Louisiana’s Proposed Tax Plan is a Bad Deal
Louisiana Governor John Bel Edwards (D) released details of a proposed tax plan a few weeks ago, which my colleague Nicole Kaeding covered here. Since then, some new details have emerged, but the main thrust of the plan is an attempt to remove the recent sales tax increase (the famed “clean penny” that wasn’t so clean in effect), and pay for it with a gross receipts tax. The full details include almost a dozen moving parts:
- Individual Income Taxes: The plan would lower the current individual income tax rates from 2, 4, and 6 percent to 1, 3, and 5 percent, contingent on a repeal of the deduction for federal taxes paid (which would be a constitutional amendment requiring voter approval).
- Corporate Income Taxes: The plan would consolidate the state’s five corporate income tax brackets of 4, 5, 6, 7, and 8 percent into three brackets of 3, 5, and 7 percent, also contingent on a repeal of the deduction for federal taxes paid (again, requiring a constitutional amendment/voter approval).
- Sales tax: The 1-cent sales tax increase passed in 2016 would expire as planned at the end of the 2018 fiscal year. The state would expand its sales tax base to include a number of services, mirroring the tax base of neighboring Texas. The state would also unify the sales tax bases of the remaining 4-cent, state-level sales tax to local sales tax structures (which virtually every other state already does).
- Gross Receipts Tax: Governor Edwards proposes to create a new gross receipts tax. The tax, set at 0.35 percent of receipts above $1.5 million, would serve as a minimum tax to the corporate income tax. The plan has been dubbed the “Commercial Activity Tax,” a name used by Ohio to describe its gross receipts tax, but Louisiana’s structure would be notably different than the Ohio CAT. In recent days, more details of this plan have emerged, and the structure is quite complex, with labyrinthian rules for pass-throughs, regular C-corporations, and manufacturing C-corps. See Jason DeCuir’s summary here.
- Franchise Tax: The state’s franchise tax would phase out over the next 10 years.
Over the last two years, Louisiana has commissioned studies, convened task forces, and hosted extensive legislative conversations about ways for the state to accomplish comprehensive tax reform. The governor’s plan is far-reaching, and touches on every major tax type in an attempt to improve the state’s tax structure, but I believe it fails in that regard for some really important reasons.
First, all of the bad things in the plan take effect immediately, while all the promised positive changes are unlikely to occur due to extended phase-in times or constitutional hurdles. There is a very real possibility that all that could be accomplished under this plan is a new gross receipts tax, a reduction in the sales tax (which is scheduled to happen anyway), and a franchise tax that is reduced mildly for one or two years, and then halted.
Second, the introduction of a gross receipts tax is a nonstarter. The proposal is markedly out of line with public finance literature, and was not included in the recommendations of either the 2017 blue ribbon task force on fiscal reform, the 2015 commissioned report of economists Richardson, Sheffrin, and Alm, or the 2016 recommendations of the Tax Foundation.
Though all gross receipts taxes are undesirable due to the phenomenon they create called “tax pyramiding,” or taxes on taxes, the structure of this gross receipts tax proposal is uniquely complex in its administration and calculation. The plan has a different tax calculation depending on whether a firm is a pass-through business, a C-corporation, or a C-corporation manufacturer; and your tax burden is a result of a different branch on a decision tree for each firm type. My colleague Nicole Kaeding put together this dizzying graphic:
One of the most notable oddities is that in the case of manufacturers, the taxpayer pays the greater of three tax bases, where one of those three is the lesser of two other tax bases. Another way to think about the base for C-corp manufacturers is that it is a value-added tax, inside a gross receipts tax, inside a corporate income tax. I haven’t seen a tax quite so unique in its application of various minimums and maximums to try to achieve a result of higher tax burdens.
What Louisiana needs is fewer taxes with broader bases and lower rates, not more taxes with narrow bases and choose-your-own-adventure tax calculations.
