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Article Excerpt
INTRODUCTION
In its most general form, the base of a gross receipts tax (GRT) is the dollar value of receipts from sale of goods and services, with no omission of categories of sales and no allowance for costs incurred by sellers. All businesses within a taxing jurisdiction report the value of their receipts and apply a tax rate to those receipts to determine the amount of tax owed. Current and proposed GRTs are not this general, as they omit categories of receipts, tax categories at differential rates, and make various ad hoc adjustments for costs.
The shortcomings of the GRT are well understood. As Mikesell (2007a, 1) succinctly states, "it (the GRT) lacks any link either to capacity to bear the cost of government services or to the amount of government services used--the normal standards for assigning tax burdens." Reflecting this criticism among others, state-level use of the GRT declined through the second half of the twentieth century, to the point that by 2002 only Delaware, New Mexico, and Washington levied significant gross receipts taxes. And the New Mexico tax is best regarded as a broad-based sales tax.
However, rather than continuing to fade away, since 2002 some form of GRT has been enacted in New Jersey, Kentucky, Ohio, and Texas, and modified GRTs have recently been considered in Illinois, Maine, and Montana. Michigan's just-enacted (2007) replacement for its single business tax has a GRT component. The New Jersey tax was short-lived, expiring in 2006. These new GRTs have been enacted in part as replacements for existing taxes and in part as sources of additional revenue.
This resurgence in the use of and interest in GRTs raises the question of why this tax, long denigrated by economists, is being considered again by state legislatures. To address this question, I first consider several more fundamental questions. What principles should guide choice among taxes collected from businesses? How does the GRT stack up not only against these principles, but also against existing and other feasible taxes? How do the newly enacted GRTs compare to the taxes they replace? Are there better replacement taxes than the GRT?
BUSINESS TAX PRINCIPLES
Since income from economic activity ultimately accrues to individuals, the burden of taxes collected from businesses necessarily falls on individuals. Businesses have no tax-paying capability independent of the persons who are their owners, customers, employees and suppliers. In short, business taxes are indirect taxes on persons.
What does it mean then to label a tax as a "business tax"? Does it mean that the burden of the tax falls fully on the owners of businesses--on suppliers of capital? Does it mean that the tax has some other specified incidence? If so, to label a tax we would have to know its incidence with fair precision. Or, does it simply mean that the tax is collected from businesses? In this paper, I use the term in this second sense.
So why not collect all taxes from persons? Why collect any taxes from businesses? There are two reasons for doing so. The first and most compelling reason is that economic efficiency cannot be achieved without taxing businesses for the costs of their activities that they would otherwise ignore. I term these the social costs of business activity (Pogue, 1998). These are external costs, such as production-generated air and water pollution. And they are the costs that governments incur in providing services and facilities used by businesses--transportation infrastructure, police and fire protection, the court system required to enforce contracts and property rights, etc. The term "social cost" is sometimes used to refer only to external costs and not the costs of government services. However, I include both categories of cost because both are borne by society at large unless government acts to internalize them.
Economic efficiency requires that businesses face taxes (or government mandated charges and fees) that accurately reflect the social costs of their activities, just as market prices reflect the costs of other inputs. When such taxes and charges fall short of social costs, businesses are subsidized. Efficiency also requires that businesses be taxed uniformly, so that relative prices are not changed, unless tax differentials can be linked to differences in social costs. However, if businesses do differ in their social costs, whether external costs or costs that government incurs on their behalf, efficiency requires differential taxes. In that case, efficient taxes may alter relative prices, and in doing so appear to lack neutrality unless one recognizes their role in offsetting social costs. I will follow the tax policy literature and use the terms "efficiency" and "neutrality" interchangeably, recognizing, however, that neutral taxes may affect relative prices.
Imposing taxes to offset businesses' social costs may lead to higher product and service prices and/or lower payments for labor, capital, and natural resources than would otherwise be the case. Output, employment, and/or profits may fall in some sectors (those with relatively high social costs), while rising in others. Some businesses may fail. But these outcomes are not an argument against taxing or otherwise charging businesses for the social costs of their activities. Higher output prices and/or lower input prices are necessary consequences of internalizing social costs. So too is the realignment of production from sectors with relatively high social costs to those with relatively low costs.
