One of the hardest concepts for some students of tax policy to grasp is the fact that in business, it is really transactions rather than entities that get taxed in most cases other than direct property taxes on real estate. By this I mean that while the applicable sales, income or other bill or form applies on paper ordinarily to one tax payor, every participant in a taxable transaction can be described as an indirect taxpayer.
Consider: Does American business care about income taxes on employees' wages? In one sense, not really other than for the administrative burden of withholding wages on their own payroll. But in another sense, business must care deeply about the issue for at least two reasons. First, all employees need to make enough money after taxes to meet their needs and, more or less, some of their wants. So an increase in individual taxes challenges every business, not just because of their own payroll pressures but those of their suppliers (whose costs will go up) and their downline end consumers, who will have less money to spend.
The second, indirect reason is that wages are a trade of time and sweat for money. If the employee's trade of time and sweat gets less money in return, the employee (or his union delegate, etc.) may be more likely to want to trade less time and sweat after a certain point. Why? Because the marginal payoff of extra work is lower than the marginal payoff of spending that time doing something else, such as recreation, early retirement, etc. If basic needs are met, getting an iPod, say, may seem less attractive than sleeping in on a Saturday. While an increase in taxes might result in more time being traded for money, it might also result in less time being so traded. A income tax increase has two effects on what economists call "marginal utility": while it decreases the money utility of an extra hour (week, year) of work, it also deprives the consumer of purchasing power, depriving the consumer of increasingly more important goods and services, increasing the marginal utility of the next buck. Put simply, a tax increase makes every worker both slightly more demoralized and slightly more desperate at the same time. Whether the worker is more demoralized than desperate will determine whether a broad-based tax increase will reduce or increase the marginal propensity to trade time and sweat for money, and the answer to that question does directly affect business.
It is in this light that one should analyze sales taxes and tax holidays. Maryland has recently instituted a short tax holiday for limited clothing purchases in preparation for the school year. For the week ending August 27, 2006, sales taxes on limited clothing items have been suspended.
Much has been made of tax competition from Delaware, which imposes no sales taxes on retail goods. What is interesting to note is that Delaware does impose a tax on the gross receipts of businesses doing business in Delaware of approximately 1%, sometimes more, sometimes slightly less. What this means in practice is that businesses that sell goods with semi-predefined prices such as published paperbacks with Manfacturer's Suggested Retail Prices (MSRP) on the cover, or retailers under pressure to follow MSRPs or Manufacturers Advertised Prices (MAP) for appliances, are under profits pressure actually to sell the item if possible outside of Delaware, if they can. Their businesses will make more profit per item if they do so. On items with low profit margin or low-margin wholesalers, the gross receipts tax can actually be a big deal, the difference between making money or not doing so, since the gross receipts tax is not an income tax, i.e. no deductions are allowed for the costs of acquisition, etc.
The Delaware corporate tax rate is higher than Marylands: 8.7 vs. 7.0 percent, on transactions that occur clearly within their respective jurisdictions. Delaware does not tax corporations on the fund received from passive, out-of-state activities such as royalties. Thus until recently Maryland corporations would sometimes set up a Delaware corporation to hold their trademarks and pay that company a sizeable royalty which would be a deductible business expense against U.S. and Maryland income taxes, and for the subsidiary a taxable item on its federal return, but no Delaware income tax would accrue. If the royalty were a million per year, the move would save about 70,000 grand in Maryland income taxes. Comptroller Schaefer clamped down on this practice recently, though I suspect (but have not analyzed case law) that if the. subsidiary were truly arms-length from the parent company, it might still work.
One of the most persistent myths among small business owners is that they can incorporate a business in Delaware and pay no state taxes. This is, in general, quite false. If the business provides goods and services to real people, its income is generally taxable by each respective state where business activity takes place. Every state except South Dakota imposes a corporate tax of some type, and corporations (unlike people) have no constitution right to establish a presence in another state, i.e. must register as a "foreign corporation" in each state of business and pay taxes appropriately. If anything, a corporation will pay more taxes and fees if it files in Delaware because each state charges an annual renewal fee and some charge supplemental franchise fees or taxes. Delaware is a useful place for a large, publicly traded corporatiobn to file, since Delaware's corporate management laws are exceptionally deferential to management, i.e. a shareholder suit against a Delaware corporation's management is difficult to win in the absence of hard-core fraud or embezzlement.
One of the great areas of tax underreporting is the "use tax" imposed on the introduction of goods into Maryland from out of state. Businesses and individuals are responsible for self-reporting and paying this tax on all goods that were not taxed in their state of origin and would be taxable if sold in Maryland. Almost every vehicle with a Maryland license plate leaving the Wal-Mart in Shrewsbury, Pennsylvania or the Christiana Mall in Delaware contains at least one tax evader, since clothes are a major item for sale in Wal-Mart and are mostly untaxed in Pennsylvania, and no retail sales tax applies in Delaware. One of the reasons to go to the trouble to drive those distances from, say, Baltimore (38 miles to Shrewsbury, about 60 miles to the Christiana Mall) is to commit tax evasion. The taxable event occurs when the goods are brought into Maryland and used here (I guess, worn, plugged in, etc.), and the evasion or willful failure to file occurs when the form is not filed by the
applicable due date. I would be curious to learn how many "consumer use tax returns" the Comptroller receives every year. A Maryland Freedom of Information Act request would reveal, I bet, fewer than 500 such returns per year actually filed. The Comptroller's Report for 2005 can be viewed
here; while retail sales and use taxes were reported in gross on this form, consumer self-reported and paid use taxes appear nowhere in the report except possible as "other taxes."
The existence - but practical non-enforcement - of this tax is a fair question to pose to any candidate for Comptroller: should this law be stricken or should it be enforced? Perhaps some of the fans or detractors of Peter Franchot and Janet Owens might want to pose this question to their candidate.