Be sure to read our comprehensive study on Louisiana’s tax system here.
Source: Tax Policy – Louisiana’s Proposed Tax Plan is a Bad Deal
Wait. How Would Louisiana’s Gross Receipts Tax Work?
During this initial news conference to release his tax plan, Governor John Bel Edwards (D) promised greater detail and clarity on his proposed gross receipts tax. This week, with the introduction of House Bill 628, we have a better sense of how the governor envisions creating this new tax. In short, it’s complicated.
The new gross receipts tax in Louisiana would function as an alternative minimum tax to the state’s corporate income tax. Firms would pay the higher of their tax liabilities under the corporate income tax or the gross receipts tax.
But it isn’t quite that simple. First, firms would calculate their gross receipts tax liability two ways: firms with receipts above $1.5 million would pay 0.35 percent of all receipts, while firms with receipts between $150,000 and $1.5 million would pay a set amount based on tiers. Then, firms compare their gross receipts tax liability to their corporate income tax liability and pay the higher of the gross receipts tax or corporate income tax.
For firms “engaged” in “merchandising or manufacturing or gaming,” it is even more complicated. If receipts are between $150,000 and $1.5 million, firms would pay the set amount based on the specified tiers. Otherwise, they would calculate their gross receipts tax liability of 0.35 percent of all receipts. But, now, they have to add another step. These industries would also calculate their gross profits–gross receipts minus costs of goods sold–and assess a tax rate of 2.76 percent. The firms would take the smaller of gross receipts or gross profits, then pay the higher of the gross receipts/gross profits tax liability or the corporate income tax liability.
The flow chart below illustrates the incredibly complex tax structure laid out under this proposal.
The flaws of gross receipts taxes are well documented. The tax pyramiding, coupled with non-neutral, makes it an undesirable tax type. But in this case, the proposal is even worse.
This plan is a nightmare. It will add significant compliance costs to the state’s tax code, while retaining all of the flaws of Louisiana’s corporate income tax. The way to fix Louisiana’s corporate income tax isn’t to make it more complicated by adding multiple new layers of tax to it.
This plan is a complex mess.
Source: Tax Policy – Wait. How Would Louisiana’s Gross Receipts Tax Work?
Competitiveness Impact of Tax Reform for the United States
- Among 43 nations surveyed, the United States has the second highest statutory corporate income tax rate at 39.1 percent and is one of the few nations that has not reduced its statutory tax in the past seven years.
- The U.S. tax burden on new investment, the marginal effective tax rate (METR), is fifth highest among the 43 nations at 34.8 percent. If bonus depreciation were made permanent the METR would be 27.3 percent. The average METR among developed nations is 19.2 percent.
- Both the House GOP and President Trump have proposals that would greatly improve the competitiveness of the U.S. tax system by reforming the corporate income tax.
- The House GOP proposal to convert the corporate income tax into a “destination-based cash-flow tax” would reduce the corporate income tax rate to 20 percent and the METR on new investment to 16.1 percent.
- A proposal similar to that put forth by the Trump administration would reduce the statutory corporate tax rate to 15 percent and the METR on new investment in the United States to 21.4 percent.
As residents of the United States’ northern neighbor, Canada, we watch with great interest the unfolding debate in the United States with respect to business tax reform. Since 2000, Canada achieved a much more competitive business tax structure by lowering corporate income tax rates from roughly 43 to 27 percent, broadening the corporate tax base to make it more neutral among business activities, eliminating a capital tax on nonfinancial companies, and reforming sales taxes that removed most sales taxes on capital purchases. From having the highest tax burden on new investments in 1999 among industrialized countries, Canada moved to the middle of the pack by 2012. The reform led to more investment and better growth in both GDP and national income without a significant loss in corporate income tax revenue as businesses found it more attractive to keep profits in Canada.
