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The Robin Hood Fallacy: Blagojevich Wants Corporations to Foot the Bill for Social-Service Plans PDF Print E-mail
News/Features - Feature Stories
Wednesday, 28 March 2007 02:37

Reader issue #626 Bobby Green is Illinois Governor Rod Blagojevich's dream spokesperson.

Green owns the Cordova-based company Bob's Blacktop. His company brings in annual revenues of roughly $750,000, he said, and he doesn't offer his three employees health insurance. He doesn't have health insurance, either.

"I myself have had a couple surgeries, and those bills are just stacking up," Green said this week. "And I'm just having to make monthly payments on them."

Green supports the governor's four-pronged "Investing in Families" plan, which would increase funding for health care, education, and state pensions. (Details of the plan can be found at

Few would disagree with those funding priorities, but the catch comes - as it typically does - with the payment mechanism, the fourth prong. Blagojevich has proposed a "gross-receipts tax" that would boost state tax revenues by an estimated $6.1 billion a year. The tax would be applied to all revenue brought in by companies with income greater than $1 million a year.

The tax rate would be 0.5 percent for "goods-producing" businesses such as manufacturers, wholesalers, construction companies, and restaurants. The rate would be 1.8 percent for service businesses. Some goods - most notably groceries and drugs - would be exempt from the tax.

Green, whose company hosted a visit by Blagojevich earlier this month, said he likes the benefits of the plan - particularly the element that would provide all Illinoisans with access to affordable private health insurance - and said he doesn't have a problem with the tax.

"The gross receipts would take care of us on health care," he said.

And even though the business doesn't currently meet the revenue floor for the tax, he thinks a $5,000 tax for his business on $1 million in revenue would be reasonable. "You pay your fair share of taxes," he said.

And he claims that he wouldn't pass on the cost of the new tax to his customers. "Even when our fuel prices rose last year, we didn't raise our prices," he said. "We kept them the same. I just didn't take as much of a profit."

I asked Green if he thought he was a typical business owner in terms of not increasing his prices to account for higher costs. "I'm probably not [typical]," he said. "I'm probably one of the very few that look at things like that. I'm not out to be a millionaire or to be rich. I'm out for having money and buying things and enjoying life."

The governor's plan is being sold as "tax fairness," as a way to force big business to foot a reasonable share of the bill for state services. According to Justin DeJong, director of communications for the governor's Office of Management & Budget, individuals paid $8.5 billion in income taxes in Fiscal Year 2006, while business paid only $1.5 billion in corporate-income taxes.

The pitch is that small businesses and consumers won't be affected, and that this will be a way for the state to capture new revenues from companies that in the past have avoided corporate-income-tax liability.

But that premise, critics charge, is full of false assumptions. It first assumes that all businesses are like Bobby Green's - that they're willing to eat the cost of a new tax. Second, it assumes that suppliers to small businesses won't pass the tax on through their higher prices. Third, it assumes that a business that earns more than $1 million in revenue is no longer a small business.

In the simplest terms possible, the stated premise of the gross-receipts tax is that the business community in Illinois can and will absorb $6.1 billion in new taxes without passing that cost onto consumers.

"In most cases," DeJong said, "we believe businesses will build the gross-receipts tax into the cost of doing business" - as they do with higher utility or property-tax costs, for example. Instead of raising prices, DeJong said, companies might cut back on other expenses or reduce staffing.

If you're skeptical of that claim, you're not alone.

"Yeah, right," said Kathaleen Mosley, president and co-owner of Harris Pizza. Her company has more than $1 million in revenue, and she said that Harris will likely need to raise its prices to account for the gross-receipts tax and a July 1 increase in the state minimum wage.

"If the gross-receipts tax were to go into effect in Illinois, it would undoubtedly increase the cost of goods and services in our state," said Doug Whitley, president and CEO of the Illinois Chamber of Commerce. "The governor wants to hide the true cost of government from the citizens of the state by trying to wash taxes through the economic supply chain of the business community so that the individual does not directly see the income or sales tax go up. ... That money's going to come in the form of higher prices."

