Friday, April 10, 2009

The Business, Professional, & Occupational License (BPOL) Tax: Facts and Economic Considerations

I wrote this analysis back when Stafford County was debating swapping their Merchants Capital Tax for the Business, Professional, & Occupational License Tax. I've tried to be as qualitative as possible regarding effects, and I must caution in considering effects that any one effect rarely occurs in isolation. Other effects can reinforce or mask any effect I mention below. That does not mean that the effect did not happen. It just means that our ability to measure it independently may be limited or non-existent.

I am accustomed to paying the BPOL as a business owner. I am well aware of the effects of this tax and other taxes on my ability to adjust prices. It is important to remember that prices are related to costs, but that prices are pushed down by external factors like competition, substitution effects, and individual assessment of benefits. That is to say, the market determines the price. My analysis touches on this problem by separating goods and services according to their "price elasticity of demand". The bottom line is that some businesses are hurt by the BPOL, and some are not. My own business is not hurt by the BPOL, but I am also a consumer of goods and services and understand the costs of providing them.

Jerry Logan (Spotsylvania Supervisor) is not a fan of the BPOL and has been trying to build support for changing or eliminating it (ht Dan Telvock, here). Supervisors and citizens should be well-informed of the characteristics of this tax before they speak for or against it and before they suggest modifications. In politics, it seems that Unintended Consequences are rarely considered, even though they are easily forseeable (e.g., making food into fuel causing food prices to spike around the world). At least do the homework and try to limit the Unintended Consequences!

The BPOL Tax is similar to the Retail Sales Tax, except

  • It taxes services as well as goods;
  • The rate differs according to the type of business; in Spotsylvania County,
    • 0.0025% for wholesale merchants
    • 0.08% for contractors
    • 0.10% for direct sellers, itinerant merchants and peddlers, and retail merchants
    • 0.18% for amusements, business services, developers, miscellaneous, photographers, personal services, rentals, and repair services
    • 0.29% for financial, real estate, and professionals
  • The tax is not shown on invoices or sales receipts;
  • There is a threshold below which taxes are not collected nor returns filed;
    • Spotsylvania: $200,000
  • There is a standard deduction that reduces the tax liability;
    • Spotsylvania: $50,000 [1]
  • It does not matter whether the business is profitable or not;
  • Annual limits on the amount a business is liable to pay reduces the effective tax rate for that business;
    • Spotsylvania: $150,000 [2]

Consumers ultimately pay the BPOL Tax.

  • Cash flow in a business ultimately comes from only three sources:
    • Investment by owners
    • Borrowing from creditors
    • Revenue from consumers
  • Owners do not add new money to pay the BPOL;
  • The business does not borrow from its creditors to pay the BPOL;
  • Therefore, the BPOL is paid from revenue, just like all other business expenses.
  • Not all consumers are county residents. This is an important part of the decision whether to tax capital or revenue.

Businesses and Government in the County incur additional cost to collect the BPOL tax if it does not replace an existing collection effort.

  • Businesses must file annual returns stating their revenue derived in the County;
  • These returns must be handled, processed, and stored by the government;
  • The government must send out reminders to report revenues;
  • The government must send out invoices to collect the tax;
  • Businesses must pay the tax invoices;
  • The government must pursue late or missing payments;
  • The government must pursue and prosecute non-filers;

The BPOL tax system collects data on business activity for every business over the filing threshold.

  • The government can derive measures of economic activity from the collected data;
  • The measures of economic activity can be combined with other sources such as Retail Sales Tax reporting to obtain estimates of economic activity in below-threshold retail goods businesses;
  • Service-businesses below the filing threshold must be measured in one or more other ways;

To the extent that the BPOL tax is greater than the tax(es) it replaces, micro-economic activity might fall, in some cases temporarily, in others, permanently.

