Business group pushes end to failed margin tax

The National Federation of Independent Business is applauding the Texas Legislature for extending a temporary measure that shields some small business owners from something the Legislature itself created: the margin tax.

The tax was spawned by a 2005 Texas Supreme Court ruling that the state’s system of funding schools, primarily through property taxes — was unconstitutional. Justices gave the Legislature a June 2006 deadline to fix it. Gov. Rick Perry formed a tax reform commission, which came up the margin tax, implemented retroactively in 2008. The aim was to lower property taxes while replacing the state’s school funding mechanism. It also served as a replacement for the state’s existing, loophole-ridden business franchise tax.

The margin tax initially targeted businesses with annual gross receipts of $300,000 and up. From the beginning NFIB’s Texas chapter fought for exclusion for businesses making $1 million or less. That exclusion was supposed to drop to $600,000 and up in 2012, though NFIB this year session successfully lobbied for a two-year extension at the current level. A top priority for NFIB in 2013 is to stomp the margin tax like a roach.

"We want to repeal it," said Will Newton, executive director of NFIB’s Texas chapter. "It’s a bad tax and the Legislature made a bad, bad mistake."

Although NFIB lobbied this year for an extension of the gross revenue exclusion, the group chose not to push hard to repeal the margin tax since lawmakers already had plenty on their plates — a major revenue shortfall and redrawing the state’s political districts, for instance. The next session will be a different story, Newton vows, noting that legislative leaders have committed to confronting the issue in 2013. He predicts the margin tax will be history once the session is over.

"There are certain issues we will fall on our sword for and this is certainly one of them," Newton said.

The franchise tax on business that existed before the margin tax was also deeply unpopular in portions of the private sector, in large part because it was applied unevenly. Multinational corporations — oil companies for instance — proved skillful at exploiting loopholes in the franchise tax whereas smaller companies did not. Newton said. NFIB would have been more supportive of the franchise tax if the loopholes had been plugged, he said.

"It was sort of a voluntary tax," Newton added.

As for the margin tax’s promises of property tax relief, owners of refineries and other capital-intensive properties doubtless enjoy substantial benefit, though for the vast majority of property owners the effect is "a drop in the bucket," Newton said.

One big problem with the margin tax is that it’s based on gross rather than net receipts, meaning it doesn’t take into account whether a business is actually making a profit or not. Then there’s the state’s $20 billion-plus budget shortfall, in which the margin tax plays a central role. Despite the sales pitch in 2006, the tax has fallen far short of revenue projection — by about $2 billion a year each year since it was enacted. The recession, which cut deeply into business profits, has only made it worse. Carole Keeton Strayhorn, who was Texas State Comptroller when the margin tax was passed, opined that it was "an income tax, pure and simple." She also questioned its constitutionality and warned it would create a large shortfall.

"She predicted exactly what this tax was going to do," Newton said. "They chose not to listen to her."

Recalling a meeting with the chairman of the House Ways and Means Committee at which Newton offered business-friendly reforms to the margin tax legislation, Newton said he was told the committee was hesitant to act because nobody knew what the margin tax was going to do.

"That to me was the biggest ‘Oh my God. Houston, we have a problem’ moment," Newton said. "It’s bad legislation and a bad way to create legislation — especially something that can be as impactful as statewide tax policy."

He said NFIB will lobby for a return to the previous business tax structure — but with safeguards built in and loopholes closed so that everyone who’s supposed to pay it does. NFIB would only agree to a dollar-for-dollar swap, however, and would reject any deal that raises more than $2 million a year since that would amount to a net tax increase, Newton said.

Gautam Hazarika, associate professor of economics and chairman of the University of Texas at Brownsville and Texas Southmost College economics and finance department, said the fundamental flaw of the margin tax is that it relies on an inherently unreliable source of revenue.

"It doesn’t do very well in a recession, because in a recession business incomes fall — sometimes drastically," he said. "It shouldn’t have been a surprise. Tax collection is cyclical. Any percentage of earnings is going to follow the business cycle. That is the crux of the problem."

Underlying the entire debate is a deeply rooted philosophy that individual income taxes are to be avoided at all costs, Hazarika said. Otherwise, he said, a solution aimed at spreading the burden might reasonably include at least a small personal income tax. That said, to Hazarika there’s not much daylight between an income tax and the margin tax — it’s just who’s getting nailed. He suspects that, even if there’s not much difference between them, a tax on business is viewed as "the lesser of two evils."

He thinks the easiest solution, whether it’s the best solution or not, would be to go back to the way things were, at least to some degree. It would be a known quantity. As long as an individual income tax is out of the question, Texas has two key options for raising revenue: property taxes and business taxes.

"The bottom line is that revenue has to be raised or you under fund the schools," Hazarika said. "Cutting back funding for schools is a complete no-no. Funds have to be raised from someplace."