The United States is looking at major business tax reform packages that could boost growth and make it more attractive to keep profits in the United States. In this paper, we specifically model the impact of a variation of two business tax reforms: the House GOP Blueprint Plan promoted by Speaker Paul Ryan, and Plan B, which has a simpler approach.
The House GOP Blueprint plan proposes a major revamp of the business tax system by converting the corporate income tax into a “destination-based cash-flow tax”. The federal corporate income tax rate would be lowered from 35 to 20 percent. Noncorporate business income would be taxed at a rate of 25 percent. Tangible and intangible capital expenditures would be generally expensed (associated net interest would not be deductible). Border adjustments would be introduced that would exempt export revenues from tax and disallow the deduction for imports cost. Investment income (dividends, capital gains, and interest) would be half taxable at the personal level.
In other terms, the House GOP Blueprint equivalently abolishes the corporate income tax (which is partly a production tax) in favor of a subtraction-method value-added tax (VAT) on consumption with a negative payroll tax or wage credit for labor costs (labor compensation is deducted from the cash-flow tax base). The economic effect would be to make the U.S. tax structure much more competitive compared to the existing business tax structure and thereby boost growth.
However, the House GOP plan is not without controversy. The border adjustments, similar to any destination-based VAT, would result in higher taxes on products sold in the United States while removing taxes on exporters. The elimination of net interest deductions incurred in the financing of tangible and intangible capital expenditures would affect most heavily leveraged companies. Financial companies with net interest income would be exempt unless financial firms are taxed otherwise. Transition issues with respect to the tax treatment of old capital and debt would need to be considered as well as the division between a cash-flow treatment of business income and a regular income tax approach to investment earnings and capital gains.
Perhaps, a more straightforward plan – called Plan B in this paper – is to lower corporate income tax rates to a federal rate of 15 percent and undertake sufficient base broadening to make up for any revenue losses beyond dynamic scoring to account for a bigger profit base. For example, tax could be imposed on both remitted and retained foreign profits of U.S. companies at a relatively low rate (with a credit for earning brought home) that would not impact on the tax burden for domestic investments.
Looking at both versions of these plans (even in the absence of border adjustments), this paper will show that the U.S. effective tax rate on new investments would dramatically fall due to lower corporate income tax rates and capital expensing. While the United States currently has one of the highest effective tax rates on capital among industrialized and emerging economies, both the House GOP Blueprint plan and Plan B would put the United States closer to the middle of the pack.
This brief study begins with a comparison of the existing U.S. corporate tax burdens on new investments in comparison with 43 other countries for manufacturing and services. It then turns to an analysis of the House GOP plan and Plan B in their impact on U.S. tax competitiveness.
How this study measures tax competitiveness for investments
When comparing tax burdens on capital across countries, it is not sufficient to focus on corporate income taxes only (both tax rates and treatment of costs, such as depreciation and inventory costs). Many countries impose other taxes on capital, such as Japan’s tax on fixed assets or India’s tax on profit distributions to residents and nonresident owners. Several countries have stamp duties or transfer taxes on financial and real estate transactions (such as Australia and China). Others impose sales taxes on capital purchases, such as those under U.S. state retail sales taxes, which are quite significant in their impact.
To account for these differences in tax systems, an analytical measure is developed to account for the various taxes borne by businesses on their new investments. This measure is the marginal effective tax rate (METR), which is the annualized value of corporate taxes paid as a percentage of the pretax profitability of marginal investments. Marginal investments are those that are incremental to the economy: they earn sufficient profit to be taxable, to attract financing from investors, and to cover risk. At the margin, businesses invest in capital until the rate of return on capital, net of taxes and risk, is equal to the cost of financing capital (their interest rate). If the rate of return is more (less) than financing costs, firms will invest more (less) in capital. Thus, if a government increases the tax burden or wedge between gross and net returns, it will result in businesses rejecting marginal projects that would otherwise be profitable if the tax burden were smaller.
