Oregon Another Step Closer to a Gross Receipts Tax Funding Public Education

Tax Policy – Oregon Another Step Closer to a Gross Receipts Tax Funding Public Education

Last night, Oregon’s Joint Committee on Student Success passed House Bill 3427, which raises about $2 billion over the next biennium to improve the state’s public school system. The improvements will be funded via a gross receipts tax, entitled the Corporate Activity Tax, levied on businesses with commercial activity over $1 million. Included in the bill is a reduction in Oregon’s individual income tax rates for those making less than $125,000 by 0.25 percentage points for each tax bracket.  

The bill will require a three-fifths supermajority approval in the legislature to be enacted as per Oregon’s constitution, as the bill includes a new revenue-raising mechanism for the state. If the bill fails to earn a three-fifths supermajority in the legislature, voters must consider the proposal via a ballot initiative.

After discussions with businesses in the state, the Committee increased the deduction options for firms from 25 percent to 35 percent of labor compensation or business input costs. To ensure that the tax raises the $2 billion target for the biennium, the Committee raised the tax rate from 0.49 percent to 0.57 percent. Lawmakers excluded dairy farms and agricultural co-operatives from the tax base in addition to the exemption on the wholesale or retail sale of groceries.

In final form, the Corporate Activity Tax deduction for the cost of business inputs will only include cost of goods sold (COGS), omitting the unsold inventory that was originally deductible. This narrows the deduction and increases the potential for tax pyramiding.

In addition to the economic costs and harm to low-income Oregonians that will be created by the gross receipts tax, there is a risk that a future state legislature may consider a reduction or elimination of the deduction for business inputs or labor compensation to raise more revenue. In City of Seattle v. Department of Revenue (2015), the Oregon Supreme Court determined that repealing a tax expenditure is not considered a bill for revenue-raising by the legislature, which requires the three-fifths supermajority to enact. Instead, changes to tax expenditures such as the Corporate Activity Tax deduction may be passed on a simple majority vote once the bill becomes law.

The Committee decided not to include public sector pension reform in the debate over the gross receipts tax and public education improvements. This puts Oregon at risk of offsetting the new revenue due to cost increases from the public sector pension system. As Hillary Borrud and Mike Rogoway of The Oregonian framed it, “Unless lawmakers find some way to insulate schools from the state’s pension crisis, soaring pension obligations will gobble up a quarter of the tax money once it does arrive—and more than half of it within a decade.” This would provide the motivation for the legislature to eliminate the Corporate Activity Tax deduction with a simple majority vote, leaving Oregon with a gross receipts tax with a relatively high tax rate.

The gross receipts tax is being considered amid other tax proposals in Oregon, including a proposed carbon tax and paid family and medical leave. Brighter Oregon, a coalition group of Oregon consumers, taxpayers, and businesses, estimates that the legislature is considering about $5.6 billion in new taxes for the upcoming biennium. This broader context makes it important for the legislature to carefully consider the cost of imposing a gross receipts tax at this time, especially if policymakers are tempted to eliminate the deductions for business costs or labor compensation in an effort to raise revenue in the future.

Source: Tax Policy – Oregon Another Step Closer to a Gross Receipts Tax Funding Public Education

A Property Tax is a Wealth Tax, but…

Tax Policy – A Property Tax is a Wealth Tax, but…

Last week, Senator and presidential candidate Elizabeth Warren (D-MA) was quoted on Twitter as making a comparison between her proposed wealth tax and the traditional property tax. Addressing a crowd, she said: “You’ve been paying a wealth tax for years. They just call it a property tax. I just want their tax to include the diamonds, the yachts, and the Rembrandts.”

In a way, this analogy works well because residential property taxes are a type of wealth tax. For homeowners, a house is an asset and the value of one’s house, minus the remaining balance on a mortgage, is part of an individual’s net worth. Each year, an individual is required to pay local property taxes, which are a set percent of the value of one’s home. Property taxes have been used in the United States since its founding. They are relatively stable sources of revenue for local governments.

