West Virginia Gross Receipts Tax Proposals Just Won’t Die
In West Virginia, a past tax is never dead. It’s not even past.
Never mind that the legislature showed scant interest in Governor Jim Justice’s three previous proposals to reintroduce a gross receipts tax. Never mind that, after years of trying, the state abolished its previous gross receipts tax thirty years ago. Never mind that the tax in question was adopted in 1921, before the state had income or sales taxes. Never mind that, in the near-century since the old tax was adopted, nearly every state repealed its gross receipts tax.
With the revival of the governor’s commercial activity tax proposal, West Virginia’s course runs against the current, borne ceaselessly into the past.
But what’s truly amazing is that the whole fight is over $11 to $12 million.
When Governor Justice (D) first proposed a commercial activity tax, it was supposed to raise $214 million. A later, scaled-back plan would have raised $45 million. The latest proposal, an 0.015 percent tax on gross receipts, would raise a mere $11 to $12 million, ostensibly dedicated to highway funding.
The same amount could be generated by increasing the gas tax rate by one cent per gallon, from 33.2 to 34.2 cents per gallon. Not only would this make more sense—the cost of highway improvements should be borne by those using the highways—but it would avoid the need to create and administer a brand-new tax.
Even if the tax never grew, this would be a significant burden. All tax administration comes at a cost, but building out the infrastructure to collect and audit a tax that raises a mere $11 million or so is highly inefficient. More likely, though, is that the tax would increase with time; few taxes remain that modest forever. It would be the easiest tax rate to adjust every time the state wanted some additional revenue. And once the rates rose—perhaps to the 0.2 percent rate the governor had proposed originally—West Virginia businesses would be at a significant disadvantage, faced with a tax that is imposed without regard to profitability. (More on the implications here.)
It’s not for nothing that economists widely see gross receipts taxes as among the most economically destructive sources of state tax revenue. Our State Business Tax Climate Index, which is a measure of tax structure, looks on them with disfavor as well: West Virginia would slide seven places on the Index if it enacted such a tax. (Raising the gas tax by one cent wouldn’t move the needle.)
West Virginia is looking to some very old ideas about taxation. But might I suggest an even older one? In 614, the Edict of Paris prohibited the adoption of any new or “unheard-of tax,” and pledged that everywhere a new tax had been “wickedly introduced,” the matter would be investigated and the tax “mercifully abolished.” This might have been something of an overreaction, but West Virginia’s state-level gross receipts tax having been mercifully abolished in 1987, it would be a shame to bring the idea back now.
Source: Tax Policy – West Virginia Gross Receipts Tax Proposals Just Won’t Die
A Quick Overview of the Asymmetric Taxation of Business Gains and Losses
The current tax treatment of operating losses
If a business has tax liability from the prior two tax years, it may carry the net operating loss (NOL) back to offset that liability. However, if the NOL exceeds its profit from the recent two years, the business cannot exhaust the NOL deductions through carryback. It can carry the NOL forward to be used as a NOL deduction against future taxable income. The current U.S. law allows NOL to be carried forward up to 20 years.
When all NOLs in this tax year are completely carried back to prior years, this firm could immediately utilize all such NOLs and get full NOL deductions. However, if the business must wait for years to deduct its NOLs, the real value of the tax loss is diminished, due to inflation and the time value of money. The deferred tax benefits or refundability of a certain amount of NOL will be worth much less to the business.
Tax asymmetry on business profits and business loss
Current law taxes profits immediately, while losses often reduce taxes only with a delay. A perfectly symmetrical treatment of losses and profits would require the income tax value of a loss to be refunded in the year the loss is incurred, just as profits are taxed immediately as they occur. If the losses are carried forward, the real value of losses should be preserved by adjusting them by an appropriate rate of inflation and the normal real return to capital (in effect, augmenting them by an appropriate interest rate). Instead, U.S. tax systems operate under a partial loss-offset system where firms can only carry the fixed nominal balance of their losses forward up to 20 years without any interest-like adjustment added to lower future taxable income.
The impacts of partial refunding of net operating losses
Tax asymmetry penalizes new firms disproportionately. New businesses usually run losses for several years before generating profits. There is no way for them to carry back the losses or utilize the NOL deduction before they make profits. It is highly possible that the startups do not survive and their losses expire and never get utilized. As a result, the share of NOLs reported by new corporations (less than five years old) was 17 percentage points lower than that for old ones in late 1990s. Startups thus face a significant tax disadvantage compared to established businesses that can deduct losses on new ventures against ongoing profits from other activities.
Tax asymmetry is especially disadvantageous to risky business investment due to the high uncertainty associated with the investment’s streams of return for the upcoming years. When choosing between two projects with equal expected pretax rates of return, the risky one is less likely to be selected because of the penalization caused by partial loss offsets, should they occur, compared to the less risky one.