This paper includes taxes that impinge on capital investment, including corporate income taxes, sales taxes on capital purchases, asset-based taxes (capital taxes and property taxes), profit distribution taxes, and transfer taxes on real estate and financial transactions for manufacturing and service sectors (services include construction, utilities, transportation, trade, and other business and household services). In the analysis, most taxes are included; however, municipal property taxes are excluded, as they are difficult to measure due to variation in municipal rates, exemptions, and bases and cannot be compiled by industry sector.
This analysis uses similar capital structures to isolate tax differences among 35 OECD countries, 5 BRICS countries, and some other selected countries. The capital structures, reflecting the distribution of assets among machinery, buildings, inventory, and land investments, are based on Canadian data. We include all industries except oil and gas, mining, and finance. Economic depreciation rates for assets are also based on Statistics Canada estimates. Bond interest rates reflect differences in inflation rates across countries (following the purchasing-power-parity assumption that implies interest rates rise 1 point with each 1-point increase in inflation). Equity costs are based on a marginal supplier of finance equating the after-tax rates of return on stocks and bonds. (The marginal investor is assumed to be a G7 investor holding an international portfolio of bonds and equities.)
How does the U.S. stand currently?
In 2017, the United States has the second highest corporate income tax at 39.1 percent, just below Colombia’s 40 percent (Figure 1). Among OECD countries only, the U.S. statutory corporate income tax rate is the highest. A high corporate income tax rate not only results in a higher tax burden on investment but also encourages both U.S. and foreign-controlled companies to shift costs into the United States, thereby reducing potential revenue for federal and state governments.
For these two reasons – growth and revenue concerns – many fiscally challenged governments have reduced corporate income tax rates and/or broadened tax bases or increased reliance on other business taxes even after the 2008 financial crisis. Since 2010, the average OECD corporate income tax rate has fallen by more than 1 percentage point, with the biggest reductions in Japan (8.5 points), Spain (5 points), Finland (6 points), and the United Kingdom (10 points).
Figure 2 provides a ranking of effective tax rates on new investments (METRs) for the 43 countries, from highest to lowest tax burdens (the Appendix provides results for manufacturing and service companies). The U.S. tax burden on new investments is fifth highest at 34.8 percent. (If bonus depreciation were permanent rather than being phased out, the METR in the United States would be 27.3 percent, eighth highest among the 43 countries.) Since 2010, the tax burden on new investments has particularly declined in Finland, Japan, and the United Kingdom due to corporate rate reductions, and in Italy, which provides a substantial allowance for the cost of increased equity financing.
Figure 3 provides a breakdown of the impact of different taxes on METRs by country. In the case of the United States, the retail sales tax imposes a significant burden on capital, while sales, capital, and transfer taxes increase effective tax rates on capital quite sharply in Brazil, India, and Japan. For example, Brazil would have a lower METR than the United States if not for Brazil’s nonrefundable VAT on capital. Japan would also have a lower effective tax rate on new investments if not for its tax on fixed assets. India has announced moving ahead with its VAT reform that will reduce significant sales taxes on capital purchases (not shown in the graph).
U.S. tax reform proposals would have a large impact on competitiveness
The U.S. corporate tax needs reform for several reasons:
- The corporate income tax rate is high, as shown above, discouraging investment. Despite its high corporate income tax rates, the U.S. also collects a surprisingly low amount of corporate income tax at only 2 percent of GDP (2010-15 average), in contrast to OECD countries collecting 2.9 percent of GDP with an average corporate income tax rate of 25 percent.
- Various incentives are given for specific activities undermining productive efficiency by encouraging investments in some business activities and not others. As a result, the corporate income tax is one of the most economically costly revenue sources to fund public services.
- The high statutory corporate tax rate encourages U.S. multinationals to shift profits to foreign jurisdictions, with one estimate suggesting a cost of $100 billion per year.
