This report provides a five-point comparison between a state corporate income tax and a state gross receipts tax. FRC Brief 15

Edward Sennoga

Laura Wheeler

English

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  May 2007, Number 154   ALTERNATIVE STATE BUSINESS TAX SYSTEMS:   A COMPARISON OF STATE INCOME AND  GROSS RECEIPTS TAXES  Nationally, there has been increased attention at the state level in a gross receipts tax as a replacement for the standard state corporate income tax.1  Washington State has imposed a gross receipts tax since 1935.2  In 2005, this tax structure was also adopted in Ohio.  And in May 2006, Texas lawmakers voted to replace their franchise tax with a gross receipts tax.  The reasons given for such a move include tax simplification and increased economic competitiveness, very much the same forces that are fueling the discussions of a Federal sales tax.  The expected gains associated with a move to a gross receipts tax are relative to the original tax system being replaced.  Both Ohio and Texas replaced a franchise tax3 with the gross receipts tax.  In most other states, the main form of state corporate taxation is a modified version of the Federal corporate income tax.  Since there are substantial differences between an income tax and a franchise tax, it is not clear that states currently taxing corporations according to their corporate income would benefit by moving to a gross receipts tax.  This paper compares a gross receipts tax with the standard   state   corporate   income tax.  The basis for comparison involves several criteria such as the relative tax burdens, efficiency, the degree of progressivity, revenue stability and adequacy, complexity and administrative costs.  To provide a benchmark for our comparison of the different features of the state corporate income tax and gross receipts tax, the paper begins with a general discussion of the criteria of a sound tax system followed by a discussion of both the common form of the state corporate income tax and the gross receipts tax.  What is a Sound Tax System? The American Institute of Certified Public Accountants (AICPA, 2001) developed ten “guiding principles” of good tax policy; principles that aid the evaluation of proposals to adjust or change tax rules and tax systems. These principles include equity/ fairness, certainty, convenience of payment, economy of collection, simplicity, and neutrality. Other principles include economic growth and efficiency, transparency and visibility, minimum tax gap, and adequate government revenues.    Gross Receipts Taxes A gross receipts tax, also referred to as a turnover tax, is measured on the value of products sold, gross proceeds of sale (or total revenue), or gross income of the business.  The specific definition of a gross receipts tax base is decided by officials when designing the tax.  There are currently two gross receipts tax systems operating in the United States, one in Ohio and one in Washington State.  Both bases include gross receipts from the sale of goods and services and from the operation of a business.  The Washington State base includes all revenue to the firm including interest income, dividend income, rental and royalty income, and both short and long term capital gains.  In this way, the Washington State tax is actually a gross income tax since all forms of income are subject to tax.  The Ohio tax base, on the other hand, includes gross receipts from the sale or operation of the business as well as rental and royalty income but excludes from the base interest earnings, dividends received, and capital gains.4  Thus, the Ohio version of the gross receipts tax bears more resemblance to a business sales tax or consumption tax since it does not tax the return to capital.   State Corporate Income Tax (SCIT)   In 2004, the major tax on corporations in 40 out of 50 states was some form of a corporate income tax.  In general, this is a tax on corporate income as defined at the Federal level with several modifications imposed at the state level.  For instance, the Federal definition of corporate income allows for more generous depreciation deductions than many states.5  By the same token, some states offer deductions that are not allowed at the Federal level.6  After computing the state corporate income tax base, corporate income is apportioned to represent the percent of total income that is earned in the state.  The state tax rate, significantly lower than the 35 percent Federal rate, is applied to this adjusted, apportioned base to yield a firm’s state tax liability.   Advantages of Gross Receipts Taxes over the State Corporate Income Tax A gross receipts tax has some advantages over a corporate income tax.  First, it is usually, as is the case in both Ohio and Washington, imposed on all business entities. This is not a necessary characteristic of the gross receipts tax as it could be applied to only a select type of business entities.  