Any day now, the Texas Supreme Court could rule that the state's major
business tax is unconstitutional. If it does, Texas lawmakers will have a
major new budget problem to solve, while many Texans will not be shedding any
tears.
In 2006, the legislature modified the franchise tax that businesses pay,
as part of a tax swap that also reduced property taxes and raised cigarette
taxes. The moves came in response to a state Supreme Court ruling that found
the school funding scheme in Texas to be unconstitutional.
Under the old franchise tax, what businesses paid was primarily based on
their profits. Under the new franchise tax, which has become known as the
margin tax or margins tax, the starting point is companies' total revenue,
though various deductions cut into that base. The concept was to cover more
businesses, raise more money and make the tax system better aligned with the
modern economy by, for example, taxing more heavily companies that provide
services.
Critics on the left, the right and in between have several objections to
the tax. Advocates for public services note that it hasn't come close to
providing the revenue the state expected. It's averaged about $4.5 billion a
year, instead of the $6 billion that was promised. That shortfall helped
contribute to Texas facing its most serious budget problems in modern history
in 2011.
Business groups complain that the tax affects more small businesses than
the old franchise tax and costs firms money even when they don't turn a
profit. They argue that the tax's various deductions and definitions make it
costly and confusing to calculate what is owed.
"What Texas is doing is setting the example of what not to do in state
tax policy," says Will Newton, the executive director of Texas' chapter of the
National Federation of Independent Business. "What we have is the most
complicated, convoluted system of taxation ever devised by state government."
And some businesses object that the various deductions and the tax's two
rates -- half a percent for retailers and wholesalers and 1 percent for others
companies, such as manufacturers -- make some companies winners and others
losers. It's that final complaint that prompted the Nestle company to
challenge the tax's constitutionality.
Nestle's particular objection is that it pays the 1 percent rate, even
though it only sells its goods in Texas, while manufacturing them elsewhere.
But, because the Texas Constitution declares that "taxation shall be equal and
uniform," that objection gets at a bigger constitutional principle. "There is
no question that there are disparities in the tax," says Dale Craymer,
president of the Texas Taxpayers and Research Association. "The question is
just whether those disparities rise to a level of being unconstitutional."
When the legislature wrote the law creating the tax back in 2006, it did
something unusual. Expecting that there would be legal objections and not
wanting doubts to linger, it allowed challenges to go directly to the Texas
Supreme Court and required the court to decide in 120 days. Nestle's current
challenge was filed in late June (an earlier one was thrown out on a
technicality), requiring a ruling soon if the court abides by the schedule the
legislature mandates.
The most dramatic outcome would be for the court to throw the tax out and
require refunds dating back to its start. Peter Nolan, a lawyer who represents
Nestle, argues that even if court rules the tax unconstitutional, it's more
likely to only do so prospectively, by setting a future end date for the tax.
"There's no financial disaster," Nolan says. "There's no economic cliff."
Even without such a ruling, many lawmakers want to change the tax. They
are expected to debate the tax next year, even if the court upholds it.
Still, Craymer argues, turning that talk into action is politically
difficult. While the state's budget situation has improved substantially since
2011, it will be hard-pressed to find money for a deep tax cut. That means any
changes that reduce the burden on some taxpayers would have to raise it on
others, likely spurring a backlash from those who would pay more.
What would change the political dynamics, Craymer says, is if the court
forces the legislature's hand -- in the Nestle case, another challenge to the
tax or in a new school finance ruling. "Restructuring the franchise tax," he
says, "is going to take some kind of outside catalyst."
