Texas’s franchise tax, commonly known as the “margins” tax, has been controversial since its inception, facing lawsuits and repeated repeal attempts. Lawmakers are expected to take up legislation again this year to repeal the tax.
Under the margins tax, business taxpayers have three options for their tax base: total revenue minus cost of goods sold, total revenue minus wages (limited to $300,000 per person) and benefits, or 70 percent of total revenue. The tax charged is 1 percent, with a reduced special rate of 0.5 percent for retailers and wholesalers. To quell complaints from small businesses, all businesses with revenue of less than $1 million were exempted from the tax.
The margins tax causes several problems. First, because it is imposed on total revenue and not merely profits, even struggling businesses not making a profit are forced to pay the tax. Unlike corporate income taxes and sales taxes, gross receipts taxes apply to all transactions, including intermediate business-to-business purchases of supplies, raw materials, and equipment. This creates “tax pyramiding,” the layering of taxes at each stage of production. The result is higher costs to consumers, who often have no idea how much tax they ultimately pay for their purchases. In recent years, several states – including Indiana, Kentucky, Michigan, and New Jersey – have repealed gross receipts-style taxes.
The Texas margins tax has restrained the state’s economic growth and fallen well short of revenue estimates. According to the Texas Public Policy Foundation, even with an improving economy the tax still ran short of expectations, producing in fiscal year 2011 $3.93 billion, an increase from $3.86 billion the year before but $500 million below projections.
Several studies have examined how Texas would fare without the margins tax; each predicted an increase in jobs, new investment, and economic growth. The Tax Foundation points to a 2012 analysis by the Beacon Hill Institute at Suffolk University that found repealing the margins tax in 2013 “would have created 41,500 new jobs by 2017, $3.4 billion in new investment, and $9.8 billion in real disposable income over the same period. This would have made $209 per capita in additional real disposable income.”
A forthcoming study by John Merrifield and Corey DeAngelis of the University of Texas at San Antonio finds the state’s cumulative disposable personal income would have increased by $30.5 billion to $46.3 billion between 2006 and 2013 if Texas had never implemented the margins tax, generating $1.4 billion to $2.2 billion in additional tax revenues.
The margins tax has failed on all counts. It has proven unable to generate the revenue it was designed for, has slowed economic growth, and has added unnecessary complexity and inequity to Texas’s tax system. Repealing the margins tax would improve Texas’s ranking in the Tax Foundation’s State Business Tax Climate Index from 10th to third best in the country. Texas legislators should consider repealing this burdensome tax.
The following documents examine Texas’s margins tax and the problems such a tax creates.
Ten Principles of State Fiscal Policy
http://heartland.org/policy-documents/ten-principles-state-fiscal-policy
The Heartland Institute provides policymakers and civic and business leaders a highly condensed, easy-to-read guide to state fiscal policy principles. The principles range from “Above all else: Keep taxes low” to “Protect state employees from politics.”
Texas’s Margins Tax: Principles for Reform
http://heartland.org/policy-documents/texass-margins-tax-principles-reform
Texas’s franchise tax – better known as the margins tax – does not work as advertised. The tax has not achieved any of the goals its creators set out for it. This paper describes how the margins tax works, outlines the promises made at the time of its creation, describes how those promises were broken, and provides three guiding principles for policymakers.
“Fixing” the Texas Margin Tax
http://heartland.org/policy-documents/fixing-texas-margin-tax
Talmadge Heflin, Chuck DeVore, and James Quintero argue Texas has a spending problem, not a revenue problem. They contend “fixing” the margins tax by increasing the revenue it produces will not solve anything: “The margin tax presents both a financial and a compliance burden on small businesses and the Texas economy. To remedy this, the Legislature should phase out the tax over the next several years.”
The Texas Margin Tax: A Failed Experiment
http://heartland.org/policy-documents/texas-margin-tax-failed-experiment
Scott Drenkard of the Tax Foundation reviews the timeline of the adoption of Texas’s margins tax, discusses the calculation procedures taxpayers must go through to complete a tax return, and reviews major lawsuits against the tax. Drenkard argues the unique structure of the tax is a problem for taxpayers, legislators, and judges. The paper closes with a review of two studies examining how repealing the margins tax would affect the economy.
The Texas Franchise “Margin” Tax: A Tax Out of Step and Out of Time
http://heartland.org/policy-documents/texas-franchise-margin-tax-tax-out-step-and-out-time
This white paper from the Texas Conservative Coalition Research Institute describes the franchise tax’s origins and how it came to be the tax it is today, especially in the context of school finance: “The current form of the franchise tax also has interesting and potentially profound economic implications. Many of these are quite negative despite Texas’ recent strong economic showing among the states. These effects will be analyzed and quantified to some degree, with an eye toward eliminating the Texas franchise 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-
Joseph Henchman of the Tax Foundation notes the Texas margins tax has collected far less 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.
Rich States, Poor States
https://heartland.org/policy-documents/rich-states-poor-states-7th-edition
The seventh edition of this publication from the American Legislative Exchange Council and authors Arthur Laffer, Stephen Moore, and Jonathan Williams offers both individual-state and comparative accounts of the negative effects of income taxes.
Research & Commentary: Gross Receipts Taxes
http://heartland.org/policybot/results/20724/
This Heartland Institute Research & Commentary examines the effects of gross receipts taxes on businesses and shows their regressive effect on consumers.
Tax Pyramiding: The Economic Consequences of Gross Receipts Taxes
http://www.taxfoundation.org/research/show/2061.html
This study by the Tax Foundation explains why gross receipts taxes (GRTs) are poor tax policy. The author notes GRTs lead to harmful “tax pyramiding,” distort companies’ structures, and damage the performance of state and local economies.
Research & Commentary: Franchise Taxes
http://heartland.org/policy-documents/research-commentary-franchise-taxes
Heartland Institute Senior Policy Analyst Matthew Glans explains how states are approaching franchise tax reform. Lowering or eliminating franchise taxes improves a state’s competitiveness by removing a double tax on business, Glans notes.
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 argue Texas’s margins tax has dulled the state’s competitive edge. Without significant reform, they say, it will spell trouble for the state’s future economic prospects.
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 subject, visit Budget & Tax News at https://heartland.org/publications-resources/newsletters/budget-tax-news, The Heartland Institute’s website at http://heartland.org, and PolicyBot, Heartland’s free online research database at www.policybot.org.
The Heartland Institute can send an expert to your state to testify or brief your caucus; host an event in your state; or send you further information on a topic. Please don’t hesitate to contact us if we can be of assistance! If you have any questions or comments, contact Nathan Makla, Heartland’s government relations manager, at [email protected] or 312/377-4000.
Matthew Glans joined the staff of The Heartland Institute in November 2007 as legislative specialist for insurance and finance.
