At halfway mark of session, tax debate shifts ‘into high gear’

Erin Neff

Thursday, April 3, 2003 | 11:11 a.m.

Text of Guy S. Hobbs' letter to the Nevada legislators

Editor's Note: This is the complete text of Guy S. Hobbs' letter to Nevada legislators.

April 1, 2003

Dear Legislator,

As Chairman of the Governor's Task Force on Tax Policy in Nevada, I have followed the discussions regarding the various tax issues before the Legislature with great interest. As you know, our Task Force spent a full year studying the fiscal challenges facing the State and methods that could be used to address these challenges. Our study resulted in the creation of the most extensive database ever assembled with regard to the State's fiscal system, and an unprecedented amount of expert analysis regarding the alternative methods that could be used to mitigate projected funding gaps. The recommendations that were forwarded with our report represented those we strongly believed, and continue to believe, best address the challenges at hand.

As you may recall from reviewing the Task Force's report, we examined nearly every prospective source of revenue imaginable as a candidate for inclusion within our solution set. Some sources clearly fell out of favor due to some form of fatal flaw, while others moved to the top of our list because they better achieved the overall goals set forth by the Legislature in ACR 1 and by the Task Force during its deliberations. Simply put, it was our judgment that any solution (or mix of solutions) must 1) stabilize the State's overall revenue structure by reducing reliance upon revenues with questionable future prospects, 2) broaden the State's tax base to better insulate the revenue from volatility and to enhance fairness within the overall system, 3) evenly spread the burden such that any individual segment of the taxpaying community is not overburdened with respect to others, and 4) provide for additional revenue sufficient to maintain existing service levels. These points were clearly embodied within ACR 1, suggesting that the Legislature endorses these guiding principles. The recommendations of the Task Force also embrace these principles.

It was predictable that, after our work was completed, there would be those coming forth with criticisms of Task Force recommendations or with solutions that they thought to be superior to those made by the Task Force. At the end of the day, it matters very little if the solutions come from the Task Force or some other source, as long as they adhere to the principles stated above. While undoubtedly suggested with the best of intentions, many of alternatives proffered thus far do not fully respect these very logical, legislatively endorsed principles. It might be worth noting here that if these principles are not met, we are reasonably certain that the forces that have led us to this point of fiscal challenge will be certain to repeat in the near future.

By way of example, we are aware of proposals that would seek to replace revenue sources recommended by the Task Force with other forms of taxation, including variations of payroll tax, conveyance tax, transient lodging tax, expanded sales tax upon services, net profits tax, and/or other devices. This, in and of itself, provides for a very necessary and healthy dialogue that should occur prior to making the type of decisions that must be made with regard to the State's fiscal health. And again, the Task Force has no quarrel with a deliberative process that forces our recommendations to be examined, dissected, and questioned from every angle. Rather, it is our strong feeling that the importance of these deliberations requires a fact driven, as opposed to an emotion driven process. Much of the testimony and many of the alternatives offered thus far, unfortunately, seems to fit into the latter category.

The primary purpose of this correspondence is to offer some observations and clarification with respect to some of the information, testimony, and other options provided thus far. These observations are intended to assist the process by restoring clarity with regard to our recommendations and the reasoning underlying those recommendations. The paragraphs that follow are each intended to address specific issues, misconceptions or questions that have arisen since we first presented our recommendations to you during the opening week of your current session.

STATE ACTIVITY (GROSS RECEIPTS) TAX

It is important to recall that the suggestion to include the gross receipts element among the Task Force recommendations was not arrived at lightly. The Task Force considered a wide variety of alternative business-based taxes prior to settling upon gross receipts as the preferred vehicle. Other forms of business taxes examined included net profits tax, margin (value added) tax, gross receipts tax, adjusted gross receipts tax, business license tax, filing fees and certain targeted excise tax levies (i.e., commercial leases, payroll, inventory, etc.). As you are aware, the Task Force settled upon the adjusted gross receipts method, an inflation adjustment to the business license tax, increases to the gross gaming and slot route levies, and increases to the corporate filing fees as the business-related alternatives that would best meet the needs of the State. Of the above, it seems that a majority of the focus has been placed upon the adjusted gross receipts tax.

The arguments that have been raised regarding the adjusted gross receipts tax include its lack of association with profitability, impact on pricing (or pass-through of tax burden), the issue of pyramiding, the impact upon economic development and diversification, and the ease of administration. In nearly every case, these arguments have been made without citation of analytical support, attempting to draw a conclusion without substance. Also, in every case, these arguments are not unique or peculiar to the adjusted gross receipts tax.

