This commentary originally appeared in The Hill on March 31, 2017.
“There are no great limits to growth because there are no limits of human intelligence, imagination, and wonder.” – President Ronald Reagan.
Imagine governments without general business taxes. Imagine many businesses wanting to open with growing consumer demand. Imagine people not bearing the ultimate burden of business taxes.
Congress is appropriately discussing cutting the federal corporate income tax from the highest in the industrialized world at 35 percent to a more respectable 20 percent. However, the 85th Texas Legislature looks to make Texas the leader in America—and even the world—in tax policy by ending the business franchise tax.
Business taxes in Texas date back to the late 1800s, with the latest version being the franchise tax. It was a poor tax and was made worse in 2006 in response to an unconstitutionally flawed property tax system. Instead of enacting an efficient solution, the legislature reformed the franchise tax to deal with a problem that created another problem commonly called the “margins tax.”
The margins tax forces businesses to calculate their tax liability from the product of the lowest of four tax bases dependent on their gross revenue, hence the term “margins tax,” and two tax rates. This unique tax worldwide can require businesses with a net loss to submit the tax if revenue is above $1 million, pushing them further in the red.
It doesn’t take a tax specialist or a Ph.D. economist to know that the margins tax, which is estimated to collect $7.8 billion or 7 percent of total tax collections in the upcoming 2018-19 biennium, is bad policy. While there are differing opinions on how to eliminate it, there’s a general consensus from both sides of the aisle to do so.
While SB 178 would end the margins tax on Jan. 1, 2018, the worry by some legislators of limited taxes available to fund essential government services this session gives the phase out approaches in SB 17 and HB 28 the most attention.
Of course, like most governments, Texas doesn’t have a tax revenue problem, it has a spending problem, as spending is up 11.8 percent above population growth plus inflation since 2004. By controlling spending and considering the economic growth generated without the tax to balance the budget, immediate elimination of the margins tax is possible.
SB 17 is a trigger bill whereby half of the estimated general revenue for the upcoming biennium that exceeds a 5 percent increase from the prior biennium would reduce the margins tax rates each period until elimination. This reform is estimated to cut the tax rates in the 2020-21 budget for a total taxpayer savings of $1.1 billion.
HB 28 would use the lesser of either surplus dollars at the end of a fiscal period or $3.5 billion to buy down the margins tax rates. The estimated ending balance for the current biennium of $1.5 billion could have been used this session.
These steps would substantially improve the competitiveness and prosperity in Texas.
The Tax Foundation ranks Texas’ business tax climate 14th best nationwide. However, if Texas eliminates the margins tax, the state could move to third place, joining South Dakota and Wyoming as the only states without an income tax or a general business tax.
My research finds that if the explicit margins tax liability and implicit compliance cost are abolished, then Texas could have increases of $16 billion in new personal income and 130,000 new private sector jobs above the status quo within the first five years. Even the most conservative estimates from other studies indicate that Texas could gain billions of dollars in new personal income and tens of thousands of new private sector jobs.
The Texas Comptroller notes that businesses will still technically submit taxes in Texas. Businesses are estimated to submit 42 percent of the projected $32 billion in sales tax and 51 percent of the expected $36 billion in property taxes for school districts in FY 2019.
The 2015 Texas Legislature helped reduce this burden on people by cutting the margins tax rates by 25 percent and lessening the compliance cost for a total taxpayer savings of $2.6 billion that began January 1, 2016. The Comptroller’s preliminary estimatesshow that margins tax collections in the 2016-17 period are 18.6 percent less than in the prior period, so less than the cut in rates even with slower economic growth from less mining activity, a weaker global economy, and other economic factors.
The evidence is clear: Texans are poorer every day that the margins tax exists. Eliminating it as quickly as possible, maybe by combining both bills above, would enhance Texas’ prosperity. This leadership in Texas, where almost one-third of jobs have been created since December 2007, should encourage Congress to control government spending and end the federal corporate income tax.
Testimony before House Ways & Means Committee for HB 28 by Dr. Vance Ginn, Economist in the Center for Fiscal Policy.
This commentary originally appeared in The Gilmer Mirror on February 14, 2017.
