Perils of the Gross Receipts Tax

Staff

When the taxman cometh, the businessperson stays away, especially if it’s the gross receipts tax.

Like any turnover tax, Nevada’s falls upon revenues (that is, the amount of money that the firm takes in), not on profits (the amount of money that it keeps after paying workers, banks and so forth)

How the Gross Receipts Tax Work

Consider a small store that sells $1 million of goods annually and pays its workers and landowner $900,000. The profit is $100,000. The profit tax falls on this $100,000, and the gross receipts tax falls on the full $1 million.

In sum, the impact of the gross receipts tax on a firm is several times greater than that of a profit tax (called a corporate income tax). That is why owners of small firms get sweaty palms over the turnover tax.

The History of the Gross Receipt Tax

Gross receipts taxes were popular in the Great Depression of the 1930s when states were strapped for cash because of declines in revenues from property and income taxes. They sought to tax firms on a large base, so they taxed gross receipts rather than just profit. They were oblivious to the wrongness of raising taxes in a depression. This was the time to encourage people to spend more, by cutting their taxes.

In any event, since the Great Depression, gross receipts taxes have gone out of style. State courts have often ruled against them – we will see why in a minute. Today, only seven states have gross receipt taxes.

Nevada established its Commerce Tax in 2015, backed by Republican Governor Brian Sandoval, after voters refused to approve it the year before. The only neighbor of Nevada with a gross receipts tax is Oregon, with a rate of .57 of one percent. Nevada’s rate varies wildly over 26 types of business, from 0.051 of one percent on mining to .281 of one percent on educational services and .331 of one percent on rail transportation. Washington State has the country’s highest rate, a whopping 3.3. percent.

The Downfall of Nevada’s Commerce Tax

The tax discourages firms from producing as much as they can. As they produce another shirt, revenue falls (because shirts flood the market) while cost rises (workers demand overtime).

By cutting weekly output, the revenue from the last shirt rises (the market is no longer flooded) at the same time, the cost falls (workers don’t work overtime). Thus, the firm has more profit from the last shirt after paying the tax. Unfortunately, cutting output also means cutting jobs.

The tax reduces the number of small firms and enables big firms like Amazon to take over the market without worrying about competition from the small fry.

New businesses in Nevada are declining

The impact on budding entrepreneurs is especially severe. Most startups lose money for a few years before turning the corner. For them, the gross receipts tax puts them deeper in the red. The tax discourages people from becoming entrepreneurs – a loss in small firms that we don’t observe and may underestimate.

The Census Bureau shows that the number of new businesses in Nevada is diminishing, unlike in most of its neighbors. From November to December, with a seasonal adjustment, the number fell in Nevada by 2.9 percent. The only neighbor in which the number decreased was Oregon (by 10.1 percent).

A similar pattern held for December 2022 to December 2023: Nevada was unusual in the West for suffering a decline in new firms.

Is the Commerce Tax Hurting Us?

Tax rates vary across business types, which invites political maneuvering. The low rate on telecommunications (.136 of one percent) was a concession to industry lobbyists, writes the Tax Foundation.

The gross receipts tax also has a subtler effect on a company’s size and nature. It penalizes each transaction that generates sales, such as hiring someone to sell shirts.

The firm would gain by merging with another firm with a shirt salesperson. Thus, the tax encourages firms to merge with their suppliers. Economists, always looking for fancy phrases, call this vertical integration. Vertical integration makes firms larger. It also discourages competition among suppliers because the firm buys shirts from itself rather than from someone who offers them at a slight discount.

The gross receipts tax also slows the development of the economy by discouraging transactions and blocking the production of complex goods, which require more steps. For example, ee get a phone that can send text messages but not images.

The tax is inefficient because it does not encourage firms to produce as much as they can with their workers and machines. In principle, the market, not the government, should set most prices, because the market reflects what buyers want and what sellers can provide. Tax rates should be neutral to allow the market to set prices. That is, they should apply the same way to all industries.

However, the gross receipts tax in Nevada is higher for educational services than for mining. This induces firms to move from education to mining, slowing learning and the growth of human capital.

Finally, the turnover tax is unfair. It makes sense to tax profits because these result from good luck. It does not make sense to tax labor twice – through gross receipts and again through the payroll. Over time, as production inevitably becomes complex, the rising tax forces firms to raise prices, impoverishing already poo consumers.

Other States’ Responses to the Gross Receipts Tax

The states recognize these problems with the gross receipts tax and have tinkered with it.

Texas permits the firm to deduct wages, or the production cost of goods sold from its tax base. The result is to make labor-intensive firms less so. In other words, they will rely on labor less than before, which is not all bad. The firm must diversify its inputs, which shields it from certain risks. A hamburger joint will not lose so much from a hike in the minimum wage.

But Nevada has a peculiar rule. It lets the firm deduct half of its liability for paying the Commerce Tax in the previous four quarters from payroll taxes. This encourages the firm to do the things that make the Commerce Tax costly – to make more transactions, to buy from outside suppliers, to increase output, and resist vertical integration, all of which is good for the economy.

But the dependence on the prior year may touch off sharp, dizzying changes. Last year, the firm began hiring part-time workers. Now it hires even more, although it is more used to full-time workers. The rule also increases the Commerce Tax’s share of all business tax revenues over time, magnifying its distortions.

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