Baker Institute expert explores surge of state gross receipts tax proposals

While some states may consider a gross receipts tax (GRT) to generate revenue, enhance business competitiveness or implement alternatives to the administratively burdensome state corporate income tax (CIT), the GRT is viewed by most economists as a bad tax primarily because of “tax pyramiding,” according to an expert at Rice University’s Baker Institute for Public Policy.

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Joyce Beebe, fellow in public finance, outlined her insights in a new issue brief, “A Primer on Gross Receipts Taxes.” She explains the structure of the GRT, compares it with other business tax instruments, such as the CIT and value-added tax (VAT), and examines these seemingly conflicting trends.

Beebe said pyramiding, a feature of the GRT, occurs when products and services are taxed each time they are purchased and sold by subsequent firms during the production process. “The tax thus becomes part of the base in each subsequent sale, and final purchasers pay a higher tax because of the repeated taxation of the same inputs,” she wrote. “Because of the lack of deductions for business-to-business sales and the repetitive tax levy at each stage of production, the effective tax rate on final sales under the GRT is not only higher than the statutory rate, but it could also be different for similar goods, depending on the number of taxable intermediate transactions in the production-distribution process.”

In 2017 Oregon, Oklahoma, Louisiana and West Virginia sought to enact a statewide GRT to replace their obsolete tax systems and improve revenues. “Although none of the proposals were implemented, Oregon has indicated that it might propose creating a GRT again in the next legislative session, and West Virginia’s proposal was approved by the legislature but ultimately not enacted,” Beebe wrote.

Five states (Ohio, Texas, Delaware, Washington and Nevada) currently have a statewide GRT. Besides Delaware, these states do not explicitly refer to the tax as a GRT. Ohio refers to the GRT as the commercial activity tax (CAT), Texas calls the state GRT a franchise tax or margin tax, Washington named its GRT the business and occupation tax and Nevada’s GRT is the commerce tax, Beebe said. New Mexico has a GRT, but its characteristics are more similar to a broad-based sales tax, she said.

States typically impose a GRT as a privilege of doing business in the state, Beebe said. “In its most general form, the base of the GRT comprises the receipts from all sales of goods and services and applies to all businesses within a state,” she wrote. “A GRT does not provide allowances for costs incurred by sellers or offer exemptions to particular types of sales. Business entities simply apply a single tax rate to the sales receipts to calculate the taxes owed. None of the current state GRTs fit squarely into this description — they either exclude certain types of sales or entities, tax different businesses at different rates or allow various deductions.”

Texas legislators have made attempts to repeal the state’s franchise tax, a hybrid form of the GRT. The franchise tax has been the subject of several lawsuits, Beebe said. “For example, the Texas Supreme Court in September heard oral arguments for a case in which the petitioner claimed that the 10-year-old franchise tax is actually an income tax,” she wrote. “The unpopularity of the tax is widespread, leading policymakers to propose repealing it; however, such efforts were unsuccessful in the 2017 legislative session.”

State business tax reform cannot happen in a vacuum, Beebe said. “A state’s existing business tax structure, economic climate, industry concentration and other state or local taxes all need to be considered,” she wrote. “Although most economists support the VAT, its transition costs and unfamiliarity have been major obstacles to its successful adoption. A policy choice between the GRT and the CIT may reflect what is more tolerable to state and local constituents and policymakers — a distortionary tax that generates revenue or the incumbent, more complicated tax.”

“Regardless of which business tax a state decides to implement, the overarching characteristics that are desirable are clear: The tax should be a broad-based, low-rate tax that has limited pyramiding and does not create many tax avoidance opportunities,” Beebe wrote. “After such a tax is enacted, states also need to avoid the pressure to erode the tax base over time — either by offering concessions to specific industries, excluding particular groups or providing incentives for certain activities. Without ongoing maintenance, the shrinking tax base will necessitate rate increases to bring in the same amount of revenue, and the modified tax may eventually look like the CIT today.”