Texas Governor Greg Abbott recently released his 2018-19 state budget proposal. He noted in that proposal, “Spending restraint must always be practiced, especially when the revenue projection is tight. While there are difficult choices to be made, the Governor’s budget funds the state’s priorities without issuing new debt, raising taxes, or utilizing the Economic Stabilization Fund.”
Some will claim that restraining or cutting government spending will slow economic growth. This point fails basic economics. Given that the state budget is funded by taxpayer dollars, fewer budgeted dollars means less takings from you, and more opportunities to prosper.
Of course, there are essential services provided by the government, but those limited, effective provisions are far fewer than we have today.
An indicator of this is the fact that the state’s current total budget—the footprint of government—is up 11.8 percent compared with compounded population growth plus inflation since 2004. This amounts to families of four paying roughly $1,600 more in taxes this year alone, thereby hampering your ability to satisfy desires and support economic activity.
The Governor gets it right that “spending restraint must always be made.” Like tightening your home budget when there’s less income and more essential expenses, so must state government. However, unlike your home budget, state government must collect tax dollars without generating income, so they must also consider how to leave more money in your pocket.
Fortunately, there are opportunities to achieve these goals of restraining spending through the Sales Tax Reduction (STaR) Fund and reducing tax burdens by eliminating the business franchise tax.
Texas House rules allow legislators to appropriate money cut from one program to another more preferred agency. This provides little opportunity for legislators to actually cut ineffective or excessive areas of the budget, leaving many legislators understandably frustrated with the budget process.
The STaR Fund, passed as ALEC model legislation in 2015, would be a budget-cutting mechanism to resolve this issue. It would operate by aggregating state surplus dollars from various sources (i.e., budget cuts, budget surpluses, and funds above the Economic Stabilization Fund cap) to temporarily reduce the state sales tax rate for a specified period. This would restrain the growth of government while keeping more money in your pocket.
As legislators consider which tax is the most costly for Texans, the reformed franchise tax, often called the margins tax, would top that list. It has been a failure since its reform in 2006 by restraining economic growth and job creation from the tax liability and cost of compliance. Since it is based on the gross revenue of a business with more than $1 million, businesses can have high revenues but be running net losses and be pushed further in the red by paying the margins tax.
Research shows that every year the margins tax is in place, Texans lose tens of billions of dollars in personal income and tens of thousands of new job opportunities. This leaves fewer opportunities for you to prosper. This must end.
By eliminating the margins tax, the Tax Foundation shows that the state’s business tax climate could increase from 14th highest nationally to third best. The combination of higher personal income, more job creation, and increased economic competitiveness makes abolishing this tax a no-brainer for legislators. While it may not be possible to entirely eliminate it this session, the largest cuts in the tax rates possible would be the best choice.
As the data make clear, Texas doesn’t have a revenue problem, it has a spending problem. By achieving the goals outlined by Governor Abbott to restrain spending, the 85th Legislature can take steps to create the STaR Fund and put the margins tax on a path to death as quickly as possible. These steps along with meeting the needs of Texas will hopefully allow for what could be a historic second consecutive conservative budget and better support the success of the Texas model.
The Tax Foundation recently released their 2017 State Business Tax Climate Index report detailing the rankings of all fifty states. The overall score is determined by the burdens of each state’s corporate income tax, individual income tax, sales tax, unemployment insurance, and property tax. The purpose of the report is to “show how well states structure their tax systems, and provides a roadmap for improvement.”
Chart 1 shows the ranking of each state. A common factor between a majority of the top performing states is the absence of at least one major tax, such as the individual income tax, and for states that do levy all the major taxes, they do so with low rates and broad bases. States ranked in the bottom bracket share similar shortcomings such as complex non-neutral taxes and comparatively high tax rates.
Texas’ overall ranking declined one position to 14th nationwide. While Texas excels in the unemployment insurance and individual income tax categories, the overall ranking decline can be attributed to poor scores for corporate income and property taxes.
Although the 2015 Texas Legislature cut the business franchise (margin) rates by 25 percent for a total value of $2.6 billion, the relative ranking of the corporate income tax remained unchanged at 49th, or second worst! This is due to the fact that the business tax is a gross receipts-style tax that is costly to comply with and pay. The Tax Foundation published a previous paper that finds the state’s overall business tax climate would increase to 3rd if the margin tax was eliminated. Moreover, the Texas Public Policy Foundation and the Legislative Budget Board (LBB) have estimated large economic gains from eliminating this onerous tax.
