With Texas job growth outperforming the rest of the country by a wide margin and sales tax collections exceeding projections, all is relatively well with the Texas economy.
But when the 83rd Texas Legislature convenes in about 60 days, a number of issues of importance to the Texas business community will be on the table, not the least of which is how the state taxes business to fund a budget thought to be at least a billion dollars underwater due to rising Medicaid costs and deferred payments for education.
Because Texas has no state personal income tax and relatively generous incentive packages for businesses moving here, Texas’ tax structure has long been considered a competitive advantage when it comes to economic development vis-à-vis other states. (See Texas Tax Code Chapter 313, The Texas Economic Development Act).
But some legislative leaders and stakeholders want to look again at the business tax structure and particularly its impact on small business.
The current business “margins” tax (our state corporate income tax) has already received a significant amount of attention from legislators anticipating a battle over the budget. In recommendations to committees during the legislative interim, House Speaker Joe Straus specifically identified the need to evaluate the margins tax and “determine whether the tax structure should continue to exist in its current form or in a revised form, or whether the existing tax structure should be repealed and replaced with a different business tax.”
The margins tax, which replaced the prior franchise tax of 4.5% on earned surplus with a broader 1% tax on total revenue, was created in 2006 in an effort to reduce Texas’ high property tax burden that disproportionately impacted capital intensive companies.
The new tax has resulted in higher taxes for many businesses and because the margins tax eliminated various deductions, even unprofitable businesses are compelled to pay the tax. This has been frustrating for small businesses in particular, many of which have struggled in a challenging economic environment.
To address small business concerns, in 2011 Governor Rick Perry signed into law an exemption to the margins tax for companies with annual revenues under $1 million. This exemption is set to expire in 2014 and if it does taxes on small businesses will increase dramatically. Small business advocates in both the House and the Senate will likely push hard to make this exemption permanent, or at the very least extend it for several more years.
Other options for reform include creating a blanket exemption for unprofitable businesses; a complete restructure in favor of a net income tax on business entities; a graduated rate system; or some variation thereof.
There will likely also be a move to clarify the law about how we collect sales taxes on e-commerce, particularly after a recent dispute with Amazon. In September 2010, Texas hit Amazon with a $269 million bill for uncollected sales taxes over a four-year period. Amazon responded by closing a distribution center in Irving, but then struck a deal with the state comptroller to begin collecting sales taxes from Texas customers on July 1 of this year. To resolve the dispute, Amazon also said it made an “immaterial payment” on the assessment and promised to create 2,500 new jobs and invest $200 million in the state.
Within that context, the general sentiment within business and legislative circles is that any tax reform needs to be applied across the board so that business sectors are treated equally and fairly, with an eye on the state’s long-term economic growth. When it comes to an issue of such complexity, getting the various parties to sing the same song — much less dance to it — is no easy task.