The structural problems with a margins tax

Victor Joecks

When it comes to the tax debate in Nevada, there are two questions to consider.

First, what tax instruments or types of taxes should Nevada have?

Second, how many tax dollars should the state collect?

For the purposes of this discussion, let’s leave aside the second question. This post isn’t about if Nevada needs more to take more tax dollars or not. It’s about if a margins tax, one of the new taxes Democrats have proposed and also called a gross receipts tax or franchise tax, is a good type of tax instrument to have.

The margin tax that’s being proposed would be a .8 percent tax on a company’s revenue after a $1 million exemption. The tax would be imposed on a company and applied to the lesser amount of the following:

  • 70% of total revenue
  • Total revenue less wages and salaries paid
  • Total revenue less cost of goods sold

As Geoffrey Lawrence described in NPRI’s revenue-neutral tax-reform proposal, One Sound State, there are four important components when considering a tax: (1) reducing revenue volatility, (2) ensuring economic efficiency by minimizing tax-induced distortions in economic behavior, (3) minimizing compliance costs through simplicity of the revenue structure, and (4) ensuring vertical and horizontal tax equity.

Regardless of how much tax revenue it collects, a margins tax has problems in every single area (analysis adapted from Geoffrey Lawrence’s One Sound State):

1. A margins tax is nearly as volatile as a corporate income tax, because the additional financial burden imposed on firms would accelerate business closures. Thus, not only would the state be unable to collect revenue, but the uniquely perverse distortions caused by a margins tax would generate significantly higher unemployment.

2. A margins tax distorts economic behavior because the tax “pyramids” as it is added onto business-to-business transactions. This penalizes the production of complex goods that require multiple stages of production and would limit economic diversification in Nevada.

The higher tax rates that would be assessed against more complex goods would also distort consumer behavior away from optimal consumption patterns by introducing artificially increasing the cost of more complex goods.

3. A margins tax will burden businesses with new accounting measures that will increase compliance costs.

4. A margins tax favors vertical mergers. Because businesses wouldn’t pay a tax on supplies it “sold” to itself, a margins tax would accelerate vertical mergers as firms seek to reduce the amount of taxes paid.

While no tax instrument is perfect, there are inherent structural problems with any margins 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.