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Read My Lips

March 2, 2015

By: Stephen Waguespack

What constitutes a tax increase?

While making his acceptance speech for the 1988 presidential nomination at the Republican National Convention, then Vice President George H. W. Bush told the nation, “Read my lips:  No new taxes.” A few years later, as part of a budget deal with the Democrat-controlled Congress, he agreed to an increase in rates on existing taxes. 

During his re-election campaign in 1992, that reversal became a hot topic used effectively first by Republican challenger Pat Buchanan and then by Democratic challenger Bill Clinton. Bush initially tried to argue that an increase in existing taxes was different than a new tax, but that argument soon fell to the wayside. Once the reversal of his commitment became a weekly parody on Saturday Night Live by comedian Dana Carvey, the rest was…as they say…history.

We all agree that a simpler and flatter tax code is better economic policy than the patchwork code we have today. Unfortunately, the current budget proposal being considered by the Legislature is not attempting to accomplish this goal. Instead, the question at hand is whether a repeal of certain credits constitutes a tax increase.

While not all tax credits are alike and will be defined differently by this analysis, without question, one credit is a significant tax increase should it be repealed.

For decades, Louisiana has maintained an ad valorem tax on inventory held by manufacturers, distributors, and retailers that is assessed and collected by local government. Louisiana’s local inventory tax is assessed on tangible personal property used in a business, including goods awaiting sale, commodities that are in the course of production, and raw materials and supplies.

In 1991, the Louisiana Legislature passed legislation to implement a state tax credit for the local inventory tax paid by such businesses, which was a major step to make the state more competitive for business investment and jobs. Everyone understood the uncompetitive nature of this tax and wanted its negative impact on our economy eliminated. To accomplish this objective, this complicated approach was enacted rather than an outright repeal of the tax.

The state inventory tax credit had an immediate positive economic impact and was credited for bringing a number of new warehousing facilities into the state, along with the jobs they created. Today, employers across Louisiana receive a tax credit against their state corporate income and franchise tax liability for the inventory tax amount they pay to local government. Any amount beyond their state tax liability is refunded to employers up to the amount they actually paid to local government. This rebate is equivalent to the amount of inventory taxes actually paid.

More than 10,000 businesses – from large, multinational corporations to small manufacturers to neighborhood grocery stores – pay inventory taxes to local government and claim the refund, generating about 11 percent of all local property tax collected in Louisiana.

The vast majority of states do not have inventory taxes. In fact, the Tax Foundation estimates only 13 states levy an inventory tax, and that states are reducing or eliminating taxes on tangible personal property as a trend more generally due to their many disadvantages.

By definition, inventory taxes disincentivize investment, expansion, capital accumulation and growth. That can put neighboring states without the tax at an advantage particularly in attracting distribution centers.

Researchers estimate that a tax increase on personal property, such as the inventory tax, of one percentage point reduces annual employment growth by 2.44 percentage points.

The tax applies to mobile property that can quickly respond to a change in tax laws and regulations, which according to the Tax Foundation creates “strong incentives for companies to locate inventory in states where they can avoid these harmful taxes.”

The negative effect of property taxes, such as the inventory tax, is particularly severe, primarily because these taxes are paid annually, regardless of any profits or losses earned by employers. Inventory taxes are a substantial business expense that will likely be passed on to consumers, raising costs for everyone, not just employers.

Furthermore, the effect of inventory taxation is such that consumers can end up paying the inventory tax amount several times over. Here’s how: (1) A parts manufacturer stores raw materials for use in the manufacture of parts to be used in building a final product. That manufacturer must declare those raw materials as inventory for every month they are held, along with any parts in stock, and accordingly pay a local inventory tax amount on these. (2) The parts manufacturer then sells the parts to a finished product manufacturer. That manufacturer pays inventory tax on the parts it holds for use in building the finished product, along with any of that finished product or good it holds for distribution. (3) Later, as the good is turned over to a distributor that stores it in a warehouse, it is taxed anew as inventory. (4) Finally, when it is sold to a retailer for sale to consumers, while sitting on that retailer’s shelf awaiting purchase, the good is once again taxed as inventory. So, the parts manufacturer, the finished goods manufacturer, the distributer and the retailer all pay the inventory tax and every time add it to the cost of the product before the consumer buys it and pays sales tax on top of that.

This convoluted and uncompetitive scheme has been tolerated in Louisiana for years and the negative effects it should have on our economy has been masked by the credit since 1991.

Local governments should also oppose any elimination in the current state inventory tax credit, as they would see an erosion of their revenues when companies losing the credit choose to shift inventories to locations where such a tax does not exist. Companies will be incentivized by the credit’s repeal to warehouse their inventory in states that do not have an inventory tax. They can later ship that inventory in when it is required, putting our small to mid-size retailers and manufacturers at a huge disadvantage.

Finally, if the state inventory tax credit were reduced, jobs would be negatively impacted. Businesses that retain inventories require warehousemen, forklift operators, clerks and the like to maintain and keep track of those inventories. If businesses are forced to shift their inventories elsewhere, the number of accompanying jobs will decline.

Refunding the inventory tax was seen as a major step to make Louisiana more competitive when it was enacted, and it is still a big factor in national rankings of business-friendly states. Today, Louisiana ranks No. 35 on the 2015 State Business Tax Climate Index and No. 24 on the property tax component – before the Legislature makes the changes under discussion in the 2015 session.

Having said this, the status quo is not Louisiana’s only option. We could actually repeal the inventory tax itself, which would make the credit no longer necessary and the state would save $462 million (using FY 14 numbers). This type of approach would make us much more economically competitive as a state and save Louisiana hundreds of millions of dollars to invest in higher education and health care each year. This would be a “win-win” for taxpayers of epic proportions.

However, simply repealing the credit and leaving this burdensome tax in place would do the opposite. It would drive us down the rankings of business-friendly states, throw sand in the gears of our growing economy, incentivize employers to send their investment and inventory out of state thereby diminishing local collections, and lower the number of jobs in Louisiana.

Repealing the inventory tax credit is bad policy and a tax increase we simply cannot afford. Repealing the inventory tax itself would save Louisiana state government hundreds of millions of dollars, make our economy much more competitive and create more jobs in our state. 

The solution is easy to see if you just read my lips: We can’t afford this tax.