State-local Business Taxation
To most people, the subject of tax structure is a sleepy one. An important exception is when looming changes to the tax structure raise the prospects for who will pay for public services (and how much they will pay). In characterizing this debate, Senator Russell B. Long of Louisiana once said, “Don’t tax me, don’t tax thee, tax that fellow behind the tree!”
Public discussion also becomes animated when considering whether state and local tax structures (or changes to them) will hinder economic growth and development. That is to say, will tax hikes on business drive away jobs and income?
A recent symposium held at our Bank gathered experts together to consider emerging trends in business taxation. In recent years, there have been significant changes to business taxation in Midwest states, such as Ohio and Michigan. Ohio enacted a modest tax on business gross receipts in 2005, replacing a local tax on capital machinery and equipment. Michigan has phased out its largest business tax and is now considering how to replace the revenues that it formerly generated with its Single Business Tax.
The State of Illinois was considering a large “business” tax on business gross receipts to fund education and a subsidized health care initiative. To pay for it, Governor Rod Blagojevich advocated a large business tax on gross receipts because it would be paid by those who could afford it. Interestingly, the Lieutenant Governor Pat Quinn disagreed on the very same grounds.
Who was correct? As with many such matters, there is no certainty. But at the business taxation conference, I stated that I did not favor the Illinois gross receipts tax, at least on equity grounds. I argued that our most common principle of equity in taxation is a poor guidepost by which to design a state’s business tax structure. By equity, most people mean “ability to pay” such that taxation should progressively burden high-income households relative to low-income ones. The trouble with this approach is that businesses are not households. Businesses are organized groups of people ranging from line workers to mid-managers to active owner-entrepreneurs to silent capital-owning partners.
So who are we really taxing? We are not really sure. In particular, the taxation of business activity often results in changes to product prices that burden consumers rather than wealthy individuals. In the same vein, business taxation can sometimes result in lower wage offers to a firm’s workers. The ultimate result of such “tax shifting” may mean that a tax intended to “soak the rich” may have the opposite result. For example, it is easy to see (and universally accepted) that unduly high taxes on companies that sell gasoline in a state or city are largely shifted forward to consumers of gasoline in that state or city. Why would the companies pay inordinate taxes on the gasoline they sell in Chicago, for example? The answer is that they would not and they do not. This is in part because gasoline (energy) companies sell their products and services into many markets worldwide. Accordingly, when taxes on gasoline are pushed too high in any one locale, the price of gasoline rises until it becomes profitable for companies to sell it there. And since gasoline is presently a necessity for nearly everyone in the industrialized world, low-income households end up paying taxes on it that are a larger share of their household income as compared with the share of high-income households. The intent to achieve equity, in this instance, is foiled.
More generally, analysts have only a fuzzy and foggy notion across the breadth of business taxes as to which ones (and how much of them) are actually shifted to workers and to consumers. And so, to achieve equity, tools such as direct income redistribution or manipulation of the individual income tax are more reliable for this purpose. For this reason, I argue that it is preferable to design state and local businesstaxes around our notions of efficiency rather than on equity.
In looking at the efficiency of taxing businesses, it is important to recognize that business organizations do use costly government services, including police, fire protection, roadways, and legal protections. Having businesses pay for such services, then, is not only fair, it is efficient in several respects.
In paying state and local governments for their public services, businesses will be motivated to articulate their service needs to these governments, just as customers do with service providers in market situations. In turn, this will promote growth and development in states and localities. The resulting negotiation and conversation between governments and businesses will help identify those essential roads, bridges, and property protections that make businesses more productive. So too the process of haggling over the price and cost of government services to businesses will tend to keep governments cost efficient.
This give and take between business and government will only take place if a state’s business taxes are structured as a user charge and not set unduly high in an effort to redistribute income.
The purposeful conversation on business taxes and business service levels will also spill over in positive ways to government service provision to households. In recognizing that “business” taxes are not really subsidizing household services, such as education and health care, households and their representatives will more carefully evaluate the costs and benefits of government services.
The structure of taxes can be a sleepy one. However, those who doze off during the debate may very well find themselves stuck with the tab.