This analogy sets the wealth tax up as something very familiar and is a good sales pitch. However, the analogy isn’t perfect. There are important differences that, in my opinion, make a wealth tax a worse source of revenue than traditional property taxes.

First, traditional property taxes have a comparatively efficient tax base. Traditional property taxes fall on both the building and the land underneath. Land is thought of as a very good tax base because its supply is fixed—individuals and businesses cannot avoid a tax on land by producing less of it. Because of this, economists generally think that land taxes are very efficient taxes. In many jurisdictions, the land is a significant portion of the total value of real estate. As a result, a meaningful portion of real property taxes share this positive characteristic with a land tax.

Warren’s wealth tax would apply to land, but it would also fall on many other types of assets, some of which are much more responsive to taxation. For example, Warren’s wealth tax would fall on the ownership of financial assets such as corporate stock or bonds. A wealth tax would reduce, sometimes significantly, the return to these assets. For example, municipal government bonds, which have interest rates around 2 to 3 percent, would face effective tax rates higher than 100 percent. This would make it much less likely that individuals would hold on to these assets. This could have several negative effects on the broader economy, including a reduction in national saving.

Another virtue of the traditional property tax is that the taxable asset isn’t particularly hard to value. While there can be controversy over the value of property in a given year, localities are pretty good at determining it. One reason is that there is a lot of property to compare to and homes are sold frequently in many places. There are companies that can tell homeowners what their house is worth at any given time.

The wealth tax would fall on many assets that are very hard to price. For example, a closely held business—one that is not traded on the market—does not have a known value, and the value can change significantly from one year to another. As a result, it would be very challenging to apply the wealth tax. Tax authorities would either need to guess or use some sort of formula to impute the value—a process taxpayers would be unlikely to trust.

For homeowners, there is another important distinction to consider. Under current law, the returns to homeownership are mostly exempt from the income tax. Under current law, the first $250,000 ($500,000 for married couples) of capital gains on the sale of your primary residence are exempt from the income tax. In addition, the imputed rental income (the rent you, as a homeowner, pay yourself) is exempt from the income tax. The CBO shows an effective rate close to zero. As a result, the state and local property tax is usually the only tax that falls on real estate for homeowners.

In contrast, a lot of the wealth under Warren’s wealth tax is already taxed under the income tax before it’s hit by the wealth tax. For example, dividends from corporate stock are subject to the individual income tax. Then the value of the stock would be taxed under the wealth tax. The assets subject to both taxes would face significant effective tax rates—a combined tax burden that homeowners don’t face.

Warren’s comparison between the property tax and her proposed wealth tax makes a good sales pitch. However, there are important differences between the taxes. By no means is the property tax in many jurisdictions perfect, but it is generally better structured than a wealth tax.

Source: Tax Policy – A Property Tax is a Wealth Tax, but…

2017 GDP and Employment by Industry

2017 GDP and Employment by Industry

Tax Policy – 2017 GDP and Employment by Industry

In the U.S. economy, there are tens of millions of businesses, including more than 30 million pass-through businesses and more than a million C corporations. These firms are spread throughout a variety of industries, providing services and producing goods. Understanding how much firms produce and how many workers firms employ within each industry can help policymakers understand how particular tax policies will impact the economy.

The U.S. economy is dominated by service industries. In 2017, firms related to “finance, insurance, and real estate” generated more than $3.4 trillion in in gross domestic product (GDP), making it the most productive segment of industries in the U.S. economy. Recall that GDP measures the value of goods and services produced in the U.S. economy, and its growth is the most popular indicator of the nation’s overall economic health. The “professional and business services” industry—which includes both legal and computer services— was the second most productive, adding $2.3 trillion to the nation’s GDP. Overall, private sector service industries accounted for more than $12 trillion, or 68 percent of GDP in 2017.

