Texas margin tax: Always a bad idea

Geoffrey Lawrence

Leaders in the Democratic majority during the 2011 state legislative session proposed a dramatic change to Nevada's tax system: Phase out the Modified Business Tax — a tax on private-sector payroll — and replace it with a new, larger levy modeled after Texas' business margin tax.

The effort gained so little traction in Carson City that the Democratic leadership, embarrassed, never even brought its proposal up for a committee vote.

Now, almost a year since the 2011 legislative session began, the margin-tax scheme has found its way back into public discourse via state AFL-CIO bosses. They say they'll run a petition campaign to put a margin tax on the ballot. What they propose, however, is to install the margin tax in addition to the Modified Business Tax, not in place of it, and as reported in the Las Vegas Sun, they're seeking a tax rate of 2 percent, not 0.8 percent, as Democrats previously proposed.

Just what would that mean?

The proposed margin tax, as in Texas, would be assessed against firms with total taxable annual revenue over $1,000,000. The firms would have to pay a tax rate of 2 percent against either:

  1. 70 percent of total revenue,
  2. total revenue minus wages, or
  3. total revenue minus the cost of goods sold.

Advocates of this tax argue that allowing firms to choose between these alternative tax bases would prevent heavily labor-intensive or capital-intensive industries from suffering unique penalties from the tax, since they could deduct for labor or capital costs, respectively.

Analyses performed by Texas legislative staff, however, warn that industries that employ roughly proportional amounts of labor and capital are more heavily penalized by the tax. That's because fewer revenues can be exempted from their tax base. The result is that these industries face a margin-tax liability that is disproportionate to their share of the Texas economy. The share of margin-tax revenues paid by Texas' agriculture industry, for instance, is 2.6 times greater than its share of economic output.

The choice between alternative tax bases has made the tax-filing process more complicated in Texas, and this, in itself, has become an issue. Small businesses have complained that they do not have the accounting expertise to navigate the tax in the way that large businesses can. The high compliance costs associated with the margin tax are compounded by vague legal definitions of terms such as "cost of goods sold." It is not clear within Texas law what can be included in this category.

The margin tax doesn't just penalize small businesses, however. It also penalizes start-up businesses and others that find themselves operating at a financial loss. That's because the tax liability is calculated as a proportion of revenues and not profits — meaning that businesses operating in the red still face a margin-tax liability.

In this sense, the margin tax can be thought of as a modified gross-receipts tax: The tax is based on gross receipts, but offers an array of possible deductions. Indeed, Indiana University tax scholar John L. Mikesell has appropriately referred to the margin tax as a "badly designed business profits tax . . . combin[ing] all the problems of minimum-income taxation in general — excess compliance and administrative cost, penalization of the unsuccessful business, undesirable incentive impacts, doubtful equity basis — with those of taxation according to gross receipts."

The Tax Foundation calls gross-receipts taxation "distortive and destructive," because such taxes "pyramid," as they are assessed at every level of production. Thus, highly complex goods that require multiple stages of production are repeatedly subjected to the tax. This results in a higher effective tax rate on more complex goods, which distorts consumer behavior and leads to a loss of wealth.

Moreover, says the Tax Foundation, a margin tax is more destructive than alternative tax instruments yielding the same amount of revenue. It concludes: "There is no sensible case for gross receipts taxation, or modified gross receipts taxes such as a Texas-style margin tax."

All of these problems have become apparent in Texas. Not only is the margin tax perceived as unfair to small or struggling businesses, it also has consistently underperformed revenue projections. These problems have resulted in widespread calls for repeal or reform. In 2009 alone Texas lawmakers heard over 100 bills to modify or repeal the state's margin tax — only three years after the tax was put in place.

Given that the margin tax has been such an abject failure since its inception in Texas, it's astounding that anyone anywhere would consider replicating it, even for a moment.

It is time to throw the margin tax onto the trash heap.

Geoffrey Lawrence is deputy policy director at the Nevada Policy Research Institute. This article first appeared in Nevada Business. For more visit http://npri.org.

Geoffrey Lawrence

Geoffrey Lawrence

Director of Research

Geoffrey Lawrence is director of research at Nevada Policy.

Lawrence has broad experience as a financial executive in the public and private sectors and as a think tank analyst. Lawrence has been Chief Financial Officer of several growth-stage and publicly traded manufacturing companies and managed all financial reporting, internal control, and external compliance efforts with regulatory agencies including the U.S. Securities and Exchange Commission.  Lawrence has also served as the senior appointee to the Nevada State Controller’s Office, where he oversaw the state’s external financial reporting, covering nearly $10 billion in annual transactions. During each year of Lawrence’s tenure, the state received the Certificate of Achievement for Excellence in Financial Reporting Award from the Government Finance Officers’ Association.

From 2008 to 2014, Lawrence was director of research and legislative affairs at Nevada Policy and helped the institute develop its platform of ideas to advance and defend a free society.  Lawrence has also written for the Cato Institute and the Heritage Foundation, with particular expertise in state budgets and labor economics.  He was delighted at the opportunity to return to Nevada Policy in 2022 while concurrently serving as research director at the Reason Foundation.

Lawrence holds an M.A. in international economics from American University in Washington, D.C., an M.S. and a B.S. in accounting from Western Governors University, and a B.A. in international relations from the University of North Carolina at Pembroke.  He lives in Las Vegas with his beautiful wife, Jenna, and their two kids, Carson Hayek and Sage Aynne.