January 31, 2007
Gross Receipts Taxes: Bad Policy Prescription for States
Old Tax Unfortunately Seeing New Life
Published by the Tax Foundation and the Council on State Taxation
For media inquires please email Brian Phillips or call 202.464.5102
WASHINGTON, D.C. - Gross receipts taxes violate basic principles of good business tax policy and should be avoided by state lawmakers debating tax reform, according to a new study published by the Tax Foundation and the Council on State Taxation (COST).
The in-depth Background Paper, written by Professor John Mikesell of Indiana University, provides a history of gross receipts taxes, which date back to the thirteenth century, and makes a convincing argument against their re-emergence.
"No sensible case can be made for imposing gross receipts taxes in the modern economic environment," Mikesell concludes. "Gross receipts taxes should never be seen as an element of positive tax reform. They were abandoned for good reason."
In short, gross receipts taxes are levied on the full value of each business transaction during the chain of production, from the time a resource is extracted to the time it becomes a product for sale. Unlike other business taxes, the taxable amount is not adjusted for business costs.
According to the report, entitled "Gross Receipts Taxes in State Government Finances: A Review of Their History and Performance," gross receipts taxes violate key principles of taxation such as transparency, simplicity and neutrality. The result creates a hidden tax on consumers buried in the price of the product. Gross receipts taxes promote distortions in the market that cause businesses to make inefficient decisions to avoid higher taxes, according to the study.
"Businesses never represent the final resting place of the tax burden, but rather serve as a conduit of the tax burden to households, either through higher prices paid for goods,...lower returns received from the sale of services... or through reduced net returns to business owners," Mikesell argues. "A tax that distorts the functioning of the market is a loss for everyone; any special advantage from the distortion is less than the loss incurred by the rest of the economy."
Mikesell acknowledges that taxing private business is appropriate and that "it is logical for businesses to pay for the public services that allow them to protect their operations, to prosper financially, and to grow." But lawmakers must also understand that businesses will always pass on the costs of doing business to consumers, employees, and shareholders.
In other words, businesses don't pay taxes any more than a plot of land pays property taxes. Ultimately, people have to pay. The method of taxation should allow taxpayers to be aware of the tax and understand what is being taxed, and should treat all taxpayers the same
For state lawmakers approaching tax reform, the report offers this advice: "Rather than designing policy to tax business, a more useful approach is to recognize the role of business as a conduit to households and to structure taxes accordingly."
See also: Tax Policy Podcast: John Mikesell on the Reemergence of Gross Receipts Taxes
EXCERPTS:
"These are general taxes on gross receipts of all businesses-sellers of both goods and services-
without allowance for costs of the business or for receipts from sales made to other businesses.
Although the actual incidence of a gross receipts tax depends on market conditions, under most circumstances the tax is likely to be reflected in product prices as it flows to the final customer. And the final price is likely to reflect the gross receipts tax added at each point that the product and the inputs used to make the product changed hands in the distribution flow."
"To require payment of tax by business entities is convenient because economic activity is more concentrated in businesses than in households and because businesses are generally more familiar with the requirements of financial recordkeeping and reporting than the average household. Collecting taxes from business is thus administratively economical and convenient. It appears reasonable because private businesses are the source of economic prosperity in a market economy and the government must seek financial support from the places that have resources available. It is politically attractive because placing a tax on business appears to relieve the fiscal burden from households-where the voters are. And it is logical for businesses to pay for the public services that allow them to protect their operations, to prosper financially, and to grow."
"Suppose, for example, that a company manufactures and sells an automobile. The value of that automobile would be measured as part of the gross state product. A turnover tax would apply to
those gross receipts. However, that tax would also apply when tire manufacturers sold tires to the company to install on the automobile, when steel manufacturers sold sheet steel to be fabricated into the body of the car, when utilities sold power and water to the automobile manufacturer and to the tire maker, and so on.22 Hence, it is apparent that the gross receipts or turnover base exceeds the value of final production (or gross product) of the state. The gross receipts base is broad. But is it reasonable to have an annual tax on a flow whose base is larger than the sum of economic production in the state?"
"A tax (and a tax system) should raise revenue in a way that has minimal effect on economic choices made by individuals and businesses. It ought not interfere with the functioning of the competitive market as it allocates resources to the betterment of society. When taxes distort decisions, the result is a higher cost of getting goods and services to the public than would otherwise be necessary and lower potential living standards for the citizenry than would otherwise be attainable."
For media inquires please email Brian Phillips or call 202.464.5102
