The much-maligned inventory tax

When it comes to inventory taxes, five issues are easily identified.

First, they are complex.

Second, companies that pay taxes on inventory hate them.

Third, inventory taxes are unfair because they are not neutral, and businesses that must maintain large inventories, such as manufacturers and retailers, are penalized by paying more taxes than businesses that maintain smaller inventories.

Fourth, local governments rely heavily on revenue from inventory taxes in addition to other property taxes to fund schools and other local needs, such as fire protection and policing.

And fifth, whether imposed at the state or local level, competing political interests can make inventory taxes difficult to repeal.

Comparatively speaking, inventory taxation is not widespread. While business personal property is subject to tax in 38 states, inventory is only included in 14 of those states.

Some states, such as Kentucky, Mississippi, and West Virginia, mandate inventory at the state level. In other states, such as Alaska, Georgia, Louisiana, and Texas, inventory taxes are imposed and administered by local jurisdictions.

Unfortunately, this means that in some cases a business that has moved into an area where local jurisdictions overlap may have their inventory taxed twice. To complicate matters further, Texas has 250 real estate appraisal districts, each employing their own appraisal factors.

However, in several states, many local jurisdictions encourage businesses to locate within their borders by offering “freeport exemptions.” For example, nearly all counties and 140 cities in Georgia have approved a Freeport Tier 1 exemption, which exempts 20, 40, 60, 80, or 100 percent of specified types of commercial inventory from tax, but with restrictions.

Although the goods are not eligible for a tier one exemption, by referendum, a local jurisdiction may approve a tier two exemption, which includes goods.

Other states have a kind of hybrid structure. In Maryland, local jurisdictions impose inventory tax, set rates, etc. The state acts as the central collection agent.

So, for a business with inventory in three local jurisdictions, instead of reporting and filing forms with each jurisdiction, the business reports for all three jurisdictions on one form, which it then files with the state.

Massachusetts imposes an excise tax on a corporation’s personal business property, including inventory. Other types of business entities – individuals, partnerships, associations and trusts – are assessed and taxed locally.

In recent years, Kentucky, Louisiana, and Texas have attempted to ease the burden of inventory tax on their business taxpayers.

Kentucky, which imposes an inventory tax at the state level, implemented an inventory tax credit scheme that provides businesses with a non-refundable, non-transferable credit of 100% of inventory taxes paid and can be applied against personal, corporate and limited liability entity taxes.

Louisiana, where inventory taxes are imposed and administered by local jurisdictions, implemented a tax credit mechanism in the 1990s that has gone through several iterations, mostly in response to the state’s fiscal difficulties in mid 2010s.

Starting today, the state is allowing a fully refundable credit of up to $500,000, with a 10-year carry-forward period. The downside, however, is that a company will lose any unused credit at the end of the deferral period.

In 1997, Texas, where inventory taxes are also locally imposed and administered, gave businesses a $500 credit for taxes paid. In 2022, this credit is still generously set at $500. Excluding inflation, credit was worth $397 in 2019 dollars and worth even less today.

Critics have long decried the inventory tax as damaging to a state’s business climate because it increases the cost of doing business and reduces profits.

Inventory taxes, it is argued, put states at a competitive disadvantage. Businesses considering relocating to a state with inventory taxes may choose to relocate to a state without inventory taxes. Thus, critics conclude, imposing taxes on inventory limits a state’s economic expansion.

I spoke with Martin A. Sullivan, chief economist at Tax Analysts, and asked his opinion on inventory taxes. He said there are three big questions to consider when thinking about inventory.

“Inventory is an investment,” Sullivan said, “that makes a business more productive. It’s a productive asset. easily, he said.

However, there are costs for a business that keeps a lot of inventory, such as storage, insurance and financing costs, Sullivan explained, adding that a business with too much or too little inventory can be culpable. poor inventory management, but having an inventory by itself is not a negative.

Second, he continued, “the tax implications of managing inventory, which business uses [first-in, first-out] Where [last-in, first out] methods. »

A business that uses FIFO will make more profit, but, in turn, pay more taxes, Sullivan said. Using the LIFO method means a company will make less profit but save more in taxes, he explained, adding that inflation has a big impact on which method a company uses: In times of rising prices, it makes more tax sense for a company to use the LIFO method, and vice versa when inflation is low. However, even in times of high inflation, Sullivan said, there is an advantage to using FIFO “because it reduces the tax penalty.”

Third, he said, “The inventory tax is very old-fashioned, from our manufacturing past. [Inventory] was taxed because you could see it and get an idea of ​​the size of the business. [But] there is no reason to tax inventory [today]. A business that needs to move a lot of inventory may decide not to locate in a state that has an inventory tax. But if the company is big enough and promises to provide a significant number of jobs, it could negotiate with the state for an inventory tax exemption as an economic development initiative. It’s unfair to the company that has been in the state for 20 years and pays a tax on inventory. Having a tax on inventory creates a bad business climate, and if the entering company gets a waiver, it creates tension with the companies that were already there.

Sullivan further pointed out that having enough inventory becomes more important in the event of a supply disruption: “If companies could keep more inventory without tax consequences, we would have fewer supply disruptions.”

As for states, he said, an inventory tax is “a stupid tax. It’s inefficient. On top of that, if states give special breaks, it’s unfair.

Given the unpopularity of the inventory tax among businesses and its detrimental effect on a state’s business climate, state legislatures often attempt to repeal the tax. It’s not easy, however.

This year, the West Virginia state legislature, which has tried unsuccessfully in the past to repeal its inventory tax, is trying again. The initiative will be on the ballot for the November elections. The initiative is expected to improve the business climate in West Virginia, in hopes that businesses will locate there and create more jobs in the state.

State Sen. Chandler Swope (R), who has long advocated for the repeal of inventory and other property taxes, said“Last year, we thought cutting personal income tax would have a higher rate of return on investment, but it turns out that these taxes will,” adding that “hundreds of businesses cancel West Virginia because of these taxes”.

Chandler believes lost revenue will be replaced as businesses and people move into the state. Local governments are not so optimistic. County assessors pointed out that property taxes should be doubled to make up for lost revenue, but Chandler assured that was not the case because the state would fill in that revenue.

As for the repeal effort, he said the problem “is that counties and school boards don’t trust the legislature to replace the money.” That’s a good point, especially since, according to Chandler, “The counties and the assessors association were told by the tax department, ‘Oh, you’re not getting the money back.'”

Still, Chandler says West Virginia has the money to make local jurisdictions whole because the state has grown organically in the past three years and repealing property taxes will only improve its climate. economic.

County officials said the proposal was good — in theory. Their concern is how the revenue will be built up in the long run.

In addition to the revenue issue, other groups have pointed out that the repeal of inventory and other property taxes that local governments rely on represents a “significant shift of power from local governments to state government.” .

Based on these comments and others, it looks like Chandler and other repeal supporters are going to have a tough fight on their hands.

Conclusion

Inventory taxes, whether imposed at the state or local level, are complicated and much maligned by businesses. They have been criticized as damaging a state’s business climate and stifling economic growth. Yet local governments rely heavily on them to provide the services needed by businesses and residents.

However, states and local jurisdictions have recognized the tax burden borne by businesses and have taken steps to ease the burden by offering credits and special exemptions. Its good.

The problem is that these special credits and exemptions don’t evenly affect all businesses in states that apply the inventory tax, which explains the many failed efforts in recent decades to eliminate the tax.

In 2022, a state is once again considering the inventory tax. For them, this time might just be the charm.