- Corporate taxes fall most heavily on internationally immobile factors of production (land and labor) either through lower negotiated wages or higher consumer prices, reducing the purchasing power of income earned by internationally immobile factors of production.
It is not surprising that both Democratic and Republican parties have had various tax reform proposals to lower corporate income tax rates and broaden tax bases in the past several years. With the election of Donald Trump as president in November and Republican control of the Senate and House of Representatives, a renewed focus has been placed on business tax reform, including corporate and noncorporate forms.
We model two variations of proposals made in the United States. The first is two variations of the House GOP Blueprint, with a 20 percent federal corporate income tax rate on both manufacturing and service industries. We assume expensing of capital limited to structures and machinery (House GOP Plan 1) or full expensing for tangible and intangible capital (House GOP Plan 2). In both cases, we assume that the state income taxes remain the same and deductible against the federal tax base as well as other taxes on capital, including the retail sales tax on capital purchases. Interest expense incurred to finance capital is assumed not to be deductible in both cases.
In Plan B, we assume a federal corporate income tax rate of 15 percent with expensing limited to manufacturing (no interest deductions are incurred if expensing is elected). The loss in revenue is made up by taxation of multinational foreign profits as originally proposed by President Trump during the election campaign (this base-broadening measure would not affect the domestic effective tax rate on new investments in the United States).
Table 1 provides effective tax rates on new investments under both the House GOP Plans and Plan B. The House GOP Plan under full expensing has the largest impact on the effective tax rates. Even taking as a starting point the case of bonus depreciation under the current system, the METR declines from 27.3 percent to 16.1 percent for House GOP Plan 2. The remaining 16.1 percent tax burden is associated with state corporate income taxes and the retail sales tax. The METR on manufacturing drops by more than a half, from 25.4 percent to 11.1 percent. If bonus depreciation is ignored due to its temporary status, the reductions in effective tax rates on new investments are even more dramatic.
Under the House GOP Plan, the United States would have a much more competitive corporate tax system; its major competitors would no longer have a distinct tax advantage over U.S. domestic investments. The two NAFTA partners that have so long pursued a business tax advantage would lose it altogether except for manufacturing in Canada and services in Mexico that would face tax rates roughly comparable to their U.S. counterparts.
If expensing is limited to only depreciable assets, the METR (House GOP Plan 1) drops less dramatically to 18.4 percent (manufacturing) and 23.9 percent (services), for an aggregate drop of 21.9%. From tax levels without bonus depreciation, the METR falls by more than a third, from 34.6 to 21.9 percent.
Under Plan B, the reduction in the METR is not as dramatic as with House GOP Plan 2. Starting with bonus depreciation, the METR drops by a fifth, from 27.3 percent to 21.4 percent. Ignoring temporary bonus depreciation, the METR declines more dramatically, by more than a third.
Table 1: Impact of Potential U.S. Tax Reform on Marginal Effective Tax Rates on New Investments (METRs)
|Source: Authors’ calculations.
|Current U.S. (ignoring temporary bonus depreciation)
|Current U.S. (with permanent bonus depreciation)
|House GOP Plan 1 with 20% federal rate and expensing for machinery and structures only
|House GOP Plan 2 with full expensing
|“Plan B” with federal rate of 15 percent and elective expensing for manufacturing only
While corporate tax rate reductions have a significant impact on competitiveness, the expensing proposals add much more grease to make the wheels turn in the U.S. economy. House GOP Plan 2 would result in the largest increase in capital stock and growth in the United States. It would also minimize variations in effective tax rates on manufacturing and service activities.
Without a doubt, proposals for corporate income tax reform in the United States would raise investment and growth rates, especially when corporate rate reductions are combined with expensing broadly applied to assets. While other aspects of the U.S. tax system impact on investments, especially retail sales taxes at the state level, the proposed U.S. tax reforms would change the international game quite dramatically. Even without border adjustments, the U.S. would require many other countries to reconsider their tax burdens on capital investments. This need not be a negative result if the world economy is ultimately jolted to better economic performance, leaving behind a decade of low growth as a “new normal”.
