Stop Playing
Favorites with
the Tax Code
LORI TAYLOR Mosbacher InsƟtute, The Bush School
MOSBACHER~
INSTITUTE
~
*
*
TRADE
An inconsistent tax code hurts all consumers and firms, especially small businesses Via the Lone Star card system, Texas can help poor households at much lower cost Tax breaks for some firms and industries necessarily mean higher tax rates for others Sales taxes on business‐to‐
business transacƟons is a parƟcularly harmful form of playing favorites with the tax code taxincreases.Iftheygivein
tothistemptation,theycould
severelydamageTexas’
abilitytoattractworkers and
ϐirmsandriskapermanent
deteriorationofthestandard
oflivingintheLone Star
state.
Afundamentalprincipleof
taxpolicyandgood
governanceisthat
·11.,
VOLUME 2 | ISSUE 1 | 2011 http://bush.tamu.edu/mosbacher/takeaway
The Takeaway© Mosbacher Institute
2011
PUBLIC POLICY
WHAT’S THE TAKEAWAY? TheGreatRecessionhaspunchedagapingholeinstategovernment
budgets.Californiahasaprojectedbudgetdeϔicitof$21.3billionfor
the2012 ϔiscalyear.Illinoishasaprojectedshortfallof$17billion;
NewJersey’sis$10.5billion.Texasmayhavea$10billiondollarhole
to ϔillineachyearoftheupcomingbiennium.1Fortunately,thereare
solutionsthatcouldnotonlynarrowthestate’sbudgetgap,butalso
reducethedistortionsimposedbyitscurrentsystemoftaxation.
Texas’ϐiscaloutlookisnot
theworstamongtheϐifty
states,butthereisno
denyingtheseriousnessof
itsbudgetaryproblem.A
ϐiscalcrisisliketheonewe
facetodaycantempt
legislatorstoabandongood
governancepracticesin
favorofacross‐the‐board
spendingcutsandill‐advised
ECONOMICS
~R(iS_I)
-=
·
~
lllO•llll'U>•••1Tl
~ I TEXAS A&M
·
I
u ' ' v •
R
s
T
v
“Governmentsshouldnotplayfavoriteswith
thetaxcode.”Keepingrulesasconsistentas
possibleappealstooursenseofequityand
promoteseconomicefϐiciency.Taxesdistort
economicdecision‐makingawayfrom that
whichistaxed.Someofthosedistortionscan
bedesirableinthesensethattheycan
discouragesociallyunhealthybehaviors
(thinkcigaretteoralcoholtaxes),butmost
arenot.Everydayconsumerchoicesare
distortedwhenonlysomeofthosechoices
aresubjectto thesalestax.Forexample,a
busyfamily’schoicewhethertoeatdinnerat
arestaurantoreatathomeisdistorted
whenthesalestaxappliestofoodprepared
attherestaurantbutnottofoodpreparedat
home.
Loweringtaxesfora
favoredfewleadstoa
largerdistortionary
burdenforthestate
Goodgovernancemeansminimizing
undesirabledistortions.Economicresearch
tellsusthat,asageneralrule,thedistortion
froma$1taxincreaseislargerthanthe
reductionindistortionfroma$1taxcutfor
thefavoredgroup.2Taxbreaksforsome
ϐirmsandindustriesnecessarilymean
highertaxratesforothers,soloweringtaxes
forthefavoredfewleadstoa netlarger
distortionaryburdenforthestateasa
whole.
HOW “PLAYING FAVORITES” PLAYS OUT TheTexassalestaxcodeisriddledwith
exemptionsandexclusionsthat favor some
industriesoverothers.Massagesaretaxable,
butmanicures,facials,andotherspa
servicesarenot.Repairandremodeling
servicesaretaxexemptifthebuildingisa
residence,buttaxableifthebuildingisa
business.Laundryservicessuchasclothes
washingaretaxable,butthecarwashing
industryistaxexempt.Dishwasherrepairis
ataxableservice,butautorepairsarenot.
Lawnmaintenanceistaxable,butonlyifthe
serviceproviderisbetweentheagesof18
and65.Cabletelevisionistaxable,but
monthlyinternetaccessisnot.Carpet
cleaningistaxable;housecleaningistax
exempt.Thelistgoesonandon.
