There Are Still Long Term Revenue Problems to Fix

The Problems:

1) Because the economy has changed and the Illinois tax structure has not, we run into continual budget crises. Our taxes tend to fall on the manufacturing and retail goods sectors that are declining relative to the whole economy. Tax rates on those sectors are too high and revenue does not keep pace with budget requirements, while the expanding service, financial and information sectors largely escape the existing taxes.

2) The corporate income tax is no longer a tax that can be effectively collected by state revenue departments. Multi-national corporations have become so large and their financial inter-relationships so complicated that it is virtually impossible to monitor the allocation of income to individual states.

David Brunori writes in his 2005 “State Tax Policy”, published by the Urban Institute:

The percentage of total state tax revenue collected from levies on corporate income has declined steadily for more than two decades. … More important, in every year since 1959, the corporate tax base has failed to keep pace with company profits, either worldwide or domestic. In other words, in relative terms, state governments are collecting less in corporate income taxes while corporations are earning more.

Robert Tannenwald, an economist with the Federal Reserve Bank of Boston, writes:

“Multi-jurisdictional entities are so thoroughly integrated that formulas designed to allocate their income geographically are in large part arbitrary and therefore controversial.”

3) The result over time has been a shift in tax burden away from business onto individuals as the response to these changes by state policy makers has been to increase individual income taxes.

Tannenwald’s study showed that between 1986 and 2000 the ratio of state corporation income taxes collected to corporate income decreased by almost 50 percent, while the ratio of state and local personal taxes and charges to personal income increased by 25 percent.

The Solutions:

1) The Governor suggested a gross receipts tax to address all three of the above long term structural problems, make the tax system fairer, and put the state on a sound fiscal basis moving into the future.

2) The only other alternative that has been suggested, SB/HB 750, does not address problems 1 and 2, and makes problem 3 worse.

Who’s Spinning a Tax Tale?

It is interesting how the opponents of the gross receipts tax have shifted the argument once their first charges proved to be untenable.

Remember the salvos? The GRT will be “devastating to Illinois employers.” “The tax has hurt the economy in every state where it has been implemented.” “It drives businesses out of state.”

We pointed out that there is no evidence to support those charges. Of the three states that have had gross receipts taxes for a long time, Washington, Hawaii and Delaware, the economies in two, Washington and Delaware, have, over the past 20 years, grown faster than the national economies.

And the business leaders in Ohio and Texas supported the gross receipts tax because the existing tax structure no longer fit with the underlying economy. The Ohio Business Roundtable said, “This new tax does not penalize job creation and investment, and also encourages participation in the global marketplace.” The Texas Economic Development Council called the gross receipts tax, “a fair business tax that closes loopholes and provides improvements to the funding for education.”

So we got past the first hurdle. The tax by itself does not devastate the economy.

Now some say we are spinning our tale because we have pointed to Texas and Ohio as examples of states that have recently passed gross receipts taxes. And they explain away the absence of any negative effect from Washington’s gross receipts tax by attributing that state’s economic success to either not having an income tax, or having no competition since it is bordered only by the Pacific, Canada, Oregon and Idaho.

They should just accept the fact that there is no credible evidence that a state gross receipts tax causes the economic sky to fall.

There are a number of legitimate questions. Is the gross receipts tax an appropriate tax to use? Is the overall size of the tax increase reasonable? Will the proposed expenditures be beneficial? Let’s just be clear about which question is being addressed.

Eight states, Washington, Delaware, Hawaii, Kentucky, Texas, Ohio, New Mexico and Arizona, have some form of a gross receipts tax. New Hampshire has a Value Added Tax. All are different, with different rates, different bases, different exemptions. The rest of the tax structure in each of the states is also substantially different. None of that has ever been the issue.

I stand by the arguments I have consistently made.

1) There is no evidence that the gross receipts tax is “devastating” to business.

2) The three states that have recently enacted a gross receipts tax did so largely because existing business taxes did not extend to significant sectors of the economy, and in the cases of Texas and Ohio did so with the support of business groups.

3) In today’s economy, the gross receipts tax is a better option for Illinois than any of the proposed alternatives.

4) Illinois is historically a low tax state, and if the Governor’s proposal is enacted, Illinois will still be in the bottom half of all states in state and local revenues (taxes, fees and interest) collected per $1000 of personal income, and below all but one of our neighboring states.

Logic is Not a Prerequisite

I was listening this past week to objections being raised against the gross receipts tax. Two jumped out, mostly because they came from the same person and followed one right after the other.

The first: the gross receipts tax is not related to profitability and will hurt businesses with small profit margins.

The second: we know that it is going to get passed on, just like all other taxes, to consumers and is going to hurt low income families.

I wanted to interrupt, “Choose one … but you can’t have both.”

If profit margins are cut, consumers won’t be affected.

If the tax is passed on to consumers, profit margins won’t be affected.

But logic has never been a necessary ingredient in political discourse.

What do economists know about what happens to taxes on business? Very little really. As William Oakland of Tulane University, and William Testa, vice president of the Federal Reserve Bank in Chicago, wrote in the May, 2000, issue of Economic Development Quarterly, “The actual incidence of business taxes remains unknown …”

There have been lots of studies, but the results depend largely on the assumptions made at the beginning as to how businesses respond to various taxes. It may be that it is this underlying uncertainty that makes the contradictory assertions about the gross receipts tax both believable.

The broad base, the low rate, and the simplicity are the strengths of the gross receipts tax. Because it applies to all economic sectors, the rate can be low. The lower the rate, the more easily it can be incorporated into the cost of doing business. Because the tax affects all economic activity and not just the production of tangible goods, if it is passed on, it is passed on to a much broader range of consumers than those now affected by the sales tax.

The gross receipts tax is better than alternatives that have been suggested to raise the same revenue. Doubling the individual and corporate income taxes would do little to spread the burden of taxes to those who now don’t pay and would simply make those who are paying now, just pay more. Broadening the sales tax to include consumer services would be far more regressive than a gross receipts tax.