"I'm kind of leery of it," said Representative Mike Boland. "I do think it's going to be passed on to consumers. ... So it might just turn into sort of a gigantic sales tax."

At this point, neither the business community nor local legislators are buying the governor's plan.

But that doesn't mean that it's dead. Members of the Illinois General Assembly from the Quad Cities - all Democrats, like Blagojevich - make clear that they could be convinced to support the plan, but that their votes have a price tag.


The Hidden Tax

Set aside what Blagojevich wants to do with the revenue from a gross-receipts tax. Tax policy is complicated enough by itself, and deserves a discussion separate from the equally complex issues of health-care and education funding.

The tax question should come first, because the scope of any legislative initiative will be dictated by the amount of revenue that can be raised for it. And if the Illinois General Assembly nixes the gross-receipts tax, the governor's health-care and education initiatives probably aren't going anywhere.

That's because the governor has pledged not to raise sales or personal-income taxes, a promise he's still committed to. "He reiterated that when we met with him, that ... he'll veto any type of sales or income tax," said Representative Pat Verschoore.

"The governor has drawn a line in the sand in opposition to any income- or sales-tax increases, and by so doing, he's put himself ... in a pretty serious box about what the possible choices are," Whitley said.

The governor is positioning the gross-receipts tax as a necessary correction to the state's tax policy.

The thinking behind the gross-receipts tax is that big business isn't paying a fair share of taxes in Illinois. DeJong said that the Illinois Department of Revenue has identified 12,500 companies in the state that paid an average of $151 in corporate-income taxes in Fiscal Year 2006.

According to a "tax fairness" paper prepared by the governor's office, "In 2004, 37 of the Fortune 100 companies doing business in Illinois paid zero dollars in state income taxes, yet averaged $1.2 billion in Illinois sales."

The Illinois Chamber of Commerce bristles at the assertion that business isn't contributing its share. According to the "2006 Illinois State & Local Business Tax Burden Study" co-commissioned by the chamber, businesses paid $29.1 billion in state and local business taxes in Fiscal Year 2006 - 49.8 percent of all state and local taxes. The key distinction is that while the governor's office is only looking at the state corporate-income taxes, the chamber takes a wider view, incorporating property taxes, for example.

The governor's "tax fairness" paper further argues that a gross-receipts tax is a more-equitable way of generating revenue than the current corporate-income tax, which would be phased out over four years under Blagojevich's plan. "Most economists agree that the least disruptive tax on business is one with a broad base and a low rate - with the idea being the bigger the pool of businesses being taxed, the lower the tax rate can be to achieve revenue targets," it states.

The paper is correct that broad-based, low-rate taxes are preferred by economists. (A discussion of how the gross-receipts tax in not good tax policy can be found in the "Good Politics, Bad Policy" section of this article.)

One problem with a gross-receipts tax, though, is that - unlike a corporate-income tax - it doesn't care whether a business is profitable.

"It doesn't matter if you're having a good year or a bad year," said Jeff Nelson, chair of the Illinois Quad City Chamber of Commerce. "You still pay."

Harris Pizza's Mosley stressed that the gross-receipts tax doesn't take into consideration fluctuations in business. An ice storm, for example, could hurt business for weeks, reducing or eliminating profitability, she said. She added that she doesn't foresee closing her Rock Island store because it's a destination, but noted that a gross-receipts tax in Illinois makes Iowa - where Harris has three stores - more attractive.

The profit-insensitive gross-receipts tax highlights a dilemma in corporate taxation: You either tax gross revenues, or you risk getting nothing from a corporate-income tax. "We shouldn't tax people when they haven't made a profit," said state Senator Mike Jacobs. But "corporations are very skilled at making sure they don't have a profit."

Another fundamental political issue with Blagojevich's proposal is that few people buy the argument that it's a tax on businesses at all; it's a consumer tax masquerading as a business tax.