 For a review of the impact of business tax reform in Canada, see D. Chen and J. Mintz, “2012 Global Tax Competitiveness Ranking: A Good News Canadian Story,” SPP Research Papers, 5(28), School of Public Policy, University of Calgary, 2012, and P. Bazel and J. Mintz, “2015 Tax Competitiveness Report: Canada is Losing its Attractiveness,” SPP Research Papers, 9(37), School of Public Policy, University of Calgary, 2016.
 For a good exposition of the various issues, see A. Auerbach, M. P. Devereux, M. Keen, and J. Vella, “Destination-Based Cash Flow Taxation,” WP 17/01, Oxford University Centre for Business Taxation, January 2017. See also G. Haufbauer and Z. (L.) Lu, “Border Tax Adjustments: Assessing Risks and Rewards,” Policy Brief, Peterson Institute for International Economics, January 2017.
 The U.S dollar would appreciate, offsetting some or all of the impact of taxes on imports as well as benefits to exporters. Some have argued that the U.S. dollar would not rise by as much as the tax given that some goods and services might be exempt, such as financial services, and because various countries have inflexible exchange rates, some fixed with the U.S. dollar (B. Lockwood, D. de Meza and G. D. Myles, “When are Origin and Destination Regimes Equivalent?, International Tax and Public Finance, 1(1), 1994, 5-24). The exchange rate adjustment is not critical to the point that the adoption of the House GOP plan would have a major impact on U.S. competitiveness by reducing taxes on new investments.
 An earlier version of the analysis is contained in J. Mintz, P. Bazel, Daria Crisan, and D. Chen, “With global company tax reform in the air, will Australia finally respond?” Minerals Council of Australia, March 2017.
 The OECD is the Organization for Economic Cooperation and Development, a group of 35 leading developed nations. BRIC stands for Brazil, Russia, India, and China, four large emerging national economies.
 Much work is needed to analyze taxes in these sectors, so international comparisons have been more limited. For some international resource tax comparisons, see J. Mintz and D. Chen, “Capturing Economic Rents from Resources through Royalties and Taxes,” University of Calgary School of Public Policy Research Paper 5, 30 (2012); and D. Crisan and J. Mintz, “Alberta’s New Royalty Regime is a Step Towards Competitiveness: A 2016 Update,” University of Calgary School of Public Policy Research Paper 9, 35 (October 2016). For finance companies, taking into account nonrefundable VAT on capital purchases, see Jack Mintz and Angelo Nikolakakis, “Tax Policy Options for Promoting Economic Growth and Job Creation by Leveraging a Strong Financial Services Sector,” Toronto: Financial Services Alliance, December 2015.
 The G7 consists of the United States, Japan, the United Kingdom, France, Germany, Italy, and Canada.
 Organization of Economic Cooperation and Development, 2017, https://data.oecd.org/tax/tax-on-corporate-profits.htm.
 B. Dahlby, Marginal Cost of Public Funds: Theory and Applications, MIT Press, Cambridge, Mass., 2008.
 See K. Clausing, “Profit Shifting and U.S. Corporate Income Tax Policy Reform,” Washington Center for Equitable Growth, 2016, http://equitablegrowth.org/report/profit-shifting-and-u-s-corporate-tax-policy-reform/.
 See K. Hassett and A. Mathur, “A Spatial Model of Corporate Tax Incidence,” Applied Economics, 47:13, 1350-1365, 2014; Liu, L. and R. Altshuler, “Measuring The Burden Of The Corporate Income Tax Under Imperfect Competition,” National Tax Journal, National Tax Association, 66(1), 215-37, 2013; and W. G. Randolph, “International Burdens of the Corporate Income Tax,” Congressional Budget Office Working Paper No. 09, 2006.