Grossreceiptstaxesandsalestaxeson
business‐to‐businesstransactionsarea
particularlyperniciousformofplaying
favorites,becausethesefrequentlylooklike
equitytothecasualobserver.Consider,for
example,twoϐirms.Oneisalargebusiness;
theotherisamomandpopsmallbusiness.
Bothneedlegalservices.Thelargebusiness
hasanin‐houselawyerwhilethesmall
businesshiresoutsidecounselas needed.A
salestaxonlegalservicestobusinesswould
fallon momandpopandtheiroutside
lawyer,butnoton thelargeϐirmoritsin‐
houselawyer.Thus,smallbusinessespay
highertaxesthanotherϐirmsfornoother
reasonthanthattheyaresmall.Taxes on
business‐to‐businesstransactions
encouragelargeϐirmstobecomevertically
integrated,offering internalserviceson
whichtheyotherwisewouldbetaxed.Small
businessesdo nothavethisoption.
EXEMPT PEOPLE, NOT SPECIFIC GOODS OR SERVICES Sometimes,legislatorshavegrantedsales
taxexemptionsoutofconcernforthepoor.
Forexample,Texasexemptsfoodpurchased
atgrocerystoresandmedicalcarefromthe
state’ssalestax.Thegoalisadmirablebut
thetoolisclumsy.Mostofthepeople
affectedbythetaxbreakarenotthe
Taylor | Stop Playing Favorites with the Tax Code | IÝÝç› 1 | VʽçÛ 2 | JƒÄçƒÙù 19, 2011 2 Butifwewanttobroadenthesalestax,how
dowelightenthetaxburdenforlowincome
earners?Thereisasimplesolution.Texas
issuesadebitcardcalledtheLoneStarCard
tolowincomefamiliesparticipatinginthe
welfareorfoodstampsprograms.Allfood
purchasesmadewiththiscardarealready
salestaxexempt,andcouldremainsoeven
ifthegeneralexemptionforfoodwere
removed.OtherpurchasesmadewithLone
StarCardscouldalsobeexemptedfrom
salestax.Orequivalently,salestaxrebates
couldbedepositedontothecards.Either
way,TexascouldmakeuseoftheLoneStar
systemtoprovidetargetedtaxrelieffor
poorhouseholdsatmuchlowercost‐and
withoutdistortingtheeconomic behaviorof
otherconsumers.
Broadeningthesalestaxbyeliminatingthe
exemptionsandexclusionswouldgoalong
waytowardssolvingourbudgetproblem.
TheTexasComptrollerofPublicAccounts
estimatesthatremovingthesalestax
exemptionsandexclusionsforfoodand
medicalcare wouldraise$4billioninsales
taxrevenue,peryear.3Removingthe
exemptionsandexclusionsforconsumer
purchaseslikespatreatmentsand
residentialelectricitycouldraiseanother$2
to$3billion.Texascouldalmostplugthe
holeinitsbudget.Inthefuture,whenthe
economyrecovers,wecouldlowerthesales
taxratebynearlyathirdandreturn
revenuestocurrentlevels—simplyby
followingthebasicprinciplesofgood
governanceandrefusingtoplayfavorites
withthetaxcode.
Texascouldalmost
plugtheholeinits
budgetsimplythrough
bettergovernance—
andrefusingtoplay
favoriteswiththetax
code
3 A BENEFIT TO CASH‐STRAPPED LOCAL GOVERNMENTS Removingthe distortionsinthesalestax
codewouldhavetheaddedbeneϐitof
providingϐiscalrelieftolocalgovernments
throughoutTexas.Cities,counties andother
localgovernmentsinTexashavetheoption
ofpiggybackingonthestatesalestaxby
addingacoupleofpenniestothesalestax
rate.Broadeningthesalestaxbasewould
helplocalgovernmentsincreaserevenues
andallowthemtolowertheirlocalsalestax
rates,lowertheirpropertytaxrates,or
balancetheirbudgetswithoutcash infusions
from thestate.