The partial loss-deduction system has noneconomic effects on firm financing decisions. Current law allows interest payments from debt financing to be deductible for tax purposes, making debt financing generally less expensive than equity financing. However, firms in a loss position are not able to utilize interest deductions immediately (having no profits to deduct against). This diminishes the tax advantage of debt financing and thus potentially causes a shift away from debt financing due to the added cost of financing.
Currently, no OECD countries with corporate taxes have a full loss-offset system or even pay interest to maintain their real values. The partial loss-offset regime clearly has its inherent merits in fighting against fraud and abuse. Nevertheless, for tax policymaking, it is important to take into consideration the impacts of this asymmetry and how it is related to other features of the tax code and how they impact business decisions.
Source: Tax Policy – A Quick Overview of the Asymmetric Taxation of Business Gains and Losses
Arizona Governor Signs Bevy of Tax Bills, Offering Something for Everyone
Arizona’s legislative session concluded in a flurry of activity, including passage of several pieces of tax legislation. Personal exemptions were raised. Tax referenda were restricted. Business exemptions were extended. Gold coinage was exempted from capital gains taxation.
The theme, if there was one: something for everyone.
Legislation signed by Governor Doug Ducey (R) modestly increases the state’s personal exemption, by $100 over two years, and thereafter indexes the exemption amount to inflation. The existing personal exemption, set at $2,100, had not been adjusted for decades. Annual inflation-indexed adjustments help avoid unintentionally exposing taxpayers to higher effective rates as time passes.
The state’s unique sales tax, called a transaction privilege tax, borrows elements from gross receipts tax regimes: it is imposed on a very broad base which includes a wide range of business inputs, and levied at different rates on different classes of transactions. Local governments have the option of imposing their own transaction privilege taxes, but only with the approval of the voters by referendum. Newly signed legislation limits these referenda to even-numbered years (corresponding with campaigns for state and federal office), which tend to have higher turnout.
The debate about election timing is not new. Across the country, municipal elections and ballot issues often fall in off-years, or even in spring elections, to allow them to stand on their own and not allow local issues to be drowned out by federal politics. In theory, those turning out for municipal elections may be more informed on local issues, and not simply driven to the polls by national concerns. Critics on both sides of the aisle have often challenged the notion that low turnout off-year elections should be favored, arguing that these decisions should be presented to a larger electorate where possible.
Other bills expand and clarify business incentives at the cost of tax neutrality. The quality jobs tax credit, a job creation incentive, is extended through 2025 and broadened to cover more businesses, while the period of eligibility to claim a credit for relocation and expansion has been increased. Job and investment credits, along with other targeted incentives, lower tax liability for some businesses and industries at the expense of others, essentially picking winners and losers through the tax code while eroding the tax base. Most economists tend to regard such programs as inefficient and see them as providing a poor return on investment.
Finally, Arizona adopted legislation exempting profits on the sale of gold, silver, and other precious coins from state capital gains taxation. Proponents argued that bullion should be understood as a hedge against inflation and not treated like other investments for tax purposes, while detractors countered that gains and losses from the sale of precious metals should be treated like those from any other investment.
The legislature’s tax bills have a scattershot quality to them this year; they are disparate proposals, not part of a larger tax package or in service of a singular goal. For sheer number of tax bills adopted, though, in 2017, Arizona stands out.
Source: Tax Policy – Arizona Governor Signs Bevy of Tax Bills, Offering Something for Everyone
Does Your State Have an Estate or Inheritance Tax?
In addition to the federal estate tax of 40 percent, some states impose an additional estate or inheritance tax. Fourteen states and the District of Columbia impose an estate tax while six states have an inheritance tax. Maryland and New Jersey have both.
Washington state’s 20 percent rate is the highest estate tax rate in the nation; ten states and DC are next with a top rate of 16 percent. Delaware and Hawaii both have the highest exemption threshold, which, at $5.49 million matches the federal exemption level.
Of the six states with inheritance taxes, Kentucky and New Jersey have the highest top rates at 16 percent. Maryland imposes the lowest top rate at 10 percent. All six states exempt spouses, and some fully or partially exempt immediate relatives.
Recently, states have moved away from these taxes or raised the exemption levels. Indiana repealed its inheritance tax in 2013. Tennessee repealed its estate tax in 2016. New York raised its exemption level to $5.25 million this year and will match the federal exemption level by 2019. The District of Columbia is set to conform to the federal level this year after meeting its revenue triggers. New Jersey will fully phase out its estate tax by 2018.
Estate and inheritance taxes have large compliance costs for states, and they may become costlier if the estate tax is eliminated at the federal level as proposed in both the House GOP Blueprint and President Trump’s tax plan. This would leave states with the full administrative burden of the estate tax instead of being able to rely on administration from the Internal Revenue Service.
Estate and inheritance taxes are burdensome taxes that disincentivize business investment. The handful of states that still impose them should consider eliminating them, or at least conforming to federal exemption levels.
