Margin tax on business would be bad for Nevada

The state does face real budgetary pressures, of course, but both Democrats and Republicans would be wise to look into the effects similar taxes have had in other states before leaping to this course of action.

During the current session, legislators have considered several options for a new business tax, each with its own history of being implemented in other states. The most popular of these nationwide, the corporate income tax, has a nearby example in the state of California — a state facing financial worries that dwarf Nevada’s. The massive budget problems in the Golden State stem from several causes, but one of them is the volatility of their tax system, including the corporate income tax. This source brought in record amounts of revenue at the beginning of the decade, but has declined dramatically during the current recession, contributing to the state’s breathtaking budget gap.

Given that unpredictable revenue streams have also been one of the chief worries for Nevada, the corporate income tax has little to recommend it.

The second is a gross receipts tax, which taxes businesses on any money that comes in the door, whether or not the company ends up realizing any profits. This tax is in effect in a handful of states, including Ohio. The chief problem with this approach is that the tax piles up or "pyramids" as goods move through the production process. The longer the production chain, the higher the effective tax rate on the final product. This produces major distortions in economic decision-making, with notably negative impacts on low-margin, high-volume businesses.

The third option is a "margin" tax on business, along the lines of the one currently operating in Texas. The margin tax is essentially a Frankenstein-like hybrid of both the corporate income tax and the gross receipts tax, with the flaws of both and no counterbalancing virtues.

Dizzyingly complex and unevenly applied across the state’s economy, the margin tax should not be used as a model for tax reform by any state. Unfortunately, it appears to be the front-runner in the Legislature. As with the other options, however, we can learn from another state’s experience.

When it was enacted in Texas in 2006, officials projected the tax would raise $5.9 billion per year (with some suggesting as much as $12 billion per year). In 2008, however, the tax raised just $4.45 billion, and collections fell under $4 billion in 2009. Far from solving the problems of the state’s previous business tax, the margin tax seems to have only aggravated them. In 2009, the Texas House Ways and Means Committee struggled with more than 100 proposals to modify the tax. These ongoing changes result in taxpayer confusion and aggravate the margin tax’s shortfall in collections.

The confusion over how the tax is supposed to be applied in the real world has reached the point where there is even debate over seemingly straightforward terms like "cost of goods sold." Groups throughout the state have highlighted this confusion and the tax’s increased compliance cost, with the Texas chapter of the National Federation of Independent Business declaring that it’s "crippling the small and mid-sized businesses." In addition, the Texas Retail Association has warned that with collections falling so far below projections, the state could be moving to raise the rate, while the Texas Taxpayers and Research Association has also raised concern about the tax’s increasingly controversial unintended consequences.

Given this negative example — in a state with a much larger and more diversified economy, no less — it is difficult to imagine a more wrongheaded approach to fiscal reform than the adoption of a margin tax. There is every reason to believe that this approach will cause significant harm to Nevada’s economy while not delivering the hoped-for revenue to the state treasury.

Even after taking the enactment of a statewide business tax off the table, the Legislature still has many options for funding next year’s budget. Legislators should be thinking long-term and keeping in mind that as the economy improves, Nevada’s current tax system is an advantage for future capital investment and job creation.

The state should not throw away one of its chief tools for fostering economic development and long-term growth because of short-term budget pressures.

Joseph Henchman is vice president of state and legal projects at the Tax Foundation in Washington, D.C. He is also the author of the study, "Nevada May Consider New Business Taxes," published last week.