Thursday, April 5, 2007

The "Regressive" Gross Receipts Tax and Its Alternatives

One of the arguments being made against the gross receipts tax is that it is regressive – that is, the tax will fall disproportionately more heavily on people with lower incomes.

The argument has several forms. Business groups simply say the tax will just be passed on in higher prices, and consumers will take the hit. More academically minded, liberal groups like the Center for Tax and Budget Accountability and the Institute on Taxation and Economic Policy say that the gross receipts tax is another form of a sales tax; sales taxes are by their nature regressive; therefore the gross receipts tax is bad; consumers will take the hit.

The analysis is far too simplistic.

The first question that needs to be asked is: Regressive compared to what?

Even assuming, for sake of the argument, that the gross receipts tax is completely passed on to consumers, how regressive is it? Will it take a larger percentage of income out of the pockets of the poor, than the pockets of the rich?

The regressivity of any tax that falls on consumption depends on the particular items subject to the tax and how those items fit into the budgets of families at different income levels.

For example, a consumption tax that falls on food and clothing is more regressive than a consumption tax that falls on laptop computers which in turn is more regressive than a consumption tax that falls on tickets to the opera. How regressive a consumption tax is depends, not on the nature of the tax, but on the nature of the items covered. Not all consumption taxes are equal.

A sales tax that falls only on tangible goods, like our current Illinois sales tax, is more regressive than a sales tax that also covers services purchased by consumers. Which is why many have argued, like the Center for Tax and Budget Accountability, that the sales tax should be broadened. The addition of consumer services will not make the sales tax progressive, it will simply make it less regressive than it is now.

I make the same argument for the gross receipts tax. Because it falls on all economic activity, it will – even if completely passed on – include all consumption, making it less regressive than any sales tax.

The incidence of a tax that falls on all consumption will be similar in effect to a flat rate income tax – except at the highest income levels – because most people at every income level spend all their incomes.

(To whatever extent a gross receipts tax is not passed on to consumers in higher prices, the regressivity will be reduced – because some of the tax will be borne by the owners of capital.)

So, a gross receipts tax is less regressive than any sales tax, is similar in incidence to a flat rate income tax, but would be more regressive than a progressive income tax.

Which brings us to the second question: what are the alternatives being suggested by those who are attacking the gross receipts tax as being regressive, and therefore harmful to working families?

Bingo. You guessed it. They want to extend the 5 % state sales tax to cover consumer services, like haircuts, laundry, and funerals, and they want to increase the flat rate income tax that falls directly on individuals. How they can with straight faces say that a 5% sales tax on haircuts hurts the poor less than a 1.95% gross receipts tax on lawyers’ fees is something I haven’t yet figured out.

The Institute on Taxation and Economic Policy avoids making any hard choices by suggesting that Illinois go to a graduated income tax and exempt food from the sales tax. It is probably unfair of me to point out that the Illinois constitution forbids a graduated income tax and food is already exempt from the sales tax. Imaginary solutions are always easier to propose. No one takes them seriously.

In the real world where actual budgets are made, the gross receipts tax is a better option than the alternatives.

2 comments:

Robb Hendrickson said...

A gross receipts tax only makes sense to someone without an understanding of business economics; specifically that EBITDA/free-cashflow margins differ from one business model to the next. For example, the typical retailer will require $12.00 of revenue to produce $1.00 of EBITDA while the average manufacturer of non-commodity (proprietary) consumer products will produce $1.00 in EBITDA for every $1.14 in gross receipts. In other words, two prototypical firms -- one from each of these industries -- both producing $500K in EBITDA will have *very* different top lines: Firm A will have $6 million in gross receipts (and be taxed under the governor's plan) while Firm B will have $570K in gross receipts (and, therefore, be exempt). Both of these firms appear to the same in terms of "income" to their owners (i.e., both "pocket" $500K), but Firm A gets taxed while Firm B does not. How is this "fair and equitable"?

Dan Johnson-Weinberger said...

Hi Representative. I think you're a little unfairly dismissive about creating a graduated income tax. Yes, the state constitution requires a flat tax rate, but there are lots of ways to make our income tax more progressive. Do you support amending the state constitution? Or, within the current restraints of the constitution, raising the state income tax to 6% and then raising the personal exemption to $8,000 or so (or creating a $1,000 credit) in order to tax high incomes at a higher rate and lower incomes at a lower rate? Wouldn't that be the most progressive solution?