Take, for example, the purported failure of the adjusted gross receipts tax to recognize profitability. Those that make this argument, by inference, are suggesting that association with profitability is an attribute and, thus, would seem to be suggesting that a net profits tax may be a superior device. We doubt this is the case. It is also interesting to note that as an alternative to adjusted gross receipts, several of the critics are suggesting a fairly broad expansion of the sales tax base. The ability to pay sales tax, interestingly enough, also has no association with profitability. Likewise, neither do payroll tax, business license tax, property tax and every other tax that isn't a direct function of profit (i.e., a business income tax). Thus, the argument regarding association with profitability is not exclusive to adjusted gross receipts and should not be used as such. If association with profits carries such a premium, then a tax on profits is the natural alternative that is being suggested. The Task Force did not believe this to be the case. In fact, given that revenue stability and ease of administration were among our primary objectives, the imposition of a net profits tax was flatly rejected due to its high degree of volatility and its ability to be creatively "managed" through inventive accounting techniques.

Let's also examine the argument about the imposition of an adjusted gross receipts tax having a deleterious impact upon both margins and pricing. Most often, we are hearing, this argument is made in a form that would suggest that the imposition of a < of one percent tax on receipts above $350,000 (or even $450,000) would cause the demise of businesses. In analyzing this consideration, it is also important to remember that, at the recommended $350,000 threshold, more than 50 percent of Nevada's businesses would exempt from the adjusted gross receipt tax altogether.

The adjusted gross receipts tax is simply one of a litany of things that could potentially affect the margin or pricing for a business. It is clearly not the only factor. Consider the impact of decisions made by individual businesses to increase employee wages and benefits, or the impact of increased utility prices, vehicle fuel, insurance, and shipping or supplier costs. Do these increases in the cost of doing business always lead to the demise of margins and businesses? Do pricing adjustments due to increases in the cost of doing business always take place in a one for one manner? The answer to both of these questions is no. Businesses adjust price as a function of both cost and what the market will bear, and they do so to maintain a sufficient margin to stay competitive and to stay in business.

With regard to the use of an expanded sales tax base as an option to the use of the adjusted gross receipts method, it was the feeling of the Task Force that a tax that is more targeted to business, as opposed to the end consumer, is preferable. With any sales tax, the burden falls most squarely on the consumer. With the adjusted gross receipts tax, more of the burden is borne by the business supplying the good or service. What makes this point interesting is that you have received testimony that the impact of the adjusted gross receipts tax will cause harm to existing and new businesses, implying that the burden will by singularly borne by business. On the other hand, you have also received testimony that the gross receipts tax is simply another form of sales tax "in disguise." Thus, on one hand you have some telling you that business will be forced to absorb the impact, while you have others telling you that they will pass it on. Clearly, both of these cannot be true. The fact is that it falls somewhere in between, thus diminishing the absolute nature of either argument.

The Task Force did recognize that the existing sales tax base is comparatively narrow, and that it depends too heavily upon robust performance of certain areas of trade. This is why the Task Force chose to recommend the expansion of the base to include an additional area of trade that is discretionary, progressive, stable, and relatively exportable; this area of trade being admissions and amusement. We could find no other easily describable area of trade that could match the positive characteristics of admissions and amusements, and we understand why others have had a very difficult time specifically identifying services (or other areas of trade) that should be taxed.

Another misconception that has surfaced has to do with the role of the gaming industry in the recommended tax regime. Despite reporting by a major newspaper to the contrary, the Task Force recommended that the tax upon gross gaming revenue be increased by < of one percent for all tiers of the gaming tax schedule. We also recommended that the resort industry, like all other businesses, be subject to the adjusted gross receipts tax for their non-gaming revenue. Thus, the Task Force recommended an increase or imposition of taxes that would affect all revenues generated by the gaming and resort industries. While we believe that our recommendation was clear as to this point, we also, in light of some less than accurate reporting, felt it important to clarify.

The impact of the proposed adjusted gross receipts tax upon economic development has also been raised as a potential concern. This is something that the Task Force gave a great amount of thought to during its deliberations. It was, and is, our collective feeling that the rate proposed, coupled with the deductions and credits proposed, will not have a significant, if any, impact upon economic development. That said, it would never have been our position to suggest that the adjusted gross receipts tax would be a "plus" for economic development. Rather, at the rate proposed (again, with the rather liberal credits and deductions), we did not feel that it would materially change Nevada's competitive position in the western region. It is interesting to note that comments made recently by business groups would seem to suggest that their concern is less with the rate as proposed and more with the concern that it might be raised in the future, which could corroborate this point.

