The following is my testimony today to the Senate Revenue Committee regarding the proposed “business margins tax” and extensions of the 2009 tax hikes:
My name, for the record, is Geoffrey Lawrence and I am deputy director of policy at the Nevada Policy Research Institute. Thank you, Madame Chair, for the opportunity to testify today.
As I’m sure you’re aware, every tax instrument impacts economic behavior in unique ways and these distortions are generally wealth-reducing because they alter human action away from the welfare-maximizing behaviors that occur within open markets. However, since governments are compelled to levy taxes in order to provide for certain “public goods,” such as the rule of law, sober consideration should be given to the relative merits and drawbacks of alternative taxing mechanisms.
I’d like to review some of these very briefly.
The Modified Business Tax is ultimately a tax on labor, which artificially increases labor costs – suppressing the demand for labor. As a result, the tax is a negative incentive for employers to retain existing workers or to hire new ones. It also can lead to an over-mechanization of industry, beyond the point of optimal production, because the cost of capital relative to labor is artificially skewed. In economics, there’s a very boring-sounding term for this trade-off between hiring workers or investing in machines to do the work called the “marginal rate of substitution.” Taxes on labor, as with taxes that specifically target capital, distort this delicate balance and lead to sub-optimal levels of production.
The Local School Support Tax, as you know, is a tax on consumption. Consumption taxes artificially elevate the final price facing consumers and, therefore, suppress consumer demand for the taxed goods. This means that, while consumer welfare is injured, retailers see fewer revenues as a result of the decline in consumer demand. This fall in business revenue is translated backwards to factor inputs like capital and labor – further exerting downward pressure on wages. As I often say, business is like a jelly doughnut: if you squeeze it, the jelly has to come out somewhere. With regard to consumption taxes, this is generally some combination of higher prices on consumers or reduced wages for workers.
I bring up these points because the adverse impacts of taxation are directly proportional to the size of the tax burden imposed. Since an extension of the Modified Business Tax and Local School Support Tax increases from 2009 would effectively increase the total tax burden beyond what is scheduled to exist, this bill would only magnify the distortions caused by these particular tax instruments.
I’d also like to briefly address the potential adverse impacts of the proposed business margin tax. A major weakness inherent to the proposed margin tax is that the tax is assessed at every stage of production throughout the supply chain. This means that the tax would have “pyramiding” effect, with a disproportionate effective tax rate imposed against complex goods that require multiple stages of production. I fear that this tax proposal would specifically place Nevada at a competitive disadvantage for high-tech industries, such as solar energy development, biotech industries and the like because they require many stages of production. If so, it would work at direct odds with the purported goal of economic diversification.
Finally, I’d like to highlight that the impact of taxation in affecting economic behavior is closer to that of a water facet that is slowly turned on than a waterfall. That is to say that even relatively low tax rates can affect economic behavior because the impact is incremental and doesn’t lie behind some threshold tax rate. For every small increase in sales tax rates, for example, there is a growing increment of consumers who choose not to purchase the product being taxed. Similarly, business owners decide to scale back production or labor force by growing increments with each new or higher levy. Economists refer to this as the “marginal” impact of a tax increase or a price change and it means that we should not delude ourselves into thinking that the proposed tax changes would not, in some measure, exacerbate the state’s economic woes.
As a side note, I would like to applaud Senator Horsford’s motion to use excess revenues to pay down unfunded PERS liabilities and would suggest that similar provisions be applied to all revenue streams.
Thank you for your time and I’m happy to entertain any questions.