CONTINUE TO SHIELD B‐TO‐B PURCHASES Broadeningthesalestaxtoincludebusiness
‐to‐businesstransactions couldraisealmost
asmuchmoneyasremovingthe
distortionaryexemptionsandexclusions,
butitwouldbeagravemistake.Taxes on
thesetransactionsdiscriminateagainst
smallbusinesses.Smallbusinessescannot
passtheirhighercostsalongtotheir
customerswhentheirlarger,vertically
integratedcompetitorsareeffectivelytax
exempt.Norcansmallbusinessesafford
Taylor | Stop Playing Favorites with the Tax Code | IÝÝç› 1 | VʽçÛ 2 | JƒÄçƒÙù 19, 2011 intendedbeneϐiciaries.Sothetaxexemption
forgroceries,forexample,givesthesame
taxbreakforϐiletmignonpurchasedbya
millionaireasitdoestothecheapestground
beefpurchasedbyawelfarerecipient.There
isnoeconomicreasonwhygroceryor
medicalcare purchasesbyafϐluent
householdsshouldbetaxexempt.
simplytotakeonefortheteam.Ifthecostof
doingbusinessinTexasgetstoohigh,small
businesseswilleithercloseshop,orsetup
shopsomeplaceelse.Eitherway,Texas
loses.Toavoidtheeconomicdistortionsthat
arisefromdiscriminatingagainstsmall
businesses,thelegislature mustresist the
temptationtoremoveallofthesalestax
exemptionsandexclusionswehavenow.
Servicestobusinessesshouldbetreatedas
“salesforresale”andremaintaxexempt.
TREAD, BUT WISELY ThisisaperiloustimefortheTexas
legislature.Thebudgetmustbebalanced;
thetoolsfordoingsoareunpopular.“Higher
taxes”normallyisnotawinningre‐election
pitch,andthe currently favored industries
willnotgiveuptheirprivilegeseasily.Atthe
sametime,legislatorshaveaunique
opportunitytoϐix a ϐlawedtaxsystemand
replaceitwithasimplersystemwithlong‐
termbeneϐits.
Removingthedistortionaryexemptionsand
exclusionsinthesalestaxcodewouldbe
goodpolicyevenifthebudgetwere
balanced,becauseitwouldallowustobuy
downthesalestaxrateandlowerthe
distortionaryburdenofstategovernment. It
isaverygoodresponseto a budget
crisis.Byeliminatingthishodge‐podgeof
exemptionsforcertainproductsand
services,wecanencouragebetterconsumer
choices,keepTexasabusiness‐friendly
state,andlooktoabetterfuture.Allweneed
todoisstopplayingfavoriteswiththe tax
code.
1.http://s.wsj.net/public/resources/documents/
st_STATEBUDGET100414_20100414.html
2.Allotherthingsbeingequal,thedistortionaryburdenofa
taxdependsonthesquareofthetaxrate.Therefore,ifyou
doublethetaxrate,youquadruplethedistortionaryburden,
andifyoucutthetaxrateinhalf,youlowerthedistortionary
burdenby75percent.Fordetails,seePublicFinanceand
PublicPolicybyJonathanGruber,2009.
3.http://www.window.state.tx.us/taxinfo/incidence09
Lori Taylor, a public finance specialist, is an
Associate Professor at the Bush School and an
adjunct Associate Professor in Texas A&M
University's Department of Economics.
ABOUT THE MOSBACHER INSTITUTE The Mosbacher InsƟtute was founded in 2009 to honor Robert A. Mosbacher, Sr., U.S. Secretary of Commerce from
1989‐1992 and key architect of the North American Free Trade Agreement. Through our three core programs –
IntegraƟon of Global Markets, Energy in a Global Economy, and Governance and Public Services – our objecƟve is to
advance the design of policies for tomorrow’s challenges.
Contact: Jody Ono, Assistant Director | The Mosbacher InsƟtute for Trade, Economics, and Public Policy Bush School of Government and Public Service
4220 TAMU, Texas A&M University College StaƟon, Texas 77843‐4220
Email: [email protected]
Website: hƩp://bush.tamu.edu/mosbacher
The views expressed here are those of the author(s) and not necessarily those of the Mosbacher InsƟtute, a center for
independent, nonparƟsan academic and policy research, nor of the Bush School of Government and Public Service. Taylor | Stop Playing Favorites with the Tax Code | IÝÝç› 1 | VʽçÛ 2 | JƒÄçƒÙù 19, 2011 4