Margin Tax is the Epitome of Bad Tax Policy
With most legislative sessions for 2014 adjourned, many states are now looking forward to November. Other than elections, various ballot initiatives will be voted on later this year. Perhaps the most economically damaging proposal comes from the state of Nevada, where voters will decide whether or not to impose a 2 percent modified gross receipts tax, or margin tax on the state’s businesses. Currently, only Texas has the economically devastating margin tax, at 1 percent, and that has been the subject of multiple votes to repeal just in the 2013 legislative session. Other states, such as Washington and Ohio also have experience with gross receipts taxes. The Texas experience with the margin tax is an instructive lesson for other states that may consider its implementation.
The overwhelming academic consensus is clear that taxes negatively impact economic growth. But it is also worth noting that not all taxes equally affect a state’s economy. Taxes on income and capital are especially bad for economic growth, such as the personal and corporate income taxes. Taxes on consumption are much less distortionary and detrimental to economic growth. However, of all the different kinds of taxation that are available to policymakers, the margin tax is among the worst in terms of hampering economic growth.
To provide some background, the Texas margin tax is a type of modified gross receipts tax. A gross receipts tax is a tax that is levied on a business’ total revenue rather than its net profits (like the corporate income tax). In Texas the tax has a rate of 1 percent (.5 percent for certain types of businesses) of a business’ “taxable margin.” It applies to all businesses that have revenues over $1 million per year, and, unlike a normal corporate income tax, it is owed regardless of profits or losses. A business’ “taxable margin” in Texas is calculated by the least of three options: 1) total revenue multiplied by 70 percent, 2) total revenue minus the cost of wages paid, or 3) total revenue minus the cost of goods sold. This calculation increases compliance costs far more than a normal corporate income tax by forcing three different calculations of taxable income each year.
Additionally, confusion and misreporting resulted from the ill-understood definition cost of “goods sold” because Texas’ definition is different from the federal definition. For instance, businesses may include bonus depreciation on their federal returns when reporting “costs” that they can deduct from their total tax liability, but for the Texas margin tax, the cost of asset depreciation under bonus depreciation rules doesn’t apply. It is these kinds of very technical differences that lead to many incorrect margin tax filings.
In addition to the extreme compliance costs of the margin tax, there are several other reasons why it is an example of a uniquely bad tax. Budgets are created by Texas legislators based on projections of what revenues will likely be in the next year. The least volatile sources of taxation are property taxes and sales taxes respectively. The margin tax is one of the most volatile sources of revenue in Texas. It has failed to reach the revenue projections every year it has existed, making it much harder for legislator’s to budget for the core state services and responsibilities.
Another reason the margin tax is so unpopular is the nature of the tax itself. As mentioned above, the margin tax is not collected on business profits but instead on a “taxable margin.” For many firms, this means owing a large tax bill in years when no profits have been made. This tax can serve as a knockout punch for struggling firms that fail to even make a profit.
Tax pyramiding is another major issue with the margin tax. Tax pyramiding means that the price of goods that consumers ultimately pay includes the economic cost from taxes that companies paid at various levels of production; this is built into the price of the good and is in addition to any general sales tax that a consumer might pay. This occurs because the tax is paid, not by the final consumer, but at every level of production. Since the margin tax does not exempt business inputs from the “taxable margin” like most sales taxes do, this multiplies the tax burden that the final consumer must pay and handicaps businesses that produce complex goods that inherently require more stages of production than others. The end result is a highly distorted tax system that artificially raises the effective tax rate on more complex goods.
But perhaps the worst thing about the margin tax is that it picks winners and losers in the market by treating similar businesses differently. For example, Firm A and Firm B both have the same amount of profits, make the same thing, have the same amount of output, and even have the same federal corporate income tax bill. Because of the way the margin tax is calculated, the two similar firms may end up owing wildly different amounts to the state of Texas if their business models are different. Businesses that operate on a thin profit margin because of a different business model are hit much harder than similar businesses that operate with larger profit margins. Similar businesses with similar profit margins might be treated differently due to varying amounts of volume as well. If one firm is nearly identical to another but their volume of goods sold is higher, that will likely result in a much larger tax bill—even if their profits are no different from a competitor dealing with less volume. Treating similar businesses differently based on individual and internal choices violates one of the most fundamental rules of sound tax policy.
Due to the massive problems associated with the Texas margin tax, it is no surprise that it is very unpopular and has been considered for repeal multiple times. John L. Mikesell, a noted tax scholar, has said that the margin tax in Texas is 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.” For these reasons the organizations listed below have begun lining up to support its repeal/non-implementation:
National Federation of Independent Businesses – Texas
Americans for Tax Reform
Texas Conservative Coalition Research Institute
Texas Public Policy Foundation
R Street Institute
National Taxpayers Union
Nevada Policy Research Institute
A final thought to consider is an oft-repeated sentiment that Texas succeeds in spite of the margin tax, not because of it. All taxes impede economic growth, but the margin tax in Texas is uniquely terrible and Nevadans should take note. Neither Texas nor Nevada is overburdened with regulations on businesses nor does either levy a personal income tax. These pro-growth policies have led to a uniquely high level of economic prosperity in Texas and Nevada. Ultimately, the margin tax hinders economic growth in Texas and threatens the economic growth potential in Nevada.