Is there a role for gross receipts taxation?

INTRODUCTION

There has been an unexpected proliferation of states adopting the gross receipts tax (GRT) and other business activities taxes in recent years. States last embraced GRTs during the Great Depression when existing tax bases failed to produce enough revenue to keep key government services functioning. Today, the need for revenue again drives states to expand taxes collected from business. State and local governments have recently faced tumultuous times, going from fiscal feast (the boom of the 1990s) to famine (the 2001 recession). But perhaps unlike the GRTs, enacted out of desperation at the time of the Great Depression, states today are also likely to turn to new business taxes for reasons beyond revenue replacement, including the promotion of economic development and the reform of highly flawed and biased tax systems. In some instances, states have expediently turned to such taxes in response to judicial opinions criticizing current state fiscal systems.

GRTs are not being enacted in the principled vacuum of an ideal world and, thus, cannot be evaluated entirely from such a standpoint. Still, fundamental principles of tax policy offer important guidance, especially since GRTs are little known and less understood, yet sometimes injected into a heated policy debate concerning the direction of a state's fiscal system. GRTs must also be carefully considered in relation to what they are replacing, if anything. Here, economic principles are once again helpful in examining the trade-offs among alternative revenue vehicles. In either case, examination of the GRT against time-tested principles is of further merit because these "GRTs" come in many shapes and sizes. Accordingly, the economic effects of their bells and whistles are often difficult to discern without knowing what to look for.

This paper suggests a tri-partite approach to understanding and evaluating GRT proposals. All three approaches start from the basic principles of equity and efficiency. But the weights on these principles and associated sub-principles vary according to the size and motivation of the proposed tax--that is, whether the GRT is proposed as a major revenue cornerstone or as a complementary piece of a general and multi-faceted tax structure.

The first approach is to consider a GRT on its own stand-alone merits, using the standard evaluative criteria (and sub-criteria) of equity and efficiency. Here, the alleged horrors raised by economists about the GRT are largely justified, although there are possible modifications to the GRT that may make it acceptable. The second approach evaluates a GRT as a general pervasive bulwark of a state's general business taxation--as a replacement or full revenue partner beside the dwindling corporate income tax (CIT) as well as local property taxation of business. In this case, the GRT is considered and contrasted with a proposed ideal general business tax, one based on value added by "origin" and levied in proportion to benefits received. (1) Certain modified versions of the GRT may approach this ideal in its structure. Even so, a caution is raised in adopting a GRT since most states already overtax business entities in relation to the benefits principle of taxation. A third approach is to consider the GRT as a corrective "fill-in" to plug into an otherwise unbalanced tax structure.

WHAT ARE GRTs?

We generally think of a GRT as an ad valorem levy against the gross revenues of a business operating within a state's boundaries. GRT and other activities taxes are distinguished from state (corporate) income taxes first because they often apply to all forms of business organization other than the limited liability corporation, (2) with some even bringing nonprofit organizations into their scope. Since fast-growing service industries, especially business services, have tended to eschew corporate form in favor of partnerships, GRTs also tend to broaden tax coverage across the spectrum of industry sectors as well. Second, unlike most CITs, the basis of taxation of activities taxes goes beyond profits and returns on capital investment to reach activity covering the gamut of productive activity.

In this breadth, however, GRTs can generate pernicious tax coverage, reaching far beyond the value added of activities that takes place within the geography of the taxing state, and reaching the same productive activity several times over. The latter is usually referred to as "tax pyramiding" in that goods or services are sometimes taxed one or more times during the production process and then once again upon final sale to consumers.

GRTs or "business activities taxes" under this general rubric have been fashioned in many ways. Table 1 lists GRT-type taxes along with characteristics relating to their tax base, extent of pyramiding and geographic reach.

EVALUATING THE STAND-ALONE MERITS OF A GRT AGAINST STANDARD TAX PRINCIPLES

One of the outward attractions of the GRT to policymakers is that it can be

designed to have two features that are viewed very favorably in the tax literature--a broad base and a low rate. If the tax base is the gross receipts of all businesses (regardless of their structure--S corp, C corp, partnership or other), the tax base is very broad and captures the revenues raised by all forms of business activity in the state. The very breadth of the tax base allows the application of a low nominal rate. For example in the Ohio version of a GRT, the rate is only 0.26 percent. In addition, in theory, GRT tax administration costs are likely lower than corporate income taxes since its taxable base is easier to identify and calculate, thereby reducing compliance burdens? Finally, a GRT may improve revenue stability, particularly for states where corporate income tax revenues have proven to be highly volatile. A recent analysis by Mikesell (2007) suggests that the GRT, while significantly less volatile than a corporate income tax, has roughly the same stability as a retail sales tax. Further, an estimate of the short-run elasticity of Washington States GRT (the Business and Occupation Tax) found that the elasticity of the base was 1.4, which was essentially the same as the states retail sales tax (Washington State Tax Structure Committee, 2002, 122). However, in the case of Washington, the same study found that the revenue stabilizing benefits of the GRT might be muted given that the tax appears to move in sync with the retail sales tax and other major tax bases. As such, it does not appear to promote overall revenue stability over the business cycle.

Given these apparent virtues, why wouldn't all states want to adopt a GRT? Mikesell (2007) provides a thorough analysis of the shortcomings of the tax and finds ample reason to suggest why it is not a favorite of tax economists. The most significant flaws identified are a lack of transparency, the inappropriateness of using the gross receipts base to measure economic activity, and perhaps its greatest flaw--tax pyramiding.

First, the base of the tax--gross receipts-is an inappropriate guide for assessing the economic presence of a firm in a given state. Geographically, receipts have little to do with the venue of production, especially as value and supply chains are widening out world wide. This disassociation between nexus and tax liability makes the GRT tax liability capricious and potentially distortive to decisions concerning investment and location. In particular, considered as an implicit user charge to firms that should relate to the firm's usage of in-state public services or the costs it imposes on the state, this flaw of the GRT is significant. Depending on the nature of the business, for example, high-volume/low-margin businesses versus low-volume/high-margin businesses, the level of gross receipts produced by a firm will have little relationship to the services it consumes from government. One way in which this flaw has been ameliorated is by setting a myriad of differing tax rates to reflect differences in businesses' ratios of value added to gross receipts. For example, since retail operations tend to purchase large amounts of inputs and, thus, have relatively low value added in relation to sales, their tax rates are lower under several GRTs. In Washington State, the tax rate for retail enterprises is 0.47 percent, while the average for all industries is 0.61 percent. In Texas, the new "Margin Tax" has a 0.5 percent statutory rate for retail and wholesale trade, while all other businesses have a one percent rate. In this approach, the administrative complexity of the GRT increases, thereby reducing one of its primary advantages--namely low cost of administration.