Oregon Shouldn’t Adopt a Margin Tax in Its Search for Revenue

Oregon’s Joint Committee on Student Success Subcommittee on Revenue is moving closer to recommending a revenue option to fund Oregon’s education system. The subcommittee presented three options to the Student Success Committee last Thursday night, modeled on Ohio’s 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. and Texas’ margin tax, a modified gross receipts 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. that allows for some deduction for a firm’s costs. While it is a step forward that policymakers are mindful of reducing the negative economic effects created by a gross receipts tax, modifying the tax by permitting partial deductions for business costs increases tax complexity and does not offset the problems imposed by 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. .

Proposed Options for Education Revenue, Oregon Joint Committee on Student Success Subcommittee on Revenue

Proposal	Commercial Activities Tax	Modified Commercial Activities Tax Proposal 1	Modified Commercial Activities Tax Proposal 2
Tax rate	0.37%	0.45%	0.90%
Deduction	None	25% of business inputs or labor compensation	100% of business inputs or labor compensation
Net Revenue Impact, 2021-2023	$2.17 billion	$2.21 billion	$2.21 billion

The first option presented to the Committee is a Commercial Activities Tax (CAT), which is levied on a firm’s gross receipts without any deductions for cost at a flat rate of 0.37 percent. The other two proposals modify the CAT to permit firms to deduct either their business inputs or labor compensation. The Committee could adopt a 25 percent deduction with a 0.45 percent flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. rate or a 100 percent deduction with a 0.90 percent flat tax rate. All of the proposals exempt firms with gross receipts under $1 million and would be paired with reductions to Oregon’s personal income tax rates, raising about $1 billion in revenue annually when the tax takes full effect in 2021.

The modified CAT proposals are modeled after Texas’ margin tax, which was created to reduce the negative economic effects of tax pyramiding by giving firms the option to deduct a portion of their costs from the 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. . Adopted fully in 2008, Texas enacted the margin tax to finance its public education system. The tax failed to raise the anticipated revenue over the first year, collecting $4.45 billion in 2008 and less than $4 billion in 2009, when official projections suggested that the tax would raise $5.9 billion per year. The construction of the tax was plagued with definitional issues over what costs could be deducted and added to business compliance costs when businesses filed their taxes.

Rather than finding a tax that offsets the negative effects of a gross receipts tax, Texas had created a “badly designed business profits tax…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,” according to tax scholar John Mikesell.

If a modified Commercial Activities Tax is adopted in Oregon, it would fail to mitigate the economic costs of gross receipts taxes while adding complexity for business taxpayers. Texas has learned this lesson, having reduced the tax rate for the margin tax by 25 percent in 2015. The Texas state legislature also communicated its intention to repeal the margin tax in the future, stating in its 2015 tax reform package that “the intent of the legislature to promote economic growth by repealing the franchise [margin] tax.”

Oregon’s Legislative Revenue Office (LRO) obtained model results for the proposed 0.37 percent CAT with no deductions for firm costs and a modified CAT with a 25 percent deduction for labor compensation or business inputs at a 0.45 percent tax rate. The LRO found that both the CAT and modified CAT raise prices by 0.33 percent in their short-run model, suggesting that the tax pyramiding mitigated by the partial deduction for business inputs or labor compensation was offset by the higher tax rate. While we do not have results for the proposal to allow firms to deduct the entirety of either labor compensation or business inputs, the higher rate imposed by this proposal—0.90 percent—would likely offset the pyramiding avoided by the deductions.

Instead of adopting a gross receipts tax with complicated provisions that do not mitigate the economic damage created by tax pyramiding, the Revenue Subcommittee should reconsider the proposed value-added tax. A value-added tax would ensure that business costs are not included in the tax base, eliminating problems with tax pyramiding. Policymakers may be concerned about the administrability of a value-added tax at the state level, as only one state—New Hampshire—administers one. While this is a legitimate concern, the Oregon Department of Revenue (DOR) stated during the March 7^th hearing that either a gross receipts tax or a value-added tax base can be administered by the Oregon tax authority.

Oregon should learn from the experience Texas had with its margin tax before settling on a modified CAT, as problems with revenue stability, complexity, and tax pyramiding make this a bad revenue option for the state to improve its public education system.

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