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A Primer on Gross Receipts Taxes

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A Primer on Gross Receipts Taxes ISSUE BRIEF 01.09.18 A Primer on Gross Receipts Taxes Joyce Beebe, Ph.D., Fellow, Center for Public Finance Ask any economist about the gross receipts Washington named its GRT as the business tax (GRT) and you are likely to get a frown and occupation (B&O) tax, and Nevada’s GRT of disapproval. However, in 2017, four is the commerce tax. New Mexico has a GRT, states—Oregon, Oklahoma, Louisiana, and but its characteristics are more similar to a West Virginia—sought to enact a statewide broad-based sales tax.3 GRT. Although none of the proposals was Typically, states impose a GRT as a implemented, Oregon has indicated that it privilege of doing business in the state. might propose creating a GRT again in the In its most general form, the base of the next legislative session,1 and West Virginia’s GRT comprises the receipts from all sales proposal was approved by the legislature but of goods and services, and applies to all ultimately not enacted.2 businesses within a state. A GRT does not In Texas, the franchise tax, a hybrid provide allowances for costs incurred by form of the GRT, has been the subject of sellers or offer exemptions to particular several lawsuits. For example, the Texas types of sales. Business entities simply Supreme Court in September heard oral apply a single tax rate to the sales receipts arguments for a case in which the petitioner to calculate the taxes owed.4 None of the claimed that the 10-year-old franchise tax is current state GRTs fit squarely into this actually an income tax. The unpopularity of description—they either exclude certain the tax is widespread, leading policymakers types of sales or entities, tax different to propose repealing it; however, such businesses at different rates, or allow States considered GRTs efforts were unsuccessful in the 2017 various deductions. to generate revenue, legislative session. How can we explain that The recent proliferation of GRT proposals enhance business four states that do not have the GRT are is not new. Several states went through seeking to enact it, while Texas is trying to similar exercises in the early 2000s; New competitiveness, or repeal the GRT? What led to these seemingly Jersey, Michigan, and Kentucky even implement alternatives conflicting trends? passed state laws adopting a GRT, but they to the administratively were later repealed.5 In the first decade burdensome state of this century, states considered GRTs corporate income WHAT IS A GRT AND WHAT HAS to generate revenue, enhance business CAUSED THE RECENT SURGE OF competitiveness, or implement alternatives tax (CIT). STATE GRT PROPOSALS? to the administratively burdensome state corporate income tax (CIT). Similar Five states (Ohio, Texas, Delaware, objectives drove the 2017 wave of GRT Washington, and Nevada) currently have proposals—all four states have budget a statewide GRT. Besides Delaware, these deficits, and additional revenue is crucial. states do not explicitly refer to the tax They also need to reform their states’ as a GRT—Ohio refers to the GRT as the outdated tax systems to match current commercial activity tax (CAT), Texas calls economic realities. In some ways, states the state GRT a franchise tax or margin tax, may find it easier to tax services by enacting RICE UNIVERSITY’S BAKER INSTITUTE FOR PUBLIC POLICY // ISSUE BRIEF // 01.09.18 a GRT than by expanding the existing sales production inputs; in this case, the payment or income tax base. The GRT also seems is for public services instead of land or labor. easier to understand and explain than other Unless a certain industry or type of entity taxes. Additionally, the GRT’s misleadingly benefits from such services differently Business taxes are low statutory tax rates are more acceptable than other types of industries or entities, imposed to reflect at first glance, despite the hidden all businesses should be taxed uniformly pyramiding effects that lead to higher regardless of profitability, nonprofit status, the true costs of a effective tax rates (ETRs), as discussed in the or charitable functions. However, although business’ activities. next section. theoretically true, this generalization Certain costs generated Several states originally based their GRT is not widely applied by legislators and by businesses (such proposals on Ohio’s CAT. What makes the businesses in practice. People tend to react as air and water Ohio CAT an attractive version of the GRT negatively toward taxing businesses that is that it replaced more unpopular taxes operate at a loss or serve as nonprofit or pollution) and costs of and has a broad-base, low-rate structure. charitable organizations, even if they do use government services Specifically, the CAT replaced the state’s government services. that businesses benefit franchise and personal property taxes in Business tax instruments generally from are not fully