One additional question often raised relates to "pyramiding." Pyramiding is the result of paying a tax on a tax when goods (or services) turnover multiple times within the economy (i.e., a product is taxed a wholesale and again at retail). It has been suggested by some that this pyramiding effect could lead to an effective sales tax rate approaching three percent in some sectors. This is simply inaccurate, and is unsupported by sound analysis or simple observation. The Task Force estimated the degree of turnover in Nevada ranges from a high of six times to as low of just over one time, averaging just fewer than two times overall. At this level, the effective sales tax rate on the end user would be well below of one percent in every sector, and less than = of one percent overall. Finally, it is also important to note that pyramiding is not unique to the recommended adjusted gross receipts tax. A sales tax on services, for example, would also have similar effects.

ADMISSION AND AMUSEMENT TAX

There are multiple clarifications required for this recommended revenue source. First and foremost, this recommended source's deepest value is the fact that it is one of the only progressive tax sources. That is, spending for entertainment rises as income rises, placing a higher burden on those with a greater ability to pay. This is not a regressive form of tax.

It is also one of the few tax sources that is completely rooted in individual choice. If one chooses to engage in more entertainment, the tax burden increases and if one chooses to engage in less entertainment, the tax burden decreases. As is not the case with other forms of taxation (i.e., property ownership, vehicle registration, purchases of tangible necessities, etc.), the amusement tax is based purely on individual discretion.

Another extremely attractive feature of this tax is that the degree of exportability is very high. That is, a large portion of the overall revenue that may be derived from this source would be paid by non-Nevadans. There is no question that Nevadans would also pay the tax, but the degree of contribution to the bottom line by non-Nevadans helps offset the burden that would otherwise be borne by Nevadans. Very few, if any other, tax sources under discussion have the same degree of exportability as the amusement tax.

Yet another important characteristic of this source is that, while it is discretionary, it also has comparatively high prospects for future growth. This is extremely important in that our State needs additional revenue sources that can be expected to grow at a per capita rate equal to or greater than the per capita growth in the cost of providing services. Some of our current linchpin revenues, such as gaming tax revenue, are declining on a per capita basis, making it more necessary to seek out sources that can help mitigate this effect.

Much has been made of the fact that the Task Force did not include participatory entertainment and amusements in the base for taxation under an amusement tax regime. You should know that six out of eight members of the Task Force did feel that the amusement tax should include participatory entertainment, due to the fact that participatory entertainment has many of the same characteristics as spectator entertainment (i.e., it is discretionary, progressive, growth-oriented, etc.). Thus, I can say that a majority of the Task Force sided with including participatory entertainment. However, as Chairman, I chose to present the issue of separating the spectator and participatory forms of entertainment to the Legislature to indicate that this was an area where further policy direction was needed. I also did so out of respect to the members of the Task Force that felt differently than the majority. Perhaps this wasn't the wisest course that I could have taken, but I felt that you should be aware that arguments had been made, based upon concerns related to family-oriented participatory activities, for segregating these types of entertainment. It is my individual opinion (and that of a majority of the Task Force members), however, that participatory entertainment should be included in the base for the admission and amusement tax.

I have also watched with great interest the seemingly expensive campaign being waged against the admission and amusement tax by the National Theater Owners Association in California, using theatrical trailers, a website, electronic billboards, handouts and the like. It is interesting that they note that there are admissions taxes in several other states, though they express concern that an admission tax here in Nevada would threaten the health of their business. It is also interesting that their non-campaign website notes that the number of screens in the country continues to rise; this despite the relatively common presence of an admissions tax. They further note that admissions to movie theaters this past year produced $1.6 billion in revenue, was up 10.2 percent over the prior year, and was the best year for growth since 1957. Finally, it is fascinating to note that the theater owner's own statistics show that the average movie admission price nationally this past year was $5.80, which, based upon a sampling in southern Nevada, is much lower than we see in this market. It may be difficult for them to explain how it is that our prices are currently higher, with neither a corporate income tax or admissions tax to attribute it to. It goes to the point that prices are not only a function of taxes imposed. Rather, prices are more a function of what the market will bear and are at the discretion of those who set the price. Suffice it to say that the campaign being waged by the theater owners would, itself, be entertaining, if not for its lack of factual foundation.

In summary, the proposed admissions and amusement tax will provide a stable and growing source of revenue, is progressive, is a matter of choice, broadens the tax base, and is relatively exportable. While not a painless tax, it does clearly have more pros than cons, especially when compared to other options.

OTHER TAXES

Beyond questions and concerns regarding the tax sources discussed above, there do not appear to be similar concerns raised about the other sources recommended by the Task Force. While differences in timing or increment of tax may be being considered, there do not appear to be the same misconceptions, or poorly founded arguments, degrading the focus of the deliberations. Consequently, we do not feel it necessary to comment further on the balance of the recommended revenue sources at this time.