"It's the kind of tax that a person doesn't get a bill for," Jacobs said. "People will pay it, but they won't see themselves paying it. ... That in a nutshell is the fallacy of the governor's argument. Those corporations are not going to pay that tax. They're going to pass it on. ... That's just the way the system is."

"A business will adjust to taxes imposed on it, and those adjustments will increase the tax burden on households; there is nowhere else for it to go," wrote John L. Mikesell in the January 2007 paper "Gross Receipts Taxes in State Government Finances: A Review of Their History & Performance." (The paper, which was prepared for the Council on State Taxation and the Tax Foundation, is available at

"It's a bad tax precisely because it's a hidden tax, and consumers and workers and investors who bear the economic burden of the tax never see it," said Chris Atkins, a staff attorney with the Tax Foundation. "They don't understand that they're paying the tax in the form of higher prices, or lower wages, or lower returns on their investment. One of the hallmarks of good tax policy is transparency. You want people to understand the tax burden. You want people to understand the true cost of government services. This is particularly important in a democracy, where you want people to make good, informed decisions about the level of government services they receive. So hidden taxes are a big no-no in a sound tax policy."

The political appeal of a gross-receipts tax is that citizens might feel business is footing the bill for the governor's proposals. But that assumes they don't understand the mechanics of business, and the reality that they'll be paying the tax in one form or another.

Beyond that, the business community is particularly angry that Blagojevich argues that small business will be spared from the gross-receipts tax.

That claim is untrue for two reasons, they say. First, small businesses that use suppliers that bring in more than $1 million annually will pay the tax indirectly. "Those businesses that fall into the million-dollar exemption are still buying goods and services from companies who are over the exemption," Atkins said, "and who are going to try to pass that cost onto them in the form of higher prices. ... Even if they don't pay the gross-receipts tax to the state, they're still going to face higher prices for their inputs that they buy."

In that way, the gross-receipts tax is doubly hidden - hidden from consumers and small businesses who are ostensibly not targeted by it.

"When the governor says this gross-receipts tax is not going to be applied to businesses with a million dollars or less in gross receipts, the owners of those businesses know better," Whitley said.

Another key issue is whether a company that brings in a million dollars in a year has graduated to the class of big business. "The million dollars in gross receipts is really our core small business," Nelson said. He added that in general, a small business with 10 employees is going to generate $1 million a year in gross revenue.

Nelson said that a million-dollar business is "your standard downtown-Moline restaurant."

DeJong said that 75 percent of Illinois businesses would be exempt.

Whitley said he didn't know what percentage of Illinois businesses have less than $1 million in gross receipts, but he was quick to point out that "every small-business person in Illinois feels threatened by the governor's gross-receipts-tax proposal, because if they're not a million dollars, they certainly aspire to be a million-dollar business."

Nelson said the Illinois Quad City Chamber is asking members to provide details on how the gross-receipts tax would affect them but didn't yet have the information. "We hope it [the response] is deep enough that it'll be fairly reflective of our membership," he said.

The local chamber does track the number of workers its members employ. According to Tiffany Williams, marketing and communications coordinator for the Illinois Quad City Chamber, 45 percent of chamber members have 10 or more full-time employees.

Nelson said he thinks the gross-receipts tax would hit small businesses the hardest, because they won't be able to avoid them. Large, national-scale companies - those that the tax is meant to target - will likely be able to dodge them, he said. "My guess is those top-50 businesses still aren't going to pay anything under the gross-receipt tax," he said. Instead, they'll sign their contracts in other states.

That gets to a core issue of corporate taxation, Atkins said. "The corporate-income tax is not going to be a viable revenue option for many states in the 21st Century global economy," he said. "Capital is just too mobile for states to be able to truly be able to tax corporations." He added that large companies are "highly sensitive" to corporate-income tax, and will move their business wherever the tax burden is lower.