Production industries together, such as “manufacturing,” “construction,” “mining,” and “agriculture, forestry, fishing, and hunting,” accounted for $3.3 trillion in GDP. Manufacturing alone was the third most productive industry overall, contributing just more than $2 trillion.

Service industries are the largest segment of the U.S. economy, finance, insurance, real estate, professional and business services, manufacturing, educational services, healthcare, wholesale, retail, arts, entertainment, food services, transportation, mining, utilities, agriculture, fishing, hunting

Service sector industries also employed the most people in 2017 at more than 100 million employees, compared to just more than 20 million employees for production industries. Overall, the “educational services, health care, and social assistance” industry employed the most private sector workers at 23.3 million, followed by the “professional, scientific, and technical services” industry at 20.5 million and the “arts, entertainment, recreation, food service, etc.” industry at 16 million. In 2017, manufacturing was the biggest production industry employer, employing more than 12 million people.

The education, healthcare, social assistance industries employ the most workers, educational services, arts, entertainment, recreation, food service, finance, insurance, real estate, transportation, wholesale trade, agriculture, forestry, fishing, hunting, mining, utilities

Business in America is not monolithic. Businesses vary based on whether they provide services or produce goods, as well as in the level of output they create and the number of workers they employ. Most output and employment come from firms that provide services to consumers—such as education, health care, and social assistance services—though a large share of output and employment still comes from firms in production industries, particularly manufacturing.

Source: Tax Policy – 2017 GDP and Employment by Industry

New Study Finds that High Tax Rates Lower the Chance of Business Survival

Tax Policy – New Study Finds that High Tax Rates Lower the Chance of Business Survival

A new working paper from the International Monetary Fund (IMF) by economists Serhan Cevik and Fedor Miryugin shows that taxes have an economically important effect on whether firms survive in the marketplace.

Amid concern by policymakers and scholars over the fall in business dynamism in the United States, the authors examine whether taxation influences how long firms stay open for business. Tax policy is an important determinant of business success, especially as business formation rates have fallen.

Using a dataset of over four million financial firms from 21 countries between 1995 and 2015, the authors find that higher effective marginal tax rates (EMTR) on firms are associated with a lower likelihood of firms surviving over time. Tax rates become especially harmful at high levels, which is something that policymakers should take into account when considering proposals that would raise tax rates to high levels.

Older firms are more heavily affected by tax burdens than young firms are. A 1 percent increase in the marginal tax rate for old firms is associated with a 6.5 percent decrease in survival, vs. a 1.4 percent decrease in survival for younger firms experiencing a similar tax increase. While younger firms may struggle with high tax burdens early on, this research shows that firms are also sensitive to taxes as they mature.

These results show that the structure and burden of business taxation affects whether firms are successful in the marketplace. Tax policy affects firms differently depending on what industry and country they operate in. Firms in capital-intensive industries, like manufacturing and information technology, experience a greater burden from higher effective marginal tax rates.

The structure of tax policy also matters for firm survival, as the authors argue that “tax systems can be designed to improve efficiency and boost investment that foster[s] innovation and job creation.” To do so, policymakers must “level the playing field for all firms by rationalizing differentiated tax treatments across sectors, capital asset types and sources of financing.”

The authors calculate the effective marginal tax rate for each of the four million firms they observe in the study, which captures the share of net profits subject to tax. The EMTR accounts for differences in tax rules across countries, such as how a country’s tax code treats depreciation.

To make sure that the tax system is not a barrier for a firm’s success, the tax code ideally would treat firms across industries and with different financing methods neutrally. At present, America’s tax code distorts the economic decision-making of firms, such as the favorable treatment of debt financing over equity. This study adds to this argument while providing motivation for policymakers to focus on how reforms to tax policy can increase American entrepreneurship.

