Oregon House Democrats are proposing new business tax rates. The proposed business tax on gross receipts would replace the state’s corporate income tax. It would tax everything from sales of raw materials to business supplies. The gross receipts tax proposed by Oregon Democrats would be a follow up to the Measure 97 defeated in the 2016 election, though Measure 97 was a 2.5% tax while the new proposal for the 2017-2019 legislative session is less than one percent. If passed, the new tax would go into effect on January 1, 2018.
Arguments for the New Business Tax Rates
The proposed business tax would theoretically net an additional three billion dollars for the state of Oregon every two years; other predictions state that the state would earn several hundred million dollars more than it earns now from corporate taxes.
Business receipt taxes generate steady income from businesses as compared to the volatility of sales tax income tied mostly to retail sales.
Arguments Against the New Business Tax Rates
A tax on gross receipts taxes all business income above a certain threshold, whether or not the business earns a profit. The gross receipts tax would thus tax startups that aren’t yet breaking even and kill many of them from the start. Businesses with very tight profit margins like grocery stores are opposed to the gross receipts tax since it would cost them their profit margin.
The business tax is similar to a VAT tax in how it increases prices at every level of the distribution chain. Many Oregon businesses are concerned people will save money by buying items online or from businesses outside of Oregon that don’t have to raise their prices to increase final costs. This is one reason why Los Angeles lowered its own business tax rate in 2016.
Businesses must raise prices to pay for the more expensive materials and B2B purchases they make, though the consumer only sees a price increase, not an additional percentage above the official price that clearly indicates how much tax they are paying. This invisibility to the consumer of the actual taxes paid is one reason why gross receipts taxes are theoretically better for politicians than a sales tax.
The tax is only paid by C-corporations. Other types of businesses pay other, less punitive taxes under a gross receipts tax. And the gross receipts tax results in the form of double taxation for small businesses that pass through profits to private individuals. This is separate from the literal double taxation businesses pay because the gross receipts tax would be in addition to the state income tax.
How Businesses Could Adapt
Businesses may consolidate vertically to eliminate the price increases that come when they buy from another Oregonian supplier – ironically leading to more big businesses which the tax’s several million dollar revenue thresholds was intended to discourage. This is called pyramiding, and it was observed in every state that adopted a gross receipts tax. Buying your suppliers or distributors or seeking to be bought out by them was a common way to reduce this tax burden, regardless of the negative impact on consumers as competition decreased.
The current debate over the threshold at which the business tax kicks in creates an interesting problem. Republicans are opposed to a business gross receipts tax at all, but some businesses are suggesting a lower tax rate with a lower cap of a million dollars. Some Democrats want a higher cap around 5 million in sales, but roughly 1% tax. If the higher tax rate, but higher sales threshold is implemented, this results in businesses choosing to stay small enough not to incur the tax at all.
An estimated five thousand businesses would have to pay the new gross receipts tax. Oregon’s corporate tax base has already been shrinking because of various regulations and taxes. Businesses could adapt by shifting their official headquarters to another state or moving as much of their supply chain to suppliers outside of Oregon as possible. In other cases, the company’s expansion into another state isn’t as a franchise of the Oregon business, but a new, separate entity that is tied to the existing Oregon business under the umbrella of the new branch in the other state. Think of it as the state tax equivalent of international businesses setting up Irish subsidiaries that then owned the American firm, thus letting it pay Ireland’s lower business tax rate.
Businesses will start by cutting costs to reduce overhead expenses so that they have more profit, such that they can stay in business by paying a percentage of sales whether or not they have a profit margin. Those that earn a profit will aggressively seek to contain costs to increase their profit margin. Shifting to solutions like Netsuite integration from Celigo to seamlessly connect online sales to back office functions and consolidate material resource planning, inventory management and labor charging will become a necessity.
The gross receipts tax is likely to become a deductible expense for businesses against their federal income taxes. Bookkeeping in and of itself will become more complicated. The attempts to shift costs and sell things under the table were why compliance costs were so high that states like Kentucky ended their gross receipts taxes. Companies that adopt Netsuite integration solutions will be better able to track cancelled orders and refunds that reduce their “gross receipts” under the new tax scheme and prepare for the likely audits that come with it.
Aggressive corporate tax planning was blamed as far back as 2008 for why state income tax revenue from businesses was declining. If a gross receipts tax goes into place, expect it to become a necessity for small businesses.
In states like Indiana, grocery stores and other retailers with very narrow profit margins lobbied for business classes that paid a lower gross receipts tax rate. This led to multiple gross receipts tax rates based on business classification, lobbying for deductions and constantly changing tax rates that made planning for the future difficult. The end result was a dampening effect on Indiana’s economy relative to its neighbors. Reorganizing the business to a type not covered by the tax may or may not be an option for your firm.
Conclusion
The proposed gross receipts tax has the potential of generating a larger and steadier stream of income for the state from businesses. The risks of adopting a gross receipts tax as observed when implemented in other states included reduced business activity, pyramiding of businesses, increased tax planning to reduce gross receipts, shifting business operations, general aggressive cost cutting and reorganizing the business legally if that is possible. Businesses would likely be faced with increased audits and more challenging bookkeeping. Small startups may be wiped out before they generate a profit, while high volume, low-profit margin businesses either lobby for exemptions, cut costs dramatically or go out of business.
