The Economist’s Case Against Gross Receipts Taxes
December 5, 2006
Almost every tax policy has both good and bad features. But there are some tax policies that, on a net basis, are so poorly designed and so counter to the economic efficiency of the marketplace that they are indefensible from the standpoint of sound public policy. As we outline in our latest report, "Tax Pyramiding: The Economic Consequences of Gross Receipts Taxes," gross receipts taxes are among those indefensible tax policies.
The basic problem with gross receipts taxes is not that they are implemented poorly by lawmakers. It's that even in theory, it's impossible to craft an economically neutral gross receipts tax. This sets them apart from income, sales, property or other taxes, all of which can be made economically neutral if properly designed.
Under gross receipts taxes, it is impossible to avoid what economists call "tax pyramiding" or "cascading," in which products are taxed multiple times as they move through the production process. For this reason, economists and other tax policy scholars have almost uniformly criticized gross receipts or "turnover" taxes, and have advocated for their repeal and replacement with more neutral consumption or income taxes since the days of Adam Smith's Wealth of Nations.
But don't take our word for it. Here's a sidebar from the paper presenting Adam Smith's famous critique of what are today known as gross receipts taxes:
Adam Smith’s Celebrated Critique of Gross Receipts Taxes
Gross receipts taxes have a long and controversial history. One of the earliest examples was Spain’s notorious alcabala tax (alternatively spelled alcavala), first imposed in 1342, and not fully eliminated until the 20th Century. In his celebrated discussion of public finance in the Wealth of Nations, Adam Smith famously pilloried the Spanish gross receipts tax for damaging the Spanish economy, and ultimately laying the groundwork for the country’s rapid economic decline in the 17th Century:
The famous alcavala of Spain… was at first a tax of ten per cent., afterwards of fourteen per cent., … upon the sale of every sort of property whether movable or immovable, and it is repeated every time the property is sold. The levying of this tax requires a multitude of revenue officers sufficient to guard the transportation of goods, not only from one province to another, but from one shop to another.
It subjects not only the dealers in some sorts of goods, but those in all sorts, every farmer, every manufacturer, every merchant and shopkeeper, to the continual visits and examination of the taxgatherers. Through the greater part of a country in which a tax of this kind is established nothing can be produced for distant sale….
It is to the alcavala, accordingly, that Ustaritz imputes the ruin of the manufactures of Spain. He might have imputed to it likewise the declension of agriculture, it being imposed not only upon manufactures, but upon the rude produce of the land. (Source: Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, Book V, Chapter II (1776).)
As we note in the paper, despite over two centuries of criticism from economists, gross receipts taxes continue to enjoy wide popularity among lawmakers—as evidenced by their recent enactment in Texas and Ohio, and the many other states considering them as a replacement for deteriorating state corporate income taxes. For our full case against the gross receipts as a replacement for state corporate income taxes, download the full study here.