Whitley said that the gross-receipts tax is bad for the Illinois business climate, sending a message that the state is unfriendly to business.

"Business owners can make choices about where they spend their capital," he said. "When the governor chooses to vilify business ... the message that businesses will begin to receive is, ‘Maybe I should reevaluate my relationship with Illinois.'"

He said they won't necessarily move jobs from the state, but they might choose to invest their capital elsewhere. "He's telling business owners and managers that ‘We really don't like you.'"

Some businesses, Whitley said, might find their way around the taxes. "Hell, I'm just going to create more businesses, more business units, and I'm going to keep all of them under a million dollars," he said. "Business people are thinking already about how they can restructure the way they do business to try to avoid this tax."

But even if that's true, he added, it's still damaging: "Why do you want to force companies to try to restructure?"

Verschoore also raised the concern that the tax could provide an incentive for businesses to stop growing. "What would be the incentive to hire people?" he asked. "What's going to stop them from laying someone off? ... It might backfire on him."


The Price of Career Suicide

The three state legislators from the Quad Cities area were cool to the governor's proposal, but none ruled out voting for a gross-receipts tax if the conditions were right.

Both Representative Boland and Senator Jacobs said they could support a gross-receipts tax if the governor came through with some major capital money for the Quad Cities.

"I will be much more interested in the governor's gross-receipts-tax plan if he's able to deliver $75 million to build a Western Illinois University in Moline," Jacobs said. "If I'm going to be asked to commit career suicide ... I am a strong believer in the need for a public university in the Illinois/Iowa Quad Cities. ... I'm willing to put my neck on the chopping block, and that cost is $75 million."

Jacobs also said that he understands that every legislator has a pet project. "When you increase a budget by $6.1 billion, you ought to be able to accommodate those legislators," he said. "I'm open. I'm ready to negotiate."

Boland was a little less bold in his demands, but he had the same message. "I'm going to hold off final judgment just to see if there might be something that we can get for the Quad Cities region that would be well worth it," he said, citing money for the Western Illinois University campus, Highway 30 in Whiteside County, and the Thomson Correctional Center. "We've got some things that I want to keep in the bag to bargain with, just in case. I would say it's going to be a very hard sell right now, his tax."

He noted that the state outlay in the Quad Cities would need to be significant. "It'd have to be massive," Boland said, throwing out the conservative costs of the three projects: $70 million, $40 million, and $40 million, respectively. "I don't expect that to happen, so I don't expect to support it. ... I'll keep the door open at least a crack."

Representative Verschoore didn't offer any conditions that would lead to his support but noted that lawmakers are presented with comprehensive budget legislation. He said he might end up voting for it as part of that larger package but said, "The way it's proposed right now, I probably will not be voting for it at this particular stage of the game, because everything I'm getting is negative." He said he's gotten at least 25 comments on the proposal, and all have been negative.

One problem, he said, is that citizens have difficulty getting their heads around the gross-receipts tax, because it operates in a different way than traditional corporate- or personal- income taxes, with their myriad deductions. "I don't think they [citizens] totally understand it," Verschoore said. "And I'll be truthful with you: I really don't know if I totally understand it."

Boland said he doesn't see the gross-receipts tax going anywhere this legislative session. "To me, it looks dead in the water," he said.

Yet the Illinois Chamber of Commerce is still treating it as a legitimate threat. "The gross-receipts tax needs to be dead and buried before the General Assembly's going to be able to move on to the next phase," Whitley said. "It's realistically an option at this point because the governor wants it to be. ... As long as the legislature's in town, it's possible the gross-receipts tax could pass."


Good Politics, Bad Policy

If the gross-receipts tax is such a bad idea, what's the alternative?

With Democratic majorities in both the House and Senate, the governor should find legislators receptive to his health-care-, education-, and pension-funding priorities. The challenge is agreeing on a way to pay for them.

"I support the notion that we should provide more money for education," Jacobs said. "I support the notion that we should provide health care for every person in Illinois. And I support the notion that we should pay our bills on time."

