Policy Documents

Research & Commentary: Franchise Taxes

November 16, 2012

Several states either have begun transitioning away from franchise taxes or are considering repeal. A franchise tax is a state tax levied on businesses and partnerships chartered within a state. It acts as a privilege tax: A company paying the tax is allowed to do business in a state under its corporate name. Franchise taxes are determined differently in each state, with the rates based on several value bases, including company assets, net worth, capital stock, capital stock plus surplus, capital, profits, or property in the state. Some states use a variety called a margins tax. 

Franchise taxes have become an unreliable source of revenue as corporate revenues have decreased considerably in recent years and many companies have reorganized to avoid the tax or have moved their affiliates to jurisdictions with better tax rates. 

Franchise taxes are often levied on top of corporate income taxes, and the increased cost of a franchise tax can be very harmful to a state’s economic competitiveness and ability to attract new businesses. Eliminating the franchise tax simplifies the tax code and removes a disincentive against in-state investments, which are penalized under the franchise tax system. 

West Virginia is currently undergoing a ten-year phase-out of its previous 0.7 percent franchise tax, with full repeal taking effect in 2015. Pennsylvania is also in a franchise tax phase-out, which will be complete by 2014. Kansas completed its phase-out in 2011. Missouri is the most recent state to begin a phase-out, voting in 2011 on a measure that phases out its state corporate franchise tax over five years. 

Franchise taxes, like all corporate taxes, are not really paid by the corporation but by customers (through increased product and service prices), employees (through lower wages), and others. Lowering or eliminating franchise taxes improves a state’s competitiveness by eliminating a double tax on business. 

The following articles examine franchise taxes and how different states are approaching reform. 

Texas’s Margins Tax: Principles for Reform
http://heartland.org/policy-documents/texass-margins-tax-principles-reform
Eli Lehrer and Julie Drenner describe how the Texas margins tax works, outline the promises made at the time of its creation, describe how those promises were broken, and provide three guiding principles for policymakers. 

The Franchise Tax Exception to the Federal Exemption Statute
http://heartland.org/policy-documents/franchise-tax-exception-federal-exemption-statute
Ronald Blasi examines the origin and history of franchise taxes, the authority of state and local governments to impose such taxes, and the legislative and judicial responses to the problems the taxes cause. He calls for elimination of the franchise tax exception to the federal exemption statute in order to promote clarity and administrative efficiency. 

Cutting the Effective Corporate Tax Rate
http://heartland.org/policy-documents/cutting-effective-corporate-tax-rate
In this Cato Institute Tax & Budget Bulletin, Jack Mintz discusses the U.S. corporate tax rate and argues tax reform would attract investment, create new jobs, and increase incomes. Mintz discusses state franchise taxes and explains how they add to the high tax rate on capital, arguing that removing them along with other tax cuts would reduce the effective tax rate on capital from 36 percent to 28 percent. 

A Closer Examination of the Total State and Local Business Tax Burden
http://heartland.org/policy-documents/closer-examination-total-state-and-local-business-tax-burden
Robert Cline, William Fox, Tom Neubig, and Andrew Phillips provide a comprehensive estimate of the total state and local taxes paid by businesses, including franchise taxes, in this study from the Council on State Taxation. They argue that state legislators, tax administrators, and business taxpayers should work together to design a fair, efficient, simple, and administrable state and local business tax system that is flexible enough to adapt to the accelerating rate of change in the U.S. economy. 

The Texas Margins Tax and Its Impact on the State’s Economic Competitiveness
http://heartland.org/policy-documents/texas-margin-tax-and-its-impact-states-economic-competitiveness
James Quintero, Robert McDowall, and Talmadge Heflin examine the Texas margins tax and its impact on the state’s economic competitiveness. The authors argue Texas’s margins tax has dulled the state’s competitive edge. Without significant reform, they say, its continued imposition will spell trouble for the state’s future economic prospects. 

Corporate Tax Reform Will Enhance Kansas Competitiveness
http://heartland.org/policy-documents/corporate-tax-reform-will-enhance-kansas-competitiveness
Jonathan Williams and Chris Atkins of the Tax Foundation examine Kansas’s business tax structure and the Kansas corporate franchise and income taxes in this Fiscal Fact piece. They conclude Kansas should eliminate its franchise tax and reduce the corporate tax rate to at most 6.25 percent.  

Nevada Lawmakers Mull ‘Margins Tax’
http://news.heartland.org/newspaper-article/2011/05/27/nevada-lawmakers-mull-%E2%80%98margins-tax%E2%80%99
In an interview, Will Newton, executive director of the Texas office of the National Federation of Independent Business, talks about Texas business owners’ experiences with the state’s margins tax. 

Texas Margin Tax Experiment Failing Due to Collection Shortfalls, Perceived Unfairness for Taxing Unprofitable and Small Businesses, and Confusing Rules
http://heartland.org/policy-documents/texas-margin-tax-experiment-failing-due-collection-shortfalls-perceived-unfairness-
In a Fiscal Fact article, Joseph Henchman of the Tax Foundation notes the Texas margins tax has collected far less in revenue than expected, caused significant confusion and compliance costs, resulted in significant litigation and controversy over “cost of goods sold” definitions, and faced calls for substantial overhaul and even repeal. Hence, he writes, it should not be used as a model for tax reform in other states. 

Overview of State and Local Taxation
http://heartland.org/policy-documents/overview-state-and-local-taxation
Ethan D. Millar of Alston & Bird LLP provides an overview of basic state and local tax rules that apply to general business operations and common business transactions such as mergers and acquisitions. He focuses on income and sales/use taxes but also briefly discusses real property transfer taxes, property taxes, net worth taxes (often called capital stock or franchise taxes), gross receipts taxes, unemployment taxes, wage withholding taxes, and unclaimed property laws. 

The Margin Tax Debunked: Dispelling Three Common Myths about Texas’ Restructured
Business Tax
http://heartland.org/policy-documents/margin-tax-debunked-dispelling-three-common-myths-about-texas-restructured-business
Texas Public Policy Foundation researchers discuss three common myths about Texas’s margins tax – and present the facts about each one. The authors argue the modest underperformance of the margins tax is small in comparison to the long-term growth of the Texas budget and that the state does not have a “structural” deficit; budget shortfalls can be as easily addressed by restraining growth in spending as by seeking more tax revenue. 

Nevada May Consider New Business Taxes
http://heartland.org/policy-documents/nevada-may-consider-new-business-taxes
Joseph Henchman of the Tax Foundation discusses some of the ideas for new or expanded taxes proposed in Nevada that have focused on business, including a corporate income tax, a gross receipts tax similar to those in Washington and Ohio, or a margins tax similar to Texas’s. 

Illinois Legislators’ Guide to the Issues: Franchise Tax
http://heartland.org/policy-documents/illinois-legislators-guide-issues-franchise-tax
The Illinois Policy Institute contends Illinois should repeal its corporate franchise tax and join the 31 states that levy no such tax or are repealing them.

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the FIRE Policy News Web site at http://news.heartland.org/insurance-and-finance, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org

If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or mglans@heartland.org.