Tuesday, March 13, 2007

The Grotesquely Revolting Tale of the Gross Receipts Tax

Illinois Governor Rod Blagojevich (D) wants to do away with the corporate income tax on businesses with $1,000,000 or more in sales receipts. The State's corporate income tax is too loophole-ridden, he says. So since there are too many loopholes to effectively soak the big corporations, he has decided to soak their customers, the people of Illinois.

And from where did those loopholes come in the first place, Governor? From the legislature, either in an effort to attract business to Illinois or to convince them to line the pockets of Illinois' infamously corrupt political establishment. In neither case will the businesses who located here as a result of promises appreciate this unexpected change in the rules, and will find Illinois an increasingly unpleasant place to operate.

Blagojevich plans to replace the corporate income tax with a 0.5% "Gross receipts tax" for goods and 1.8% tax on services. That's right: the Governor wants to tax every single transaction that he can, from cab fare to the pennies on your eyes. But the truly insidious nature of this tax is not that it taxes everything sold, but that it taxes every part of everything that is sold.

The "milk jug tax", as I like to call it, taxes suppliers of milk jug caps .5%, label printer .5%, suppliers of milk jugs .5%, and suppliers of milk .5% (if they are big enough and don't get a loophole). So the seller of milk to grocery stores pays an extra .5% for the cost of materials, and an extra .5% for his own tax. That raises the price by 1%. And the grocery store pays another .5%. The longer the supply chain, the more expensive it gets.

That, my friends, is worse than a mere Value Added Tax, and it will have a dramatic, negative effect on our economy. Blog user Kevin Sandefur explains this at IlliniPundit:

As I understand it, a VAT is only paid on the mark up at each step of the chain, so that the total pass through to the consumer is theoretically limited to the total percentage rate. I.e., a VAT of 1% would supposedly only raise the price of end products to the consumer by 1%.

A gross receipts tax, on the other hand, is effectively on the whole enchilada in each transaction, so it becomes multiplied many times over, as you illustrated.

In his penchant for disingenuity, the good Governor lauds himself for exempting exports from Illinois from the GRT. That would be fine, except for two things.

First, the States are Constitutionally prohibited from taxing exports, or at least, there are thorny legal questions that would have to be answered on a product-by-product basis.

Secondly, businesses exporting from Illinois will be paying higher prices from their Illinois suppliers. Like other consumers, they would be paying higher prices for the things they buy in Illinois.

However, under the Blagojevich plan, an Illinois manufacturer could purchase materials from other States, avoiding sales tax, produce their goods, and export them solely to other States. That manufacturer would pay no tax at all.

[Update: an anonymous commenter here says: "An out of state firm that sells to an Illinois firm will have to pay the gross receipts tax on that sale. The gross receipts tax will apply to ALL SALES MADE TO ILLINOIS BUSINESSES, and it matters not whether the firm making the sale is located in Illinois or out of state."

I think that may run afoul of the "substantial nexus" requirement, but I'm not a lawyer.]

The net effects of the Gross Receipts Tax would be 1) prices going up for everything and 2) a flattening of the supply chain. Companies with tight margins (which is to say, all companies) will see this new landscape and start making everything in-house, or buying it from Wisconsin, Indiana, or Taiwan.

While the real target of this is probably Wal-Mart, it is Wal-Mart's customers and small local competitors who will feel the crunch.

It may surprise some people, but many small businesses generate over $1 million in gross annual receipts, but nothing like that in profit. The typical small-town grocery store, for instance, can easily have $25,000 per week in sales, but their net profit is a tiny fraction of that, barely enough to keep the lights on and freezers in repair. These small players are already being pushed out of the market by pressure from Wal-mart on one side and convenience stores on the other. Being forced to fund the Governor's expansive pandering could force them out of business, another victim of government largess and the unintended consequences of intrusion into the marketplace.

A Crain's Chicago Business article said:
Gov. Blagojevich's proposal — the gross-receipts tax — has been tried elsewhere. Ohio and Texas recently adopted such a tax, but only as part of a broader restructuring in which other, more onerous taxes were eliminated. Michigan just junked its gross-receipts tax after gripes that it put its firms at a competitive disadvantage.
Michigan, by most measures, has one of the worst economies in the nation.

Back on IlliniPundit, Pseudonominal user Ammonium adds:

But not everybody is going to be worse off under this tax scheme. Large, integrated corporations that make lots of money will likely end up paying less. If you're a company like ADM you're paying out 7.3% of your more than a billion dollars in profit every year (assuming no loopholes). With this new tax scheme, ADM is paying very little. Most of their products are exported out of state, so they pay no tax on those. They may have to pay a little more for their inputs (I doubt farmers will have to pay the 0.5% tax though), but in the end they're making out with a hundred millions of dollars saved in taxes.
Companies large and small will pass these costs on to the consumer, and as many who can will leave the State. Many who can't leave will go out of business. Illinois will be following Michigan down the road to ruin, all so the Governor can make a difference. He'll make a difference all right. In the end, Illinois consumers (you know, the little people Governor Blagojevich allegedly champions) will be paying every penny.

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Anonymous said...


Good post. I wanted to correct one thing you said, however.

An out of state firm that sells to an Illinois firm will have to pay the gross receipts tax on that sale. The gross receipts tax will apply to ALL SALES MADE TO ILLINOIS BUSINESSES, and it matters not whether the firm making the sale is located in Illinois or out of state.

So, in your example, the Illinois firm who buys from out of state suppliers will still see the cost of their supplies increase, even if they turn around and export themselves.

It truly is an insidious tax.

Anonymous said...

Yes, the constitutionality of that position is an open question, but Illinois will almost certainly use the "economic nexus" approach and many companies will voluntarily pay the tax.

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