Second, the wide tax base makes it a more stable source of revenue.  Third, since a gross receipts  tax  is  not a tax on net income or profits, it does     not penalize business entities for being profitable.  Lastly, while the gross receipts tax can be levied in a very simple form, both the Washington and Ohio versions contain fairly intricate rules.   Disadvantages of Gross Receipts Taxes A major disadvantage of the gross receipts tax is that though it may not be passed on to consumers directly, it can be and probably is passed on to consumers indirectly via price increases. This effect can lead to tax cascading or pyramiding in which taxes are imposed upon earlier taxes.  The cascading effect increases as the number of taxable transactions in the production process increase.  Because of the cascading, gross receipt tax systems impose a lower burden on vertically integrated firms or production processes with fewer steps from beginning to end, such as services. Another disadvantage of the gross receipts tax is that firms can have a positive tax liability even when they do not make a profit.  That is because a firm’s tax liability under a gross receipts tax is not reduced for the cost of business inputs, labor, interest payments, or capital investments.  This tends to be particularly burdensome for startup firms with low sales but high business costs.  This issue has been addressed by the Washington and Ohio tax systems by imposing filing thresholds that exempt a base level of gross receipts.   Empirical Comparison of a Gross Receipts Tax with the State Corporate Income Tax This paper considers the potential effect of replacing a traditional state corporate income tax with a gross receipts tax.  However, based on the results of the analysis presented in this paper, the gross receipts tax is not a complete elixir for the woes of the state corporate income tax. The results are summarized in Table A.  In some categories, the gross receipts tax comes out as an improvement over the traditional SCIT when judged against the criteria of a sound tax system.  For instance, the tax base of the gross receipts tax is much broader and inclusive than that of the corporate income tax.  Furthermore, the gross receipts tax base is less volatile over time compared to the corporate income tax.  On the other hand, based on this analysis, the gross receipts tax burden is larger on average and regressive relative to the traditional corporate income tax.  Our last measure of complexity found that while conceptually the gross receipts tax is less complex, this tax is not immune to the pressures to offer special preferences to firms and industries.  The more any tax system gives in to these pressures, no matter how justified, the more complex the tax system becomes.  Based on these findings then, we cannot say that the gross receipts tax system is an improvement over an existing state corporate income tax.  This         TABLE A. SUMMARY OF TAX MEASURES Measure/Tax System Corporate Income Tax Gross Receipts Tax Size of Tax Base only applies to corporations; allows deductions for the cost of earning income; size of base varies from 0.44 percent to 5 percent of gross receipts;  is levied on all business entities, has fewer deductions and exclusions compared to traditional CIT; Size of Tax Burden Per Firm average burden for firms in sample=1.0 percent of total assets;   average burden for firms in sample=1.7 percent of total assets;  Distribution of Tax Burden generally progressive in nature; higher estimated burden for manufacturing firms; generally regressive in nature; higher estimated burden for manufacturing firms;  Revenue Stability coefficient of variation for all firms = 21 percent; for manufacturing firms = 30 percent; coefficient of variation for all firms = 13 percent; for manufacturing firms = 7 percent;  Complexity very complex with considerable compliance costs for firms; has a long history of special preferences for firms and industries; conceptually less complex than the traditional CIT but not immune to pressures to offer special treatment for firms and industries;                          will depend on the particular characteristics of the state and their priorities in setting tax policy.   NOTES 1. See Mikesell (2007) for a similar discussion of this topic. 2. Delaware, West Virginia, and Hawaii also levy taxes on gross receipts.  In the case of Hawaii and Delaware, the tax is levied in addition to the corporate income tax for those doing business in the state.  In the case of West Virginia, the tax is levied on the receipts from the provision of health care services. 3. A franchise tax is a privilege tax imposed on each corporation and limited liability company chartered or organized in a jurisdiction (or state) or doing business in that jurisdiction.  The base varies from state to state and may consist of net taxable capital, net earned surplus, income, or a flat fee.  “Corporation” also includes (but is not limited to) a bank, state limited banking associations, as well as savings and loan association. 4. Interest on credit sales is included in the base.  Gross receipts from the sale of real property located in Ohio are also included in the base.   5. These deductions include the Bonus Depreciation and the Qualified Productions Activity deduction.  These deductions were not adopted by all states and consequently firms operating in some states have to add back this deduction at the state level when determining their state corporate income.   6. Most states allow companies special tax credits.   REFERENCES AICPA. (2001). Guiding Principles for Evaluating Tax Proposals. New York: American Institute of Certified Public Accountants, Inc. Mikesell, John L. (2007).  “State Gross Receipts Taxes and the Fundamental Principles of Tax Policy.” Tax Notes 43: 615.           ABOUT THE AUTHORS Laura Wheeler is a Senior Researcher at the Fiscal Research Center with the Andrew Young School of Policy Studies.  She received her Ph.D. in economics from the Maxwell School at Syracuse University.  Prior to coming to FRC, Laura worked for several years with the Joint Committee on Taxation for Congress and as an independent consultant on issues of tax policy.  Her research interests include state and local taxation, corporate taxation, and welfare policy. Edward Sennoga is a Principal Associate at the Fiscal Research Center with the Andrew Young School of Policy Studies.  He received his Ph.D in economics from Georgia State University.  His research interests include tax evasion and tax structure.  He is currently a Professor at Makerere University in Kampala, Uganda.  ABOUT FRC  The Fiscal Research Center provides nonpartisan research, technical assistance, and education in the evaluation and design of state and local fiscal and economic policy, including both tax and expenditure issues.  The Center’s mission is to promote development of sound public policy and public understanding of issues of concern to state and local governments. The Fiscal Research Center (FRC) was established in 1995 in order to provide a stronger research foundation for setting fiscal policy for state and local governments and for better-informed decision making.  The FRC, one of several prominent policy research centers and academic departments housed in the School of Policy Studies, has a full-time staff and affiliated faculty from throughout Georgia State University and elsewhere who lead the research efforts in many organized projects. The FRC maintains a position of neutrality on public policy issues in order to safeguard the academic freedom of authors.  Thus, interpretations or conclusions in FRC publications should be understood to be solely those of the author.  For more information on the Fiscal Research Center, call 404-651-2782.               RECENT PUBLICATIONS  Alternative State Business Tax Systems:  A Comparison of State Income And Gross Receipts Taxes  This report provides a five-point comparison between a state corporate income tax and a state gross receipts tax.  (May 2007)  Status of Women in Atlanta:  A Survey of Economic Demographic, and Social Indicators for the 15-County Area.  This report provides a detailed overview of economic, demographic and social aspects of women and girls in the metro Atlanta region.  (May 2007)  Forecasting Pre-K Enrollment in Georgia Counties.  This report provides a manual that documents the forecasting methodology and provides the actual forecast of Pre-K enrollment by county for 2007-2011.  (April 2007)  A Description of the Proposed Comprehensive Revision of Georgia’s Tax Structure:  HR 900.  This brief is a summary of the provisions of the comprehensive revision of Georgia’s tax structure contained in HR 900. (April 2007)  Revenue Structures of States Without An Income Tax. This report compares Georgia’s revenue structure to states without an income  tax  in  order  to explore how Georgia’s revenue structure would have to change if it were to eliminate its income tax.  (April 2007)  Property Rights Reform:  A Fiscal Analysis.  This report analyzes the fiscal effects of a proposed statute revising the legal standard for regulatory takings in Georgia, as well as recent changes in Georgia’s eminent domain law.  (April 2007)  Self Sufficiency in Women in Georgia.  In this brief, we use one measure of self sufficiency to estimate the number of female headed households in metro Atlanta that fall below the self sufficiency standard. (March 2007)  Georgia’s Economy:  Trends and Outlook. This report tracks some of the key trends that have shaped and will continue to shape Georgia’s economy.  These include the decline in manufacturing employment, the aging of Georgia’s population, the importance of high tech and tourism industries and globalization.  (March 2007)  Financing Georgia’s Future II.  