Taxing businesses to cover social costs, as defined above, encompasses the benefit rationale for taxing businesses. But the benefit rationale, which calls for taxing businesses to cover the costs of government services, is often treated separately (Oakland and Testa, 1996 and 2000; Bird, 2003; McLure, 2005). As noted above, I have not done so because the policy objective is to internalize costs that businesses would otherwise ignore, whether those costs are external costs or the costs of government services. Of course, the taxes and charges required to internalize external costs will likely differ from those that best account for the costs of government services that benefit businesses.
The second reason for taxing businesses is that compliance and administrative costs may be lower when taxes are collected from businesses. Important examples are collecting payroll and wage taxes from employers instead of employees, and collecting retail sales taxes from sellers instead of buyers. Taxes collected from businesses for this reason are not commonly regarded as business taxes.
A need for revenue is not a reason for taxing businesses, nor is the mistaken belief that taxes on businesses do not burden individuals. Apart from taxing to offset social costs, one might argue that a corporation income tax (CIT) is needed to tax retained earnings as they accrue, in which case the tax functions as a withholding tax on individual shareholder income. However, a state--level CIT is a poor tool for this purpose because many shareholders of the corporations in any given state are likely to reside outside that state. More generally, a tax on business income or property may be seen as a partial remedy for deficiencies in existing personal income and consumption taxes. But the ideal remedy for such deficiencies is to reform direct taxes; attempting to tax personal income and consumption with indirect business taxes is clearly a second-best strategy.
Implications of the Social Cost Rationale
What are the main implications of applying the social cost rationale for taxing business?
Taxation should not be conditional on income, and it should not be restricted to profitable businesses. Unprofitable businesses benefit from government services and generate social costs. An income tax is, therefore, an inappropriate means of taxing business. Further, fairness in business taxation does not imply that businesses with equal income should pay equal taxes.
But this requirement--that profitability not be a factor in determining businesses' tax liabilities--is not easily or widely accepted by legislators and businesses. Consequently, the contrary belief that profits, especially the lack thereof, should be considered in assessing business taxes has likely deterred use of state-level value added taxes, which Oakland and Testa (1996), among others, see as the best means of charging businesses for general government services. And businesses' objections to paying the Michigan Single Business Tax even when they were unprofitable likely contributed to its termination at the end of 2006 and its replacement by the newly enacted Michigan Business Tax.
Personal income and consumption taxes are not appropriate charges for social costs, which are attributable to business activity, not income or residency of persons.
As a charge for general government services, a business tax should apply to all forms of production regardless of how organized. In particular, non-profit, not-for-profit, and charitable businesses and organizations should be taxed in the same manner as for--profit enterprises. Likewise, government enterprises--water supply, power, sewage collection and treatment, parking--should be taxed in same manner as private businesses. Failing to do so subsidizes these entities.
Even if businesses engaged in activities regarded as socially beneficial are deemed worthy of subsidy, it is unlikely that the appropriate subsidy is measured by their social costs--by either the external costs they generate or the cost of government services provided to them. Nevertheless, such businesses often face lower taxes and fees than other businesses. And they may be exempted from regulations and fees aimed at curtailing external costs. Although subsidizing in this manner is often an appealing policy, a better approach would be direct subsidies based on explicit estimates of the external benefits generated by the businesses.
If the social costs generated by businesses are proportional to some broad measure of economic activity, such as value added, then a tax on that measure is appropriate. Oakland and Testa (1996; 2000), Testa and Mattoon (2007) and Bird (2003, 708-9) have argued that the costs of general government services are indeed roughly proportional to value added, and for that reason they have advocated an income-based value added tax (VAT) to tax businesses for government services. To illustrate, for the 50 states and the District of Columbia, Testa and Mattoon (2007) estimated that government expenditures on businesses averaged about two percent of value added in 2005. Correspondingly, the VAT tax rate to cover such costs would have averaged two percent, but actual state--local business taxes were estimated to range from three to five percent of value added. Limiting taxes on businesses to the amount required to cover costs of government services would, therefore, by their estimates significantly reduce business taxes--in many states by more than 50 percent.
But use of government services as well as external costs are in fact likely to vary relative to value added, across industries and even among individual firms in an industry. So levying a VAT to cover the cost of general government services to business would only be a partial solution to the problem of taxing businesses for the social costs of their activities. The...
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