The Tax Foundation also notes that Texas’ local property taxes is a thorn in taxpayers’ side as the relative ranking of property taxes declined from 33rd to 37th, or 14th worst! Its structural complexity, unwarrantedly high rates, and lack of voter oversight continue to confuse and burden taxpayers. The 84th Legislature took steps to lower this burden by increasing the homestead exemption for school districts by $10,000 to $25,000. However, as the LBB recently noted, although homeowners paid a lower property tax amount than without the exemption increase, most homeowners paid more for their property taxes this year.
To overcome the overwhelming burden of local property taxes statewide, the Texas Public Policy Foundation published a paper highlighting key reforms that should be made in the short run and long run. Specifically, structural reforms should be made in the short run by giving voters a stronger voice in the growth of property taxes by requiring an automatic election for any local government whose revenues increase above a certain limit in any one year. In the longer run, we imagine Texas with substantially more economic growth and job creation from replacing the inefficient property tax system with a higher, broader-based efficient sales tax.
The 85th Legislature should take these rankings by the Tax Foundation and other reports into consideration to improve the state’s business tax climate. The goal is not necessarily to beat other states, but to give Texans the best chance to prosper, which can happen if we improve our rankings to encourage more new businesses and job creation.
by Vance Ginn and Talmadge Heflin
Texas faces multiple economic challenges. These headwinds have slowed economic growth of what would be the world’s 12th-largest economy, potentially leading to the state’s first major recession in 30 years. This has contributed to another possible challenge — a tight state budget in the 2017 legislative session.
Fortunately, Texas’ high level of economic freedom, diversified economy and pro-growth policies help weather these challenges and provide an environment conducive for Texans to prosper.
During the Great Recession and since, Texas has been America’s jobs engine, creating 34 percent of all U.S. civilian jobs during the last eight years in a state with less than 10 percent of the nation’s population. Texas has employed more net nonfarm jobs in 64 of the last 66 months, and created 152,300 private sector jobs during the 12 months ending in March.
Texas certainly faces challenges. There was a combined 95,500 job losses in Texas’ mining industry, primarily oil and gas activity, and manufacturing industry during those 12 months. More job losses and fewer openings were expected as the latest annualized increase in real gross domestic product was only 0.5 percent in the second quarter and 0.1 percent in the third quarter of 2015 — barely avoiding a technical recession.
These challenges would likely have caused a prolonged, severe recession in Texas if the economy looked like it did during the 1980s.
The mining industry is directly related to about 15 percent of the real private economy and less than 3 percent of the labor force today. This is substantially lower than in the 1980s, when it was about 21 percent of the real private economy and 5 percent of the labor force.
The combination of more economic diversification and pro-growth policies have supported a more resilient economy.
Consequently, the sustained steep drop in oil prices hasn’t taken nearly as much of a toll on the Texas economy as it did in 1986 when Texas had its last major recession that lasted two years.
However, increased diversification contributed to Texas being more dependent on the rest of the U.S. economy. Without growth in exports and the oil and gas sector, which fueled much of the U.S. economic expansion since 2009, the national economy stands on a shaky foundation.
With the Federal Reserve having held interest rates too low for too long and (rightly) beginning to tighten credit in December, slower economic growth and lower oil prices are likely, as highly distorted markets correct. In addition to overbearing regulations, including those of Dodd-Frank and others promulgated by the Obama administration, the American Dream is further out of reach for too many Americans.
Of course, Texas’ economic future is unknown, but so far the sky is not falling. Texas has been blessed with a long expansion contributing to great prosperity, but it will one day have another recession.
Texas legislators increased the total state budget by far more than population growth plus inflation in both 2001 and 2009, the previous two recessions.
Excessive spending in 2001 was followed by a $10 billion revenue shortfall in 2003 that was resolved with steep spending cuts without raising taxes. The 2009 Legislature balanced its books by accepting a large short-term “stimulus” payment from the federal government. Two years later, it covered a larger revenue shortfall with accounting gimmicks that were reversed in 2013.
Previous spending excesses that expanded the government’s footprint hurt Texans by forcing them to pay higher taxes and lose government benefits. This cyclical nature of excessive spending has been going on too long in Austin.