"The governor wants universal health care," Boland said. "I want universal health care. ... We just to have to find I think a better way than the gross-receipt tax for getting the money to do that."

And even if the legislature doesn't support the governor's ambitious plans, the state has serious financial problems that aren't going away. Whitley acknowledged that the state needs to generate roughly $2 billion in revenues to cover its exisitng financial obligations.

"We're not saying that the state doesn't need more revenues," Nelson said. "But before you add new programs, you have to take care of what you have in front of you first." That takes money, too.

Both Jacobs and Verschoore said a major tax hike in Illinois is inevitable this year.

But few people want to commit to an alternative funding mechanism. "The [state] chamber has not taken a position on any new revenues for the state at this time," Whitley said. "That's not to say we wouldn't, but we haven't."

"A corporate-income tax or a plain income tax is a fairer method," Jacobs said. "People would understand it better." Both Boland and Verschoore said they might favor expanding gambling to generate new revenue, or closing corporate-income-tax loopholes. Verschoore also said he might support an income- or sales-tax increase.

"There's more than one way to get to heaven," Boland said. "We can make progress toward that [universal health-care] goal. We've been making progress toward it. ... We can come up with some new sources of revenue ... ."

A gross-receipts tax might be more palatable to legislators and business groups if the exemption amount were bumped up. Nelson suggested that a $5-million exemption might make some sense.

But that doesn't address fundamental flaws in a gross-receipts tax.

"Gross-receipts taxes are great politics," said the Tax Foundation's Atkins, because citizens don't receive a bill for them. "They're just bad policy. ... The problem is that they're hidden."

That's just the beginning of the problems with gross-receipts taxes. Atkins said good tax policy is transparent (people know they're paying them), neutral (treating all parties equally), stable, and pro-growth.

Gross-receipts taxes are stable.

But they're not neutral. For one thing, there's the "pyramiding" effect, in which the tax is applied at each stage of production. For example, if a company's product has 10 inputs that are purchased from other corporations, each of the inputs is subject to the gross-receipts tax for the company that sells it. And, of course, the final product is subject to the tax. So the tax is built into the input price at each stage and compounds itself. A product with fewer production stages is taxed less than a product with more production stages.

This, Atkins said, encourages companies to integrate vertically. "The tax system should treat people and businesses the same regardless of how they're organized," he said.

Blagojevich's proposal, with its two tax rates, is "an acknowledgment of the pyramiding nature of the tax," Atkins said. But separate rates undermine the simplicity of the tax. "What was supposed to be a broad-based, low-rate tax now - because of its inherent flaws - has become a two-rate tax," he said. "And it may become a six-rate tax." Washington state's gross-receipts tax now has six rates, he said.

Furthermore, Atkins said, gross-receipts taxes don't qualify as properly broad-based. "The gross-receipts tax, though it seems broad-based, is really almost too broad," because many products gets taxed multiple times through the production process. "You can only get to that point [a fair gross-receipts tax] by allowing deductions for purchases or for costs, which is basically what a corporate-income tax does."

And corporate-income taxes, Atkins noted, are decreasingly effective because of the mobility of capital. Of course, he added, all business taxes are hidden to a certain degree.

That leaves only two good tax-policy options: sales tax and the income tax. Illinois' sales tax doesn't presently apply to services, so expanding that might be an alternative way to capture new revenue. "In a proper sales tax, services should be part of the tax base," Atkins said.

While business organizations typically don't favor tax increases, they generally agree with Atkins that sales and income taxes are the fairest way to increase revenue.

"I'm not saying I favor either one of them," Nelson said. "I'm simply saying: If they're going to look at ways to generate revenue, they need to look at a method that's spread over the largest population base."

Nelson also seconded Atkins' assertion that taxes should be pro-growth, noting that the gross-receipts tax is fundamentally punitive and is likely to drive businesses away and retard growth.

"You can't eat your seed corn and survive," he said.


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