Refresher: Why a franchise tax is bad tax policy

Victor Joecks

With the Las Vegas Sun reporting that Legislative Democrats plan on proposing a $1+ billion tax increase later today, it’s time for a refresher on why a franchise tax (a modified version of a gross receipts tax) is bad policy

The point of this post is to show why a franchise tax is a poor tax instrument, regardless of how many tax dollars you believe Nevada needs to collect.

Let’s start with the basics: What is a franchise tax (referred to here as a gross receipts tax here)?

Gross receipts taxes have a simple structure, taxing all business sales with few or no deductions. Because they tax transactions, they are often compared to retail sales taxes. However, they differ in a critical way. While well designed sales taxes apply only to final sales to consumers, gross receipts taxes tax all transactions, including intermediate business-to-business purchases of supplies, raw materials and equipment. As a result, gross receipts taxes create an extra layer of taxation at each stage of production that sales and other taxes do not – something economists call “tax pyramiding.”

The Tax Foundation has a full explanation of the consequences of “tax pyramiding” and other structural problems with the gross receipts tax here, but this negative consequence is especially worth highlighting, as Nevada’s politicians acknowledge the need for private-sector investment and growth.

Competitiveness: A gross receipts tax interferes with the capacity of individuals and businesses to compete with those in other states and other parts of the world. The tax embedded in prices grows as the share of a production chain within the state increases, so there is incentive to purchase business inputs from outside the state. It discourages capital investment by adding to the cost of factories, machinery, and equipment, and the disincentive increases as more of those capital goods are produced in the taxing state. This tax structure does not promote the growth and development of the state.

In summary, the economists at the Tax Foundation strongly denounce the gross receipts tax.

There is no sensible case for gross receipts taxation. The old turnover taxes – typically adopted as desperation measures in fiscal crisis – were replaced with taxes that created fewer economic problems. They do not belong in any program of tax reform.

Previously, Sen. Steven Horsford changed his stance on imposing a corporate income tax, from supporting to opposing, because he recognized the inherent instability in the corporate income tax.

A review of the literature and the problems inherent in any gross receipts tax should encourage Horsford and other legislators to make the same change regarding a gross receipts tax.

Regardless of how many tax dollars you want the state to have, a gross receipts tax distorts the marketplace, is inequitable and, overall, is a destructive tax instrument.

There is no sensible case for gross-receipts taxation.