The 2015 legislative session started with the state’s coffers overflowing with cash from a robust economy. Instead of discussing how much to spend, state officials discussed how much to cut taxes.
Before the session started that January, Comptroller Glenn Hegar gave his biennial revenue estimate, or BRE, to provide a guidepost of what was available to appropriate given the state’s requirement of a balanced budget. He then released the certification revenue estimate, or CRE, in October after the session ended. The CRE expected slower economic growth and lower oil prices that led to less general revenue-related funds for the 2016-17 budget cycle.
The revenue estimate shows a higher beginning balance, lower tax collections, less funds available for transfers, and a decline in the potential surplus.
Today, the taxable oil price in the CRE looks overestimated, as recent forecasts of the average oil price is about $15 lower in 2016 and 2017. This could lead to slower economic growth that would put pressure on fully funding the current budget and leave a tight budget next session.
Through the first seven months of fiscal year 2016, September through March, sales tax collections were down 2.6 percent.
Hegar recently said, “The modest growth in sales tax collections for March was in line with expectations and comes after five consecutive months of declining sales tax revenues.”
In addition, he highlighted the state’s diversity by “stronger growth in receipts” in other sectors that helped offset lower tax collections from oil and gas-related sectors.
Total tax collections are below the revenue estimate by $3.2 billion during those seven months, but a major portion of that is the franchise tax discrepancy.
Franchise tax collections are $2 billion below the CRE, but historically this tax is primarily collected monthly starting in March through the rest of the fiscal year. For example, there was $249 million net tax collected in March after six months of refunds to businesses that overpaid.
If you exclude this, total tax collections would be about $1.2 billion below the revenue estimate for fiscal year 2016.
With oil prices potentially averaging another $15 lower this year and with about a $1.2 billion decrease in revenue projected in fiscal year 2016, that could translate to $2.1 billion less for the full year. If this pace of total tax collections continues, there’s likely to be dollars available to fund the current budget but little to no potential surplus for the 2017 legislative session.
Advancing the Texas model
The 84th Texas Legislature made great strides last session to weather an economic downturn by passing a conservative budget, and $4 billion in tax and fee relief, leaving billions of dollars unspent, including about $10 billion in the state’s rainy day fund.
Texas faces real, and potentially major, economic and fiscal challenges. However, the proven recipe of a diversified economy and limited government philosophy must be enhanced to continue meeting these challenges and propel Texas toward greater economic prosperity.
The 85th Texas Legislature should provide the best economic environment for Texans to succeed and further cushion the effects of business cycles. This could be done by measures supported by the 13 influential organizations of theConservative Texas Budget Coalition. These include passing another conservative budget, eliminating the business franchise tax, reforming the state’s weak spending limit, adopting a mechanism to reduce the budget, stopping excessive growth in property taxes, and increasing budget transparency.
By advancing economic freedom and individual liberty, Texas will better deal with potentially deep downturns and other economic circumstances. This provides Texas with the best opportunity to remain a place where Americans can achieve their hopes and dreams.
AUSTIN – Texas Public Policy Foundation Economist Dr. Vance Ginn today gave invited testimony before the Texas Senate Finance Committee on an interim charge to study the economic benefits of phasing out the franchise tax and public testimony on an interim charge to improve budget transparency.
“Simply put, businesses don’t pay taxes; people do in the form of higher prices, lower wages, and fewer jobs available,” said Dr. Ginn. “No matter how you evaluate the franchise tax, commonly called the margin tax, it fails to be a simple tax, fails to meet revenue expectations, and fails to allow Texans the opportunity to reach their full potential. Texans would be best served by eliminating this onerous tax so that they will have available billions more in new personal income and thousands of new private sector jobs. Given the economic and fiscal uncertainty with the current state of the economy, a valuable path to elimination could be to phase it out over the next two budget periods, preferably by reducing the tax rates. For a more prosperous Texas, last session’s progress of cutting this business tax by 25 percent should be continued by putting the margin tax on a path to elimination.
“Regarding budget transparency, it is reasonable to expect the Legislature to provide transparency and accountability of taxpayer dollars. A great way to do this is for the Legislature to convert from a strategy-based budget format to a program-based budgeting layout and provide budget information online in real time throughout the budget process. These would be great steps toward improving budget transparency so Texans can better evaluate how their dollars are spent.”