Source: Tax Policy – Does Your State Have an Estate or Inheritance Tax?
The Cautionary Tale of Chilean Tax Reform
While most countries in the OECD have labored to reduce taxes on businesses, there is one exception. Chile introduced tax reform in 2012 and 2014, which increased the corporate tax rates and added stricter anti-tax-avoidance rules. Over the decade before the tax reforms Chile had almost tripled its per capita income of $4,700 in 2001 to almost $14,600 in 2011. Since the tax reform of 2012, the Chilean economy began to slow, and by the 2014 tax reforms, the economy was retracting on a per capita basis. Now, Chile is faced with a recession, even as the global economy is beginning to grow.
Chile was considered the miracle of South America at the end of the 20th century. It emerged from a dictatorial regime under Augusto Pinochet with pro-market reform that opened trade with the rest of the world and brought inflation under control. These reforms, along with a return to democracy, set the stage for a massive economic expansion during the ’90s and drove Chile to become the largest producer of copper in the world. By the beginning of the new century, the per capita income of Chile leaped over its wealthier neighbor, Argentina, and remained $2,000 greater until the tax reform in 2014.
Since the return to democracy in 1989, Chile has averaged around 5 percent growth while its neighbor, Argentina, could barely maintain 2 percent growth. The flood of foreign direct investment (FDI), modern economic institutions, and stable economic growth placed Chile on a path to become a developed nation. Indeed, Chile joined the OECD in 2010, becoming the first nation from South America to sign an accession agreement.
During the presidency of Sebastián Piñera, a center-right politician, mass protests by students forced the Chilean government to reform the education system. As part of the education reforms, Piñera increased the corporate tax rate from 17 percent to 20 percent for 2013 and made the increase retroactive to 2012. These tax changes in the 2012 tax reform bill, along with stricter rules for multinational corporations, raised an additional $1 billion for education even as taxes decreased for individuals.
In the presidential elections of 2013, Michelle Bachelet, a center-left politician, took back the office on a platform of reforming the constitution of Chile and reducing inequality. In September of 2014, she approved a tax reform bill that once again increased the corporate tax rate, to 21 percent in 2014, 22.5 percent in 2015, and 24 percent in 2016. The bill will further increase taxes on shareholders in 2017 and 2018. In addition, the 2014 tax reforms increased anti-tax-avoidance rules and gave the Chilean tax authorities the ability to issue regulations regarding these rules.
President Bachelet promised that the tax reforms would increase tax revenues by 3 percent of GDP by 2018, most of which she would use for social programs. However, in 2015 the Chilean economy began to slow, along with the popularity of Bachelet. By August of 2015, the Chilean central bank cut growth expectations from 3.6 percent to 2.5 percent, which delayed the implementation of Bachelet’s campaign promise of increasing social programs. By the summer of 2016, the sluggish economy weighed on the popularity of Bachelet and brought it to an all-time low.
As of the first quarter of 2017, the economic outlook of Chile is rather bleak. The Chilean economy teeters on recession, with barely 0.1 percent annualized growth in the first quarter. Foreign direct investment has stagnated since its height in 2014 and average wage growth fell to virtually zero in 2015, even as wage growth in the OECD had finally recovered from the Great Recession.
The higher tax burden on mining corporations has squeezed margins and forced companies to delay wage increases. This has sparked conflict with workers’ unions. Standoffs between mining companies and the unions over wages and compensation packages have caused a rash of strikes, which caused a spike in the price of copper at the beginning of this year.
Some have claimed that the strikes are the cause of the declining economic growth, but the reality is the strikes are a symptom of the ailing Chilean economy. The stagnation of FDI and the lower productivity resulting from capital thinning is putting downward pressure on wages. Demanding more compensation as productivity is rising, as happened in the past, is an easy lift for any company. However, when an increased tax burden reduces investment and slows productivity growth, companies are stuck between high taxes on more investment and higher wages to labor, a rock and a hard place.
It is likely the increase in taxes and the uncertainty around the tax rules is the cause of Chile’s current economic woes. Although commodity prices play a role, Chile’s economy is quickly sinking to recession even as the world economy is beginning to grow again. Both President Piñera and President Bachelet had good intentions when raising the taxes on businesses, but these intentions may have paved the way to Chile’s economic ruin.
The current debates over tax reform in the United States have argued that business tax reform is not the country’s most important priority. These tax reform opponents argue that we should be focusing on improving education or reducing inequality. Although these are noble pursuits, using the tax code to achieve them may reduce opportunity for education and wages of the working class due to an ailing economy.
We should take heed from the Chilean experience. Although we are not actively increasing the burden on businesses, we have a tax system out of step with our peers in the OECD. Let’s fix the burden on our economy, and we will find plenty of resources for more education and greater equality in the future.
Source: Tax Policy – The Cautionary Tale of Chilean Tax Reform