Again, the purpose of this correspondence was to provide some additional clarity to certain matters of taxation being considered by you during this session. Members of the Task Force, having lived with the issues before you for the better part of the past 16 months (or longer, for many of us), certainly appreciate the importance and difficulty of the deliberations that you are currently having. We appreciated the opportunity to have served on the State's Task Force, and stand ready to provide support and assistance to the process, and hope that the information contained herein is evidence of that ongoing commitment.

Sincerely,

Guy S. Hobbs

In closed meetings and quiet negotiations, representatives of the gaming and mining industries have begun talking about taxes. Legislative leaders continue to talk with Gov. Kenny Guinn and his staff, although less about short-term taxes and more about long-term plans.

Lawmakers received a letter Tuesday night from Guy Hobbs, chairman of Nevada's Task Force on Tax Policy, detailing what he calls misconceptions about some of the key components of the task force's recommendation.

"There isn't a political purpose per se. There were just so many things we had picked up on the gross receipts tax that we felt it important to correct some of the misinformation," Hobbs told the Sun.

The sudden activity on taxes this week was marked by the arrival of the 60th day of the 120-day session.

"I've always thought that the serious discussions about taxes would begin midway" through the session, Assembly Majority Leader Barbara Buckley, D-Las Vegas, said. "I think we're right on track."

Senate Majority Leader Bill Raggio, R-Reno, said he has had to refocus his efforts because half of the session is over and because the Legislature did not support Guinn's short-term tax plan.

"I think we should have passed some kind of bridge funding or short-term taxes because we are going to have cash-flow problems at the end of the fiscal year," Raggio said.

It all leaves lawmakers forced "to get into high gear" to craft a revenue plan and a budget, he said.

"When you try to do something this complex, it takes time and it isn't something that can be thrown together in one or two days," Raggio said.

Assembly Speaker Richard Perkins, D-Henderson, said he thinks consensus is building that Nevada needs to broaden its tax base in addition to looking at spending cuts.

"It appears to me that by virtue of the proposals that have been put forward, we have a range in which to work," Perkins said.

The state's projected deficit for the next two fiscal years is $704 million. Guinn wants to raise just under $1 billion to cover the gap and fund programs. A plan by Assembly Republicans would raise $600 million in taxes.

The work to build consensus for a major tax plan includes plenty of behind-the-scenes lobbying on behalf of the gaming industry, which has pledged support for a 0.25 percent increase in the gross gaming tax. The gaming industry also supports the gross receipts tax on business.

The proposed gross receipts tax is also one quarter of one percent. In Guinn's proposal, the first $450,000 of a business' gross revenue would be exempt from the tax, while the task force proposal would exempt the first $300,000.

Gaming has consistently argued that big business needs to pay more in taxes and that any significant hike in the gaming levy would harm the state's leading industry.

"We're basically at the stage where we're taking items off the table," Greg Ferraro, a lobbyist for the Nevada Resort Association, said. "We're trying to get rid of all of those ideas that are not based on fact and are unwittingly incorrect."

Gaming is working to oppose the proposed 4.5 percent sales tax on services, which is a key element of a tax proposal sponsored by Sens. Mark Amodei, R-Carson City, and Terry Care, D-Las Vegas. That plan is scheduled for a Senate Taxation Committee hearing at 6 p.m. Tuesday. In Hobbs' letter to lawmakers, he also tries to bring the focus of the tax debate back on the key elements of the task force proposal.

Hobbs writes that he expected criticism of the task force report. But he stresses that any critics who fail to meet the overall goals his panel was charged to examine would end up with failed tax policy.

The task force was charged by the Legislature to review ways to stabilize the state's revenues, broaden the state's tax base, fund services and spread any new tax burden throughout the taxpaying community.

Some proposals that seek to replace his task force's taxes with others -- including a sales tax on services and an increase for room taxes -- is good for dialogue, Hobbs writes.

"It is our strong feeling that the importance of these deliberations requires a fact-driven (process), as opposed to an emotion-driven process," the letter says. "Much of the testimony and many of the alternatives offered thus far, unfortunately, seem to fit into the latter category."

In his letter Hobbs spends two pages addressing certain criticisms of the gross receipts tax on business, including concerns that the tax fails to recognize profitability.

Hobbs states that the alternative to the gross receipts tax -- a sales tax on services -- also has no association with profitability.

Assembly Minority Leader Lynn Hettrick, R-Gardnerville, said Hobbs' letter did not assuage his concerns with the gross receipts tax.

"I think the gross receipts still has a chilling effect because businesses have a fear of something that is on their gross," Hettrick said. "Maybe it's a misconception, but in this legislative process, perception is reality."

Senate Minority Leader Dina Titus, D-Las Vegas, has also criticized the gross receipts tax and said she prefers a net profits tax. But Titus also said the proposed sales tax on services is not a broad-based business tax -- the type of tax, like the gross receipts, she thinks is needed.

"Maybe," Titus suggested, "we need to change the name."

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