or 2005. Many residents believed that the include the CIT, GRT, and value-added tax franchise tax was subject to excessive tax (VAT),8 which are discussed below. voluntarily reflected avoidance planning and did not generate in their financial sufficient revenue, while the personal VAT statements. property tax on businesses was viewed as Many economists agree that a VAT is detrimental to the state’s extensive but more efficient than other business taxes. fragile manufacturing base. In contrast, the From a benefits-received perspective, CAT has a broad base that approximates external costs generated and government a standard GRT in that it does not allow services used by businesses are roughly deductions for the costs of goods sold proportional to the incremental value 6 (COGS) or other expenses. The tax base also created by business entities at each stage includes the rapidly growing service sector, of operations, which is precisely the VAT’s which was not covered under the previous measure of economic activity.9 tax system. The CAT rate is 0.26 percent, There are several alternative structures which is relatively low, for businesses with for a VAT. The income-based VAT taxes the gross receipts of over $1 million. sum of different forms of income, including labor compensation, rental payments, interest payments, and profits. The base of ECONOMISTS’ VIEWS OF THE GRT a consumption-based VAT is the difference Economists generally agree that business between a firm’s sales and its purchases taxes are imposed to reflect the true costs from other firms. The tax bases under of a business’ activities. Certain costs these two methods can be constructed to generated by businesses (such as air and be similar to each other, while the major water pollution) and costs of government difference is the treatment of capital services that businesses benefit from (such assets. A consumption-based VAT allows as education, transportation, infrastructure, businesses to expense capital purchases, public safety, fire, the judicial system, whereas an income-based VAT replaces etc.) are not fully or voluntarily reflected expensing with deductions for depreciation, 10 in their financial statements.7 Business similar to a standard income tax. Finally, taxes therefore incorporate these costs into tax filing is reasonably straightforward, business operations. especially for an income-based VAT, This principle implies that as long as because many components can be pulled 11 the entities benefit from governmental from federal tax returns. services, they should pay for them. From Similar to the GRT, a VAT is levied at each this perspective, paying business taxes stage of operation, but it differs from the is viewed as similar to paying for other GRT in that it allows deductions of all inter- 2 A PRIMER ON GROSS RECEIPTS TAXES firm purchases at each stage. The net effect (1.6 times pyramiding) for the retail is the same as taxing the full value of goods trade industry to 3.2 percent (1.5 times and services at the time of final sale, and pyramiding) for electric, gas, and other there are no repetitive taxes for inputs used utility industries, with wide variation in ETRs in earlier stages of production. and pyramiding across industries. Certain industries such as food manufacturing GRT have an ETR of 2 percent but pyramid 6.7 The GRT is viewed as a bad tax primarily times. The average statewide ETR for all because of “tax pyramiding.” Pyramiding industries is 1.5 percent, which translates to 15 occurs when products and services are 2.5 times pyramiding. Some economists taxed each time they are purchased and view these results as large distortions, while sold by subsequent firms during the others interpret the results from a tax rate production process.12 The tax thus becomes differential perspective and indicate that the 16 part of the base in each subsequent sale, pyramiding is modest. and final purchasers pay a higher tax In principle, tax pyramiding can be fixed because of the repeated taxation of the by exempting the sale of intermediate goods same inputs.13 Because of the lack of and services from the GRT base, with the deductions for business-to-business (B2B) trade-off being reduced revenues, increased sales and the repetitive tax levy at each complexity in taxation, and conversion of stage of production, the effective tax rate the GRT to a tax that bears characteristics (ETR) on final sales under the GRT is not only of other tax instruments. This begs the higher than the statutory rate, it could also question of why the alternatives are not be different for similar goods, depending implemented in the first place. For example, on the number of taxable intermediate taxing only the value-added portion at transactions in the production/distribution each production stage instead of the full process. The more times the products value of the good or service makes the The GRT is viewed as change hands across entities, the higher GRT resemble a VAT.
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