  • To pay for the net tax increase, businesses will raise prices and accept lower profits in varying proportions;
  • Prices have variable measures of elasticity:
    • Sales revenue of relatively inelastic goods and services will rise when prices rise;
      • “Goods and services that are more essential to everyday living, and that have fewer substitutes” are inelastic; [3]
      • Lower profits are less likely to result, since prices may be increased to cover a greater share of the BPOL tax without causing an equal or greater magnitude adverse effect on demand for goods and services;
    • Sales revenue of relatively elastic goods and services will fall when prices rise;
      • “Goods and services with many substitutes, or that are not essential [to everyday living], have higher elasticity”; [4]
      • Lower profits are more likely to result, since prices may not be increased due to the adverse impact on demand for goods and services;
  • To the extent that sales revenue of inelastic goods and services is greater than sales revenue of elastic goods and services, net tax revenues will increase;
  • To the extent that sales revenue of inelastic goods and services is less than sales revenue of elastic goods and services, net tax revenues will decrease;
  • Producers of elastic goods and services will suffer the greatest adverse effects, since the market will not readily bear higher prices, with lowered demand reducing sales revenue more than higher prices would have increased it; (Pi x Qi >Pf x Qf, where “P” is price, “Q” is quantity, “i” is initial value, and “f” is final value).
    • Reductions in aggregate demand reduces the growth rate of producers;
    • If the growth rate becomes negative, then producers must shrink;
    • Producers that must shrink will choose from a variety of methods to reduce costs:
      • Substitute lower-cost supplies or labor;
        • This can result in reduced consumer choice or product quality;
      • Reduce labor hours or staffing;
      • Sell non-productive assets
        • Sometimes at a gain;
        • Sometimes at a loss;
      • Delay purchase or lease of new or replacement assets;
    • Those producers that must shrink below their ability to remain viable will close;
      • This will result in
        • Reduction in consumer choice;
        • Less price instability as a new equilibrium point is reached;
        • Lower employment within a given industry;
    • To the extent that laid-off workers are immediately unable to find re-employment,
      • The government will incur the cost of unemployment benefits;
      • Retail sales tax revenue (and similarly BPOL tax revenue) growth will fall while laid-off workers curtail discretionary spending;
      • Property tax revenue growth will fall while laid-off workers curtail durable goods spending;
      • The risk of foreclosure and eviction will increase for laid-off workers;
        • Foreclosures adversely affect property values, thereby reducing real estate tax revenue growth;
    • If, as in the past, aggregate wages increase at a greater rate than prices, then macroeconomic activity will recover; however, the change in the makeup of producers and consumers and the level of innovation that occurs in the interim makes the specifics of this recovery less predictable. It might or might not result in increased employment or increased business and tax revenue.

The BPOL Tax is willfully ignorant of the business's profitability

  • This is likely due to the difficulty of taxing businesses that do not derive 100% of their revenue (and therefore profits) within the county.
  • For instance, big boxes like Walmart and Target are multi-national companies. How do you tax their profits derived solely from doing business in Spotsylvania County?
  • Revenue is the only measure other than assets that can be allocated accurately to the county level.

Maximum Revenue Taxed Under the BPOL

  • The maximum revenue taxed differs according to the type of business; in Spotsylvania County,
    • $60 billion (in gross purchases) for wholesale merchants
    • $187.5 million for contractors
    • $150 million for direct sellers, itinerant merchants and peddlers, and retail merchants
    • $83.3 million for amusements, business services, developers, miscellaneous, photographers, personal services, rentals, and repair services
    • $51.7 million for financial, real estate, and professionals
  • The rationale behind the differing amounts and the differing rates is not clear, and are subject to manipulation by special interests.
    • In New Mexico, which has a had a statewide BPOL for more than 40 years, there are concerns over special interest carve-outs and “tax pyramiding”, wherein taxes are levied again on goods or services on which taxes were already levied at an earlier stage of production. [5]

[1] For businesses with less than $1 million in gross receipts.

No comments:

Post a Comment

Comments are welcome, but must be courteous and thoughtful. I reserve the right to delete comments that do not possess these characteristics.