Source: Tax Policy – New Study Finds that High Tax Rates Lower the Chance of Business Survival

Testimony to the Joint Session of the Nebraska Revenue, Education, and Retirement Committees

Tax Policy – Testimony to the Joint Session of the Nebraska Revenue, Education, and Retirement Committees

Members of the Revenue, Education, and Retirement Committees,

Thank you for the opportunity to testify today on LB 289 as amended by AM 1381. My name is Joseph Bishop-Henchman, and I am with the Tax Foundation in Washington, D.C. We are a national think tank that collects data and conducts analysis on tax issues. We do not take a position on legislation, but I would like to make three informational points.

First, sales tax broadening is a common trend undertaken in many states now, as a way of modernizing the sales tax to reflect today’s service-based economy. However, you should be aware that including sales tax exemptions only for necessities is a difficult task, as every sale of a good or service is considered a necessity by someone. Additionally, picking only a few goods and services to subject to sales tax, rather than a more comprehensive approach that doesn’t leave many exemptions on the table as you do here, can leave the sectors you are expanding the sales tax to feeling unfairly targeted.

Second, cigarette tax revenue declines year over year, due to falling consumption of that product. This is a nationwide, decades-long trend. Using this revenue dollar-for-dollar for tax cuts elsewhere may balance in year one but will create a widening gap in subsequent years as that revenue source resumes its monotonic decline. Cigarette tax revenue should not be part of a package designed to be revenue-neutral, because it makes it not revenue-neutral.

Third, Nebraska currently has the 27th highest sales tax in the United States by rate when you include both state and average local sales taxes. This bill would take it to 17th highest, similar to Colorado’s.

Nebraska’s property tax is currently 12th highest by collection, and this bill would take it to 13th or 14th highest, still higher than Kansas, Missouri, Colorado, and South Dakota. (See table.)

Nebraska would still have the 19th highest individual income tax, just below Minnesota and higher than Missouri, Kansas, and Colorado, and 16th highest corporate income tax, as this bill misses the opportunity to address those taxes.

Overall, we project that this bill would worsen Nebraska’s ranking on the State Business Tax Climate Index, our comprehensive ranking of state tax structures for business friendliness, from 24th to 26th if the property tax reductions fully materialize, and 29th if they do not, moving below Kansas in terms of our ranking of state tax structure. It would not be unprecedented: my home state of California, for example, has a core tax policy of raising sales and income taxes to pay for lower property taxes, with resultant pros and cons.

Put simply, Nebraska has high income, business, and property taxes. This bill would result in Nebraska having high income, business, property, and sales taxes. Thank you.

State & Local Property Tax Collections per Capita (Fiscal Year 2016)
State Collections per Capita Rank
Source: U.S. Census Bureau
District of Columbia $3,535  
New Jersey $3,127 1
New Hampshire $3,115 2
Connecticut $2,927 3
New York $2,782 4
Vermont $2,593 5
Rhode Island $2,415 6
Wyoming $2,393 7
Massachusetts $2,357 8
Illinois $2,120 9
Maine $2,105 10
Alaska $2,047 11
Nebraska $1,909 12
Texas $1,762 13
Wisconsin $1,629 14
Iowa $1,582 15
Minnesota $1,567 16
California $1,559 17
Maryland $1,547 18
Virginia $1,545 19
Montana $1,520 20
Kansas $1,490 21
Pennsylvania $1,478 22
Oregon $1,444 23
Washington $1,436 24
Colorado $1,425 25
Michigan $1,413 26
South Dakota $1,394 27
North Dakota $1,296 28
Ohio $1,264 29
Florida $1,263 30
South Carolina $1,164 31
Georgia $1,159 32
Hawaii $1,140 33
Arizona $1,062 34
Utah $1,019 35
Nevada $994 36
Mississippi $988 37
North Carolina $975 38
Missouri $971 39
Indiana $967 40
Idaho $944 41
West Virginia $915 42
Louisiana $887 43
Delaware $860 44
Tennessee $836 45
Kentucky $775 46
New Mexico $768 47
Arkansas $712 48
Oklahoma $699 49
Alabama $548 50

Source: Tax Policy – Testimony to the Joint Session of the Nebraska Revenue, Education, and Retirement Committees