howardnlby Howard Stephenson
Utah should eliminate the taxation of business purchases and reduce or even eliminate the corporate income tax, according to Dr. Charles E. McLure Jr, an internationally recognized tax advisor and senior fellow at the Hoover Institution at Stanford University. McLure addressed the Utah Taxpayers Association’s annual conference on April 24, 2003 in Salt Lake City, urging policymakers to stay away from artificial business incentives and instead, to remove business taxes. As deputy assistant secretary of the Treasury for tax analysis (1983–85), McLure was responsible for developing the Treasury Department’s proposals to President Ronald Reagan that became the basis of the Tax Reform Act of 1986, the most comprehensive reform of the income tax since its introduction in 1913.

McLure emphatically stated that a logical first step for a state wanting to strengthen its competitive advantage was to eliminate sales taxes on business inputs, including capital equipment, fuel, office supplies, and transportation costs. He said Utah’s taxation of business purchases imposes a cost on Utah businesses that undermines their competitive position and makes the state a less attractive place to do business.

Under a conceptually principled sales tax, McLure said consumers would pay 100 percent of the sales tax and businesses would pay none. He said the European Union (EU) has recognized this since the 1960s, when its original six members decided to adopt the value-added tax (VAT). In the EU, as elsewhere, VAT is collected on sales to business, but registered business purchasers are allowed a credit for taxes paid on their purchases. Thus only sales to consumers (and to businesses that are not registered for VAT) are ultimately burdened by the VAT. Additionally, since VAT is rebated on exports, EU exports enter world markets tax-free, making European businesses more competitive.

Besides discouraging economic activity in Utah, the taxation of sales to businesses causes the cost of government to be understated, Dr. McLure said. “Suppose that a 6 percent sales tax yields revenue of $100 million, but that 40 percent of the tax is derived from sales to business. The $40 million that is hidden also burdens consumers or, more likely, workers whose incomes are reduced in order to compete with untaxed out-of-state competition. The tax is thus similar to one levied at a rate of 10 percent,” McLure explained.

Dr. McLure said it seems that legislatures throughout the nation are coming to realize that taxation of business inputs discourages economic development. Perhaps the most dramatic evidence is the shift that has occurred in the weight placed on sales in the formulas states use to apportion corporate income between in-state and out-of-state activities. Twenty-five years ago almost all the states that imposed corporate income taxes placed equal weight on payroll, property, and sales. Now almost three-fourths of the states that have corporate income taxes place at least half the weight on sales, and eight base apportionment solely on sales.0 I understand that Utah has not yet taken this step. If it does so, it should accord no more than double weight to sales, in part because, in my opinion, sales-only apportionment violates the nation’s international trade agreements, as well as providing a poor reflection of where income actually originates. But before doing that, it should begin by doing the obvious, namely, eliminating tax on sales to business.

States which provide various types of business incentives in order to encourage economic development are “Looking for Love in All the Wrong Places,” according to McLure. He noted that typical business incentives combine features of central planning and crony capitalism – obviously not a recipe for sound economic policy. Again, it would be better to eliminate the taxation of business purchases and reduce or even eliminate the corporate income tax. He said a sales tax exemption for business purchases is not a tax incentive, it is an appropriate exemption. While the failure to exempt business purchases creates adverse economic incentives, providing the exemption is not an incentive. As the discussion of the European VAT and the analogy to income tax deductions makes clear, the exemption of sales to business is merely part of a principled sales tax.

Dr. McLure quoted John Mikesell of the University of Indiana, one of the leading experts on sales taxation: “One great puzzle of state tax policy is why broad exclusion of production inputs from the sales tax is so difficult to accomplish even as states aggressively seek economic development and expansion by reducing taxes paid by businesses. Full exclusion of all production inputs from state sales taxation is consistent with ideas of efficiency that should drive tax policy in a market economy and with ideas of transparency critical for good governance.”

Policy makers persist in taxing business inputs because of economic ignorance and fear of the electorate, McLure said. “Taxation of sales to business is an anachronism that originated in a time when the nation’s economy was much less integrated, not to mention not being part of a global economy, as it is now. At that time the cost of taxing business inputs was not fully appreciated, even by many economists. The political rationale, such as it is, may have been that ‘if families pay tax, so should business.’ One would expect any move to eliminate the tax on business purchases to encounter this simple-minded slogan. It is thus essential to explain fully to the electorate the rationale for the move,” he said.

According to Dr. McLure, the fallacy of this slogan goes well beyond the common retort that “businesses don’t pay taxes; only people do,” which, he said might be interpreted to mean that it does not matter whether Utah consumers pay tax directly on what they buy or pay tax indirectly, via taxes on business purchases. The point is that taxed business purchases are inputs to products that compete in both Utah and out-of-state markets with products that do not bear the Utah tax on business purchases. The hidden sales tax on goods and services exported from Utah is not rebated, as under the European VAT. Under such conditions the tax on business purchases is not likely to be borne by Utah consumers, let alone by out-of-state purchasers. Rather, it is likely to discourage production in Utah and thus cost jobs and depress wages. I find it hard to believe that the voters of Utah are not smart enough to understand that message, if it is presented to them clearly.

Dr. McLure admitted that exempting sales to business would, of course, cause a temporary revenue loss. But he said the loss could be made up in any number of ways, including a reduction in public spending. Whatever is done to make up the short-term drop in revenue, McLure said the cost of government would be more transparent business would be liberated from the burden of an antiquated tax, and economic activity would be spurred.