Tax Business Outputs, Not Inputs

One of the fundamental principles of sound tax policy concerns the taxing of business inputs to production. The term “business inputs” refers to purchases that businesses make as a part of their operations. This includes many items such as computers, software, production equipment, and office equipment.

This was recently discussed on the Utah Taxpayers Association’s Blog which contains periodic postings of news you can use. To access the Blog, go to http://utahtaxpayer.blogspot.com/ . There will be a number of legislative proposals this session of the Utah Legislature seeking to remove sales taxes on tools of production, including mining machinery and equipment and a proposal to eliminate the three year life threshold on the existing manufacturing exemption.

Tax policy experts nearly universally agree that sales taxes should be imposed at the final stage of consumption and not during the various stages of production or development. Experts cite various reasons for this:

– Taxing business inputs leads to “tax pyramiding” in which taxes are imposed on taxes during the various stages of production. This hides the true cost of government since these taxes are hidden in the price of goods and services that we purchase. Businesses may also decide to pass these taxes on to employees in the form of reduced compensation or on to shareholders in the form of reduced dividends or share prices.

– Taxing business inputs discourages investment by increasing the cost of investment. Investment in production is a key driver of economic growth, and government should be encouraging business investment, not discouraging it.

– Taxing business inputs places smaller businesses at a disadvantage to larger businesses. A very large business produces much of its own inputs from within which means that these inputs are not subject to sales taxes. A smaller business acquires a larger percentage of inputs from outside the company which means that these purchases – unless otherwise explicitly exempt – would be subject to sales taxes. This disparity would especially be applicable to business services such as accounting and advertising since most small business acquire these services from outside the company. Fortunately, these types of services are exempt.

– Tax revenues on business purchases are very volatile, especially compared to taxes on final consumption. During the past recession, taxable business purchases in Utah decreased 7.9% from 2001 to 2003 while taxable retail sales increased 6% during the same time period.

Exempting business inputs from taxation essentially extends the existing practice of exempting items for resale and items that become part of a final assembly (circuit boards, paint, bolts, etc.).

Exempting all business inputs from taxation including office supplies, furniture, and retail fixtures would impact (static analysis) Utah state and local revenues by about $700 million, based on 2006 estimates. Since this amount is significant, the Legislature has targeted exemptions for certain types of businesses, particularly those that pay high wages and compete in international markets and those that improve business and worker productivity. Manufacturers receive sales tax exemptions for production equipment with a useful life of three years or more and also receive sales tax exemptions for energy consumed during the production process.

The legislature specifically exempted manufacturing and not office supplies, furniture, and retail fixtures for several reasons.

– Manufacturing is an internationally competitive industry.
– While many types of businesses have to locate near customers, manufacturers can locate their facilities nearly anywhere. Manufacturers do not have to produce in Utah.
– Manufacturing exports goods and services and imports wealth into the state.
– Utah manufacturing wages are 21.7% higher than the average Utah non-agricultural wage (2006 Economic Report to the Governor, page 56).

Telecommunications equipment with a useful life of one year or more is also exempt from sales taxes. Economic development depends on investment in telecommunications infrastructure because business productivity heavily depends on telecommunications. Also, government-owned telecommunications ventures such as iProvo and UTOPIA are exempt from these (and other) taxes, and exempting companies such as Qwest, Comcast, and wireless companies from this tax makes the playing field a little less uneven.

Many have complained that businesses get all of the sales tax exemptions, but the reality is quite different. In FY2005, businesses received about 45% of all sales tax exemptions, according to calculations by the Utah Taxpayers Association using data from the Utah State Tax Commission. In future years, the business portion will probably decrease as the sales tax rate on food is reduced.