Tax Analysts Blog

California's Trendy Business Tax Proposal

Posted on Jul 28, 2009

Now that Governor Schwarzenegger and the legislature have completed another painful round of budget negotiations, lawmakers can give some attention to the work of California's tax reform commission. The most interesting proposal under consideration would replace California's corporate and sales taxes with a "business net receipts tax." Under the tax, all businesses (not just corporations) would pay a tax on the difference between their gross receipts and their purchases from other businesses. (There would be no deductions for wages or interest.)

Michigan and Texas already have variations of the tax that is, in effect, a value-added tax. Although to many it looks like a corporation/business tax, it is really a consumption tax collected by businesses. For decades conservatives have advocated using this type of tax at the federal level as a replacement for the U.S. corporation tax. From an economic growth perspective it is much better than a corporation tax because it does not penalize investment (like a corporate profits tax does), it does not discriminate against corporate business, and it does not favor debt over equity. In the minus column, because it is like a sales tax, it places a lot more burden on lower-income taxpayers than a corporation tax. (And, indeed, one of the biggest obstacles to passage of the net receipts tax in California is finding other tax changes that can offset this regressivity.)

There are features of the business net receipts tax that make it particularly attractive to California (and other state governments). First, because state governments usually must balance their budgets and because it is difficult for them to maintain "rainy day" funds, revenue volatility wreaks havoc on state finances. The most volatile component of state (and federal) tax receipts is the corporation tax. Sales taxes are far more stable. Replacing a corporation tax with a sales-like tax would reduce volatility.

Second, most state sales taxes are directed towards goods and tax services lightly, if at all. Any attempts at extending sales taxes to services always meet with insuperable political opposition from affected businesses. As a result, the economy's shift from goods to services has been a drain on state revenues. If a value-added tax (like the business net receipts tax) were to replace a state sales tax, it would be base-broadening tax reform.

On March 25, President Obama created the Volcker Commission to study tax reform options. On July 8, commission staff director Austan Goolsbee said that corporate tax reform that lowers rates and broadens the base would be a prime issue for the commission. The commission is scheduled to report to the President in December. A net business receipts tax could be on the short list of proposals it considers.

It is likely we will be hearing a lot about net business receipt taxes--under a variety of different names--over the next few years.

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