West Virginia Becomes the Latest State to Contemplate a Gross Receipts Tax

You campaign in poetry but govern in prose (or at least, so said Mario Cuomo). With his tax increase package, newly minted West Virginia Governor Jim Justice (D) wasted little time putting the poetry of the campaign trail behind him.

Justice never explicitly pledged not to raise taxes, but he came close. “You cannot tax our people anymore. They can’t stand it,” he declared on the stump. In a debate, he dismissed the notion that the only alternatives were to raise taxes or cut government spending, insisting, “The alternative is cut, cut, cut or tax, tax, tax — and I don’t believe in either of those.” He pledged to “right-size” government. And he accused his opponent of wanting to boost local taxes.

That was then.

On the first day the West Virginia legislature gaveled into session, Justice used his State of the State address to outline $450 million in new and higher taxes, including:

• a 0.2 percent gross receipts tax ($214 million)
• a sales tax rate increase from 6.0 to 6.5 percent ($93 million)
• the repeal of sales tax exemptions for professional services and advertising ($88 million)
• an increase in beer taxes and wholesale liquor markup ($6 million)

Of these proposals, by far the most notable—and the most economically destructive—is the gross receipts tax, modeled after Ohio’s Commercial Activity Tax (CAT), which is levied at a rate of 0.26 percent on business taxable income above $1 million. As gross receipts taxes, both the Ohio CAT and Governor Justice’s proposed tax are imposed on a company’s gross income rather than its net income (profit), and thus bear no relationship to a firm’s ability to pay.

Because industries and individual companies operate under dramatically different profit margins, some companies face high effective rates. Moreover, because the tax is imposed at each stage in the production process, “tax pyramiding” results, whereby the same final transaction is exposed to taxes several times over. (See here, here, and here for more on the economics and effects of gross receipts taxes.)

Under the Ohio CAT, a firm with a profit margin of 1 percent faces a 26 percent effective tax rate on corporate net income, which is notable given that some industries do run on average profit margins of just a few percent, and of course some companies experience actual losses. An Ernst & Young (now EY) study applied average profit ratios for major industries to estimate effective tax rates under the CAT, and found rates ranging from 0.4 percent (management of companies) to 8.6 percent (construction), with a weighted average of 4.7 percent on a 0.26 percent gross receipt tax, just slightly higher than what has been proposed in West Virginia. Other industries with above-average tax rates under the Ohio CAT include wholesale (8.3 percent), retail (7.9 percent), and transportation and warehousing (7.0 percent), all low-margin enterprises.

In many ways, gross receipts taxes are a throwback to an earlier era. Once common due to their ease of administration, these taxes were largely abandoned over the course of the 20th century as states sought to modernize their tax codes and jettison their least competitive components. More recently, however, with corporate income tax revenues declining sharply, gross receipts taxes have seen a resurgence, adopted in Ohio, Nevada, and Texas, and currently under consideration in the Oregon legislature following the defeat of a high-rate gross receipts tax on the state ballot last November.

Unfortunately, the economics of gross receipts taxes have not changed. They remain a regressive, economically harmful mode of taxation which increases the cost of goods, encourages inefficient economic activity (like otherwise unprofitable vertical integration to limit the number of stages of production subject to the tax), and levies widely disparate and ultimately arbitrary tax burdens on a state’s businesses. Governor Justice has made it clear that he believes West Virginia desperately needs to become more competitive; the commercial activities tax would be a major step in the wrong direction.