which would bring in collections more than 3.5 percent above the previous year’s collections, the decision automatically is referred to the public through a tax ratification election. Levy limits constrain the total revenue a government entity can bring in, while still allowing individual taxpayers’ burdens to rise on a relative basis if their property values increase faster than those of surrounding properties.
Texas also considered increasing the state 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. to pay down reductions in local property tax millages, but the measure did not make it to the governor. This is likely to the state’s benefit, as state-for-local tax swaps are often difficult to accomplish. In this particular case, the bill would have changed revenue distributions considerably, and after an initial reduction, would not have prevented localities from nudging tax rates back toward their pre-swap rates.
Now that the Lone Star State has addressed citizen’s most vocal concerns, the legislature has an opportunity to shift its focus to the Margin Tax—one of the true problems lurking inside the state’s otherwise highly-competitive tax code.
The Margin Tax, enacted in 2008, is a complicated hybrid 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. on business revenues. When filing, businesses have the choice of deducting from their gross receipts either compensation or the cost of goods sold, but not both, for the purpose of calculating tax liability. The tax has led to confusion and various legal challenges, in addition to bringing in less revenue than expected. Phasing out the Margin Tax would make the Texas tax code far more competitive and efficient for Texas businesses.
Effective tax rates under gross receipts-style taxes, such as the Margin Tax, vary dramatically by industry or individual business—far from the principle of tax neutrality. Manufacturing companies and those which consume large amounts of material end up bearing the brunt of the tax, largely exempting those with mostly human capital. The tax burden differs even among manufacturing companies: Those which bring the whole process under one roof pay minimal gross receipts taxes, but those which are less vertically-integrated face 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. every step of the way.
Other than Texas, only four states—Delaware, Ohio, Nevada, and Washington—levy gross receipts taxes (GRTs). Oregon recently passed a measure to install its own GRT, although an association of Oregon industrial businesses is currently collecting signatures to put a repeal referendum on the ballot.
Texas has already taken some steps to lower the tax’s burden. The Margin Tax features a no tax threshold, where those making less than the threshold in revenue do not have to file. The state started raising the threshold from $300,000 to $1 million of revenue in 2010, and then gradually increased it further to 2018’s $1.13 million threshold. It did something similar with its rates—retail or wholesale rates today have dropped from 2008’s 0.5 percent to 0.375 percent, and rates on transactions other than wholesale have dropped from 1.0 percent to 0.75 percent over the same period.
If Texas is looking for revenue to replace the Margin Tax, the retail sales tax on final consumption is a much more efficient and economically neutral source of revenue. Texas’ economy, like the broader U.S. national economy, has experienced an economic shift, making services a greater proportion of the economy than goods. Many states have seen an erosion of their sales 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. s, which are largely made up of the consumption of goods rather than services. Texas installed its sales tax in 1961, which was much later than a majority of states, but still copied the Depression-era pattern of targeting the consumption of goods for its sales tax base. The Lone Star state currently taxes a number of services and has plenty of room to expand and modernize its sales tax to include additional services in order to eliminate the Margin Tax.
Going beyond property tax reform to address the Margin Tax would significantly improve the Lone Star State’s tax competitiveness.
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