 In the model, a manufacturing company would choose expensing on a prospective basis.
Source: Tax Policy – Competitiveness Impact of Tax Reform for the United States
To What Extent Does Your State Rely on Corporate Income Taxes?
Corporate income taxes are one of the smallest sources of state and local tax revenue. On average, only 3.7 percent of state and local tax revenues came from corporate income taxes in fiscal year 2014 (the most recent data available).
Some, however, mistake the corporate income tax as the entirety of a business’s tax burden. In reality, businesses pay many types of taxes (such as sales tax, property tax, excise taxes, and more) and the corporate income tax makes up only 9.5 percent of total business taxes.
The share of revenue from corporate income taxes will decline as more businesses organize as pass-throughs (S-corps, partnerships, sole proprietorships, etc.), which “pass their income through” to their individual tax returns and therefore are liable under the individual income tax code. Additionally, corporate income tax revenue will decline as more businesses receive special tax credits and incentives, eroding the tax base.
Today’s map shows what percentage of state and local tax collections derive from the corporate income tax. New Hampshire depends most heavily on the corporate income tax (9.4 percent of total tax collections) due to the lack of an individual income tax (except on interest and dividends) or a sales tax. Alaska comes in second (7.3 percent), again because the state does not levy an income tax or statewide sales tax. New York is the third most heavily dependent (6.9 percent) due to a heavy concentration of corporate payers and the state levies all major tax types.
At the other end of the spectrum, Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming do not levy a corporate income tax, though four of these states (Nevada, Ohio, Texas, and Washington) levy a harmful gross receipts tax instead. Some of these states will still show a small amount of corporate income tax revenue due to taxes on corporate net income of special types of corporations (like financial institutions).
There are several reasons why the corporate income tax share is so low on average:
- The number of businesses organized as traditional C corporations has decreased over time. Pass-through businesses now earn more net income than traditional C corporations and employ the majority of the private-sector workforce.
- States hand out generous corporate tax incentive packages to move into (or remain in) their states. Jobs and investment credits, along with other targeted incentives, lower tax liability for some businesses and industries, effectively picking winners and losers while also chipping away at the tax base.
- States further reduce corporate tax bills by adjusting their income apportionment formulas, reducing the in-state taxable income of corporations within their borders. Location Matters helps to explain apportionment effects.
Corporate income taxes are not only limited in their revenue raising capacity, but they are also an extremely volatile tax type. During economic downturns, many corporations post losses and therefore have no tax liability under the corporate income tax.
Note: This is the second in a four-part map series in which we will examine the primary sources of state and local tax collections. Other maps in this series are linked below.
Source: Tax Policy – To What Extent Does Your State Rely on Corporate Income Taxes?
Potential Colorado Ballot Measure Shows How Not to Design a Sales Tax
Colorado voters have only been asked to approve a new tax at the ballot box once before, and that was to legalize and tax marijuana. Therefore, HB 1242, which cleared the House and is pending in Senate Finance, represents something new in Colorado taxation. The legislation, which would require voter approval, increases the state’s sales tax rate by 0.62 percent, raising about $600 million per year to provide additional transportation funding.
Whatever the merits of additional transportation funding, or even raising taxes for the purpose, the bill—scheduled for a Senate Finance Committee hearing next week, where it may be greeted with greater skepticism than it experienced in the House—represents a curious, and in many ways flawed, approach to taxation. It misses opportunities to improve the state’s tax code and would instead double down on some of its inequities and inefficiencies.
Here are five things to know about HB 1242.
It Ignores Better Options for Transportation Funding
Colorado’s 22-cent per gallon tax on motor fuel places it in the bottom quarter of states on gas tax rates. The great advantage of motor fuel taxes is that they closely approximate a “user-pays” regime, with drivers (and those purchasing goods shipped by road) bearing the cost of infrastructure spending roughly in proportion to their contribution to both congestion and road wear-and-tear. If Colorado needs additional revenue for roads and bridges, it would make far more sense to raise the gas tax than to hike the general sales tax.
