Policy Documents

The Margin Tax Debunked: Dispelling Three Common Myths about Texas’ Restructured Business Tax

Lauron Fischer, Talmadge Heflin and James Quintero –
November 30, 2011

In 2006, the Texas Legislature—under pressure from a Texas Supreme Court ruling declaring the state’s school finance system unconstitutional—sought changes to the Tax Code that would broaden the base of taxpayers paying into the system and generate additional revenue for the state that could be used to reduce Texas’ local property tax burden. Ultimately, the Tax Code changes that lawmakers settled on that session, borrowed heavily from the Texas Tax Reform Commission,† brought to life the Texas margin tax, a cross between a modified gross receipts tax and a corporate income tax. 

Under the restructuring, the state’s old corporate franchise tax—which was based on the greater of a 4.5 percent tax on earned surplus (net income) or a 0.25 percent tax on taxable capital (net worth)—was replaced with a broad-based, low rate tax on a business’ “taxable margin,” a concept similar to taxable income.

Initially, expectations were high among businesses and lawmakers that the margin tax was going to be a marginal improvement over the old system; however, in the few short yearssince its inception, the tax has been plagued by a number of problems. Chief among these are: 1) the tax’s inability to meet revenue projections; and 2) taxpayer- and tax collection-related challenges stemming from compliance, complexity, and cost issues.

In fiscal 2008—its first full year of collections—the margin tax generated $1.4 billion less-than-expected. In fiscal 2009, the revenue shortfall totaled $1.6 billion. And in fiscal years 2010 and 2011, collections fell short by $500 million.

In addition, taxpayers in Texas have complained that the margin tax is a logistical nightmare, both from a tax-preparing and tax-paying standpoint. In a May 2008 survey conducted by the National Federation of Independent Business, 75 percent of survey respondents said they were dissatisfied with the new tax structure and “would choose the old franchise tax over the new margin tax.”

As a result of these shortcomings, some have begun calling for the legislature to “fix” the tax in the next legislative session, presumably by raising the rate, adjusting how the tax is calculated, or some combination of both. And it is expected that when the 83rd Legislature convenes in January 2013, lawmakers will seek to modify the tax regardless of whether or not the Texas Supreme Court rules it unconstitutional in the coming months.

However, before lawmakers consider “fixing” the margin tax, it is important that they have the complete picture, void of any misconceptions. Below we discuss three common myths about the margin tax—and present the facts about each one.