This second release of a biennial report focuses on Georgia’s taxes, making cross-state comparisons of their structure and exploring revenue performance over time.  (March 2007)  The Price Effect of Georgia’s Temporary Suspension of State Fuel Taxes. This report explores the effect of the fuel tax suspension on the price of gasoline in Georgia.  (February 2007)  An Analysis of the Financing of Higher Education in Georgia.  This report addresses the issue of the financing of higher education in Georgia by comparing financing in Georgia with other states and examining how financing affects the student population in terms of performance, and retention rates.  (February 2007)  Intergovernmental Fiscal Relations in Georgia.  This report documents the intergovernmental fiscal system in Georgia, with a focus on the expenditure, revenue, and intergovernmental grant system in the state.  (February 2007)  Comparing State Income Tax Preferences for the Elderly in the Southeast.  This brief looks at the current state of these tax preferences in the Southeast for those states that impose a major income tax and estimates the dollar value of these preferences.  (February 2007)        State Tax Incentives for Research and Development Activities:  A Review of State Practices.  This report documents state tax incentives offered around the country designed to encourage state level R&D activity.  This report also simulates the effect of various credit components in the value of the credit  (January 2007)  Transportation Funding Alternatives:  A Preliminary Analysis.  This report explores issues associated with proposed alternative revenue sources for increasing transportation for funding.  (January 2007)  Geographic Breakdown of Georgia’s Interstate Migration Patterns.  This brief looks at the geographic breakdown of Georgia's interstate migration patterns for both the elderly and non-elderly.  (December 2006)   Inventory Taxes.  Policymakers are considering 100 percent inventory tax exemptions as an economic development incentive.  This report reviews the potential effectiveness of such exemptions and presents alternative approaches to inventory tax exemptions.  (December 2006)  An Assessment of the State of Georgia’s Budget Reserves.  This report assesses the adequacy of Georgia’s revenue shortfall reserve.  (October 2006)  Revenue Losses from Exemptions of Goods from the Georgia Sales and Use Tax.  This report provides estimates of the revenue loss from sales tax exemptions.  (September 2006)  Tax Collectibility and Tax Compliance in Georgia.  This report discusses the tax gap in Georgia and options for increasing tax compliance.  (September 2006)  Four Easy Steps to a Fiscal Train Wreck:  The Florida How-To Guide.  This report is the second of three reports that address the fiscal conditions of other states, explores the factors that explain the conditions, and the likely future trends.  (August 2006)  The “Roller Coaster” of California State Budgeting After Proposition 13.  This report is the first of three reports that address the fiscal conditions of other states, explores the factors that explain the conditions, and the likely future trends.  (July 2006)  Personal Property Tax on Motor Vehicles.  This brief shows the expected reduction in the property tax base in each county if motor vehicles were tax exempt.  (July 2006)  Adequate Funding of Education in Georgia:  What Does It Mean, What Might It Cost, How Could It Be Implemented?  This report contains a discussion of what adequate funding for education means and how it has been estimated for other states.  The report then explores the financial implications for Georgia of funding adequacy.  (May 2006)  Legislative Influences on Performance-Based Budgeting Reform.  Using data from several surveys of the states as well as a survey of Georgia state legislators, this report examines the role of legislators in the implementation of performance-based management and budgeting reforms.  (May 2006)  A Georgia Fiscal History of the Past Forty Years.  This report describes spending and revenue trends through four decades and relates the trends to the agendas of the state's governors.  It concludes with a list of challenges for this decade and beyond.  (April 2006)  Gasoline Taxes in Georgia.  This report describes and compares Georgia’s fuel tax with other states and evaluates it as a long-term dedicated revenue source for highway funding in the state.  (April 2006)      For a free copy of any of the publications listed, call the Fiscal Research Center at 404/651-4342, or fax us at 404/651-2737.  All reports are available on our webpage at: //frc.aysps.gsu.edu/frc/ index.html. 

Alternative State Business Tax Systems:A Comparison of State Income and Gross Receipts Taxes - Brief

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Alternative State Business Tax Systems:A Comparison of State Income and Gross Receipts Taxes - Brief

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