It Results in a High Overall Sales Tax Rate
At first glance, Colorado’s sales tax is astonishingly low, levied at a rate of 2.9 percent. This is not, however, a reflection of low reliance on sales taxes, but rather on the degree to which tax and spending authority in Colorado is devolved to localities. The average local sales tax rate in Colorado is 4.6 percent (the third highest average local rate in the nation), yielding an above-average 7.5 percent average combined state and local sales tax rate.
Once state, county, municipal, and special district sales taxes are added together, thirty-two Colorado jurisdictions have combined sales tax rates above 8.0 percent, led by Winter Park (in Grand County), with a rate of 11.2 percent. It is in this context that increasing the state sales tax rate, as proposed in HB 1242, is rather significant. If the 0.62 percent sales tax rate increase were adopted, the average combined rate would jump to 8.12 percent.
It Misses an Opportunity to Improve the Sales Tax Base
Colorado’s existing sales tax base is unusually narrow, exempting some goods and including very few services. Across the country, most sales tax bases are heavy on goods and light on services, reflecting the economies that existed when they were first adopted, but Colorado takes this imbalance to extremes. Of 168 categories of services identified by the Federation of Tax Administrators, Colorado only taxes 14, the fewest of any state in the country. At the upper end of the spectrum, Hawaii taxes 166, New Mexico 164, Washington 157, and South Dakota 152.
With the service sector comprising 80 percent of Colorado’s economy, this means that the sales tax falls on a small (and declining) share of economic activity in the state, keeping rates high to account for an unnecessarily narrow base which favors some industries over others. Before considering rate increases, Colorado legislators should contemplate broadening the sales tax base to reflect a service-oriented 21st century economy.
It is Not Very Temporary
Although the proposed rate increase is billed as temporary, it’s set to run twenty years—an incredibly long time for a temporary measure. It has been said, borrowing from Milton Friedman on government programs, that there is nothing so permanent as a temporary tax. Whether that’s true, it seems unlikely that, after twenty years of growing accustomed to the higher rate, legislators who weren’t around when it was adopted would be willing to let it expire without a fight.
On a historical note, this wouldn’t be Colorado’s first experiment with temporary taxes. The entire sales tax, created in 1935, was supposed to sunset in 1937. That was eighty years ago, but who’s counting?
It Bifurcates the State’s Sales Tax Base
Colorado’s sales tax is complicated. In most counties, the state collects the local sales tax and remits the revenue back to county government, though Denver and Boulder counties administer and collect their own sales taxes. Cities with a home rule charter are also eligible to administer their own sales taxes. There are also metropolitan districts and special districts and authorities.
Cities and towns without a home rule charter (termed “statutory cities”), along with special districts, must adopt the state sales tax base, but are entitled to opt into any of eleven enumerated exemptions. Home rule jurisdictions, meanwhile, have eighty-nine potential exemptions from which to choose. There are 294 taxing jurisdictions, but many overlap, yielding 756 areas with different local rates and bases. A business processing sales in multiple locations must determine what is in the sales tax base in each location, applying only the state sales tax on some items, only the local sales tax on others, and both the state and local sales tax on many more.
This new proposal starts the state down the path of splitting up the state sales tax base as well. Rather than simply increasing the state sales tax rate from 2.9 to 3.52 percent, the bill would create a new 0.62 percent sales tax on top of the existing tax, but impose it on a slightly narrower base, one that excludes aviation fuels. This doesn’t add a great deal of complexity in and of itself—the community of people purchasing aviation fuel is small and specialized—but it introduces a new wrinkle to the state sales tax, and may open the door to further divergences from base uniformity in the future, a departure from the legislature’s stated desire to adopt a uniform sales tax base.
Source: Tax Policy – Potential Colorado Ballot Measure Shows How Not to Design a Sales Tax