Simply put, businesses don’t pay taxes; people do in the form of higher prices, lower wages, and fewer jobs available. Given that taxes exist to fund essential government services, the least burdensome taxes should fund conservative budgets, which grow by no more than population growth plus inflation.
The full testimony can be found here: http://www.texaspolicy.com/content/detail/testimony-eliminate-the-margin-tax-to-reach-texans-full-potential
Don't miss this video of a panel I moderated recently on advancing the Texas model with a simple tax system.
The Texas model of low taxes, no individual income tax, moderate regulation, and a good lawsuit climate has generated prosperity for many Texans. Despite these gains, is the state’s tax system with an onerous business franchise tax and burdensome local property taxes the most efficient? Join us as the panel discusses potential improvements to the state’s tax structure so that the budget meets the needs of Texans while providing an environment conducive to the greatest economic opportunity for them to succeed.
Sen. Paul Bettencourt, Chairman, Select Committee on Property Tax Reform and Relief, Texas State Senate | Presentation
Scott Drenkard, Economist and Director of State Projects, Tax Foundation |Presentation
Sen. Craig Estes, Texas State Senate
Rep. Chris Turner, Texas House of Representatives
Moderated by Dr. Vance Ginn, Economist, Center for Fiscal Policy, Texas Public Policy Foundation
This commentary originally appeared in the Austin American-Statesman on December 28, 2015.
Businesses don’t pay taxes; people do in the form of higher prices, lower wages, and fewer jobs available. Given that taxes exist to fund essential government services, conservative budgets must be funded with the least burdensome taxes. No matter how you evaluate Texas’ business franchise tax, commonly called the margin tax, it fails this test and should be eliminated.
Gov. Greg Abbott lit the torch last session by saying that he wouldn’t sign a budget without business tax relief. Conservative legislators carried this torch by debating how much to cut in taxes rather than the typical discussion of how to spend every dime.
These actions led to a generous 25 percent reduction in the margin tax that begins on Jan. 1 for a total cut of about $2.6 billion. This not only has the effect of reducing the size of government, but employers will also have more money to invest in Texas’ future to boost the slowing job market.
Although this may have been the appropriate cut given the initial state revenue estimate during the current budget period, which has since been revised lower as oil prices remain subdued, elected officials shouldn’t take their eyes off the ball. The recent Texas Public Policy Foundation report Failure of Texas’ Business Margin Tax outlines how this tax is bad public policy and must be eliminated for Texans to reach their full potential.
Problems with the margin tax are numerous. Since the margin tax’s inception in January 2008, the Texas comptroller’s office has had difficulty accurately estimating its revenue as noted by the cumulative $2.8 billion less in actual collections than estimated. In addition, the comptroller’s analysis shows that it disproportionately burdens lower income Texans as they pay more of it as a percent of their total household income than other income groups.
Ask employers about the margin tax. They’ll tell you that the compliance cost can often be more than their tax bill. Their first $1 million in revenue is exempt, which benefits some small businesses, but many surpass that quickly. They then must determine their tax base from multiple taxable margins dependent on their gross revenue and then multiply that base by different rates to get their tax owed.
While employers may choose the cheapest option after spending countless hours and dollars on determining their tax bill, it’s made more difficult because the calculations are substantially different than for the federal corporate income tax. To comply with the complexity and both tax codes, accountants are paid vast sums to keep track of multiple financial books.
There are many difficult decisions that employers make every day to remain profitable. Dealing with such an onerous tax shouldn’t be one of them.
Imagine that you have to keep two sets of financial books for your household. One book is more complex to track of, and both are a headache that requires you to sacrifice time with your family and more productive activities. If you had the opportunity, you would surely eliminate the more complex book to ease your stress.
Phasing out the margin tax over four years with certainty it will be eliminated and not replaced with another tax is a good option. A combination of potential budget surpluses, increased tax revenue from economic growth and modest restraint on spending increases would offset state revenue.
Studies show that eliminating this tax would boost job creation and economic prosperity. It would also increase the state’s competitiveness as Texas would be one of only three states to not have a personal income tax or general business tax.
Legislators should build on last session’s progress by considering a path to eliminating the margin tax for a brighter Texas.
Ph.D. Economist at the Texas Public Policy Foundation. Blog posts are publications by the author.