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Classic Tax Policy Principles and TPP
2. Classic Tax Policy Principles and TPP
There is some disagreement among scholars concerning what constitute sound tax policy principles (Brunori 2016). As the name entails, principles of “good” state tax policy are, for the most part, normative rather than based on strict economic rationale. The Principles of a High-Quality State Revenue System, a report prepared by the National Conference of State Legislatures in partnership with the Lincoln Institute of Land Policy, outlines what are considered to be the most widely accepted principles of sound state tax policy (NCSL & LILP 1992; Brunori 2016). For the purposes of this analysis, three principles and their relationships with the taxation of TPP are highlighted:
- ease of taxpayer compliance; and
- responsiveness to competition.
A sound tax policy system is economically neutral (Brunori 2016; NCSL & LILP 1992; Errecart, Gerrish, & Drenkard 2012). In other words, it prevents or minimizes the distortion of individual or business behavior. Although tax-induced economic decisions are inevitable (e.g., decisions related to capital accumulation, acquisition, growth), lawmakers should strive to create a tax policy system that encourages firms to make decisions based on business needs and principles instead of the tax system (Walczak, Drenkard, & Bishop-Henchman 2017). Even though all taxes affect a firms’ decision-making process, TPP taxes make a business consider more convoluted tax-avoidance options than other types of taxes. For instance, the TPP tax on machinery and equipment dissuades businesses from acquiring and accumulating additional assets because the tax makes such acquisitions relatively more expensive (Errecart, Gerrish, & Drenkard 2012). These decisions can have a considerable impact on determining the optimal scale of operation and output of a company, which have an effect on long-term growth (Errecart, Gerrish, & Drenkard 2012). TPP taxes on machinery and equipment can compel businesses to choose labor input over technological advances, 6 which negatively affects a state’s competitiveness (See Responsive to Competition) (Errecart, Gerrish, & Drenkard 2012; Meyer 2018). In essence, a sound tax policy system should have little to no effect on business decisions.
Additionally, the TPP tax on inventory is disproportionately borne by businesses that store large amounts of merchandise, such as large wholesale and retail stores, and rarely impacts service-oriented companies; whereas, the TPP tax on machinery and equipment overly burdens capital-intensive businesses (Walczak, Drenkard, & Bishop-Henchman 2017; Capehart et al., 1999). TPP taxes impose greater tax burdens on certain companies simply because of their choice of enterprise. A sound tax policy system requires similarly situated firms, with comparable size, operations and revenue, to be treated uniformly by the tax system (Brunori 2016).
Ease of Taxpayer Compliance
A sound tax policy system places small compliance burdens on taxpayers and minimizes compliance costs (NCSL & LILP 1992; Brunori 2016). TPP taxes are self-reported or “taxpayer active,” which means that firms themselves need to list and report all their TPP through detailed forms (Errecart, Gerrish, & Drenkard 2012; Collins 2015). These forms can be complex and time consuming, adding to tax compliance costs for companies (Errecart, Gerrish, & Drenkard 2012). Additionally, with the different rates, assessment ratios and depreciation schedules intrinsic to TPP taxes, it is challenging for businesses to estimate how much they will owe in taxes from different types of capital investments (Errecart, Gerrish, & Drenkard 2012; Collins 2015). In West Virginia, with the current structure of the tax system, businesses make use of tax exemptions, deductions and credits as a means to reduce the amount of TPP taxes they owe – as opposed to a tax system that has a broader base with no such tax reduction tools – contributing to increasing compliance costs and overcomplicating the tax system. Ultimately, TPP taxes are uniquely burdensome to firms and tax jurisdictions because of high compliance costs; this may increase the cost of production and, consequently, the price of the final good. 7
Responsiveness to Competition
A sound tax policy system is responsive to interstate and international competition for economic development. The presence of TPP taxes affects perceptions by outside investors and prospective companies (McKinsey & Company 2017). Although there are many other important factors 8 that businesses take into consideration when deciding to base their operations in (or relocate to) a given location, experts agree that, to some extent, the overall tax climate of a state (e.g., rates, compliance costs, burdens) as well as perception of the tax climate influences such decisions (Ady 1997; Brunori 2016; Walczak, Drenkard, & Bishop- Henchman 2017; Tuerck, Bachman, & Conte 2016). States strive to use tax policy to create an environment that is attractive to firms, often in comparison to the tax burden of surrounding or other competing states, with the goal of spurring in-state economic activity (Brunori 2016; Walczak, Drenkard, & Bishop-Henchman 2017; Tuerck, Bachman, & Conte 2016). Essentially, a sound tax policy system should be responsive to economic competition and to the tax policies of surrounding and competing states.
For the reasons listed above, TPP taxes are not in line with classic tax policy principles. Additionally, since TPP is a relatively mobile subset of the property tax base, it likely reacts to a greater degree to changes in tax rates and policies. A common solution found by firms is to simply relocate their TPP – and most importantly, their operations – to jurisdictions that do not impose such taxes (Errecart, Gerrish, & Drenkard 2012; West Virginia State Tax Department 2009). Consequently, TPP taxes are not the most effective way of raising revenue because property can be easily moved or even hidden (Brunori 2016). This issue is of special concern to West Virginia, which has 28 counties that border other states, including Ohio and Pennsylvania that do not impose TPP taxes. At the same time, like West Virginia, Kentucky, Maryland and Virginia levy TPP taxes on motor vehicles and/or businesses in distinct ways.
In spite of the theoretical arguments outlined above, the physical world can be very different from a textbook example of how tax policy should be devised and implemented. In theory, a tax policy system based on classic principles produces optimal outcomes and does not distort the behavior and decisions of individuals and businesses. Nevertheless, theory does not always accurately predict the behavior of taxpayers. For this reason, the effect of theory – sound tax policy principles – on actual behavioral effects is examined in section 3.
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