Perry says he cut the business tax

A "he said, she said" exchange between U.S. Sen. Kay Bailey Hutchison and Gov. Rick Perry during the Jan. 14 gubernatorial debate may have left Texans scratching their heads.

When the senator accused Perry of raising taxes on businesses, one of the things she pointed to was legislation that the governor signed in 2006 restructuring the state’s franchise tax on businesses.

Perry responded several times by saying that "we lowered the business tax from 4 percent down to 1 percent."

The mixed messages put forth by the two candidates -- higher taxes, lower taxes? -- made us wonder who was right. In a companion item, we examined Hutchison’s claim about the business tax. Now, we’ll look at Perry’s.

The centerpiece of a 2006 tax overhaul was a reduction in the property tax rate that local school districts use to generate money for operations. The Legislature revamped the franchise tax and increased the cigarette tax to help districts offset the loss of revenue from the rate cut.

Strictly speaking, Perry's statement about the franchise tax rate is correct: As part of the changes, it was cut from about 4 percent to 1 percent. But another major revision -- widening the tax base -- was so significant that tax experts told us that simply comparing the before-and after rates doesn't give the true picture.

Before 2006, the franchise tax was essentially a 4.5 percent tax on a company’s profit. The new version, often called the margins tax, reduced the rate to 1 percent while broadening its application. Now, the tax is applied to the annual revenue of qualifying companies minus one of three options: the cost of goods sold, employee compensation or 30 percent of total revenue.

"The earlier tax was mainly on profits," said Billy Hamilton, who served as deputy comptroller under state Comptrollers John Sharp and Carole Keeton Strayhorn. "The new tax is on the broader margin base. It is a different tax, and comparing the two rates is an apples and oranges comparison."

As anticipated, Texas businesses paid more in franchise taxes after the overhaul than they did before: In 2006 and 2007, franchise tax revenue was $5.75 billion. In 2008 and 2009, the first two years of the revised tax, total revenue rose to $8.7 billion.

However, one expected consequence of the legislation didn't pan out. Before the restructuring, a frequent criticism of the franchise tax was that it had become virtually voluntary, paid by only about 1 in 16 Texas businesses. The revision was designed to apply the tax to more businesses. However, because of exemptions that the Legislature gave small businesses, the number of companies that pay the franchise tax is lower than before the law was signed, said Dale Craymer, president of the Texas Taxpayers and Research Association.

"The tax has become more concentrated on larger businesses," he said.

It's also important to note that the 2006 tax changes didn't affect all businesses the same way. Because of the property tax reductions, some saw their taxes drop. Others did not.

Summing up, Perry was correct when he said the business tax rate was cut. But he failed to point out that the change in the tax base essentially transformed the franchise tax into a new levy, one that generated more money from businesses.

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