What is a Gross Receipts Tax?

A gross receipts tax is imposed on a business's total income, regardless of source. Favored by politicians because it will usually raise significant amounts of revenue at apparently low rates, it's criticized by economists and policy analysts because it exerts a great influence on the marketplace, it is not transparent, and it will ultimately shift a disproportionate amount of the tax burden to high-volume, low-profit companies. In the United States, few states impose this tax, but the concept is periodically revived and reviewed by states seeking to enhance their revenues. In those states that do impose it, the tax rate is below 1% except in New Mexico, where the gross receipts tax, at 5%, functions as the state's sales tax as well. Most jurisdictions permit few, if any, deductions or other adjustments to gross receipts taxes due.

Like a sales tax, a gross receipts tax is imposed on sales that take place within the state. Unlike a sales tax, though, it's not restricted to retail sales, but is imposed on every transaction within the state. This leads to a phenomenon called tax pyramiding, which means that the same goods or services can be taxed multiple times, leading to a higher effective tax rate. For example, a timber harvester will pay the gross receipts tax on a sale of lumber to a sawmill. The sawmill will pay the tax on the sale of milled lumber to a furniture company, and the furniture company will pay the tax on the sale of finished furniture to the store. Finally, the furniture store will pay a gross receipts tax on the sale of the furniture to the ultimate consumer. While the furniture has been taxed once, the timber component has been taxed four times.

In theory, it's easy to show how tax pyramiding increases the effective tax rate. In reality, the relationship between the two is murky. Washington State's analysis of gross receipts tax collections indicated that pyramiding took place within the range of one — no pyramiding, so that the only tax paid is on the sale to the final consumer — and 6.7 times, for some manufactured goods. By contrast, though, the effective tax rate ranged from a low of 0.32% of gross income for the agricultural, forestry and mining sectors to a high of 0.93% for the transportation, communication and utilities sector. In the manufacturing sector, which had the highest pyramiding rate, the mean effective tax rate was about 0.42% of gross income.

The fact is, though, that the highest rate is close to three times the lowest rate, even though both rates are lower than 1%. This can be a significant factor influencing business decisions for those companies paying the highest rates. Proponents of the gross receipts tax point to this data to downplay the impact of pyramiding on the effective tax rate. Opponents, however, point to other drawbacks they claim are inherent in the concept of taxing gross receipts.

The first of these is the fact that the difference in effective tax rates can encourage some businesses to integrate vertically. That is, instead of purchasing raw materials or other goods from other businesses, they'll purchase or merge with those other businesses, or start their own operation to produce the raw material and eliminate the taxable transaction. It's universally acknowledged, though, that good tax policy should be neutral; it should have no influence one way or another in the business's decision-making process. A tax policy that influences business decisions, then, is not a good policy because it supplants the market as the prime influence in making decisions.

Gross receipts taxation also discriminates against high-volume, low-profit businesses because the tax is imposed before any adjustment for the costs of doing business, such as labor. High-volume, low-profit industries like grocery stores, then, would pay the gross receipts tax at the same rate as pharmaceutical companies, even though the pharmaceutical industry is about seven times more profitable than grocers.

Finally, a gross receipts tax obscures the actual tax rate and cost of government from taxpayers. The consumer who buys a piece of furniture has no way of knowing how many times the tax has been imposed on his purchase and its component parts, nor can consumers learn the actual effective tax rate they on different consumer goods.