By Paul Merrion, Crain's Chicago News--February 18, 2007.

Bert Miller makes 2.5 billion plastic bottle caps a year in Iowa, Tennessee and at company headquarters in Naperville.

But he can't see any future expansion or new jobs in Illinois for Phoenix Closures Inc. if the state replaces its tax on corporate profits with a levy on total sales.

Mr. Miller figures his tax bill would almost quadruple if Illinois supplants its corporate income tax with a 1% gross-receipts tax, reducing his after-tax profit by more than 20%. In addition, he predicts the cost of raw materials he buys in Illinois would rise as suppliers try to pass on the costs of their own gross-receipts taxes.

"You have to understand where we are already: Illinois is our highest-cost place to do business," says the president of the 117-year-old family-owned firm, which employs 223 in Illinois and 91 elsewhere. If a gross-receipts tax is enacted, "we won't expand the Illinois plant and we will look to reduce things we do in Illinois."

The gross-receipts tax Gov. Rod Blagojevich is preparing to unveil reflects his belief that Illinois businesses don't pay their fair share of taxes. Businesses paid $25.2 billion, or 45.4%, of the $55.5 billion in state and local taxes collected in Illinois in 2005, according to a study last year by Ernst & Young LLP for the Council on State Taxation (COST), a tax research group in Washington, D.C., funded by about 600 large corporations. The figure includes all taxes paid in Illinois by businesses, including property taxes.

That's higher than both the national average of 43.6% and the share that business pays in neighboring Midwest states.

According to preliminary data, when the study is updated in a few weeks it will show Illinois business taxes jumped 6% to about $26.7 billion, or 47.7% of state and local taxes, in 2006, says Joseph Crosby, COST's legislative director. COST predicts total taxes in Illinois rose just 1% to $56 billion.

To look at it another way, state and local business taxes in Illinois were about 5.3% of the state's private-sector economic output, or gross state product, higher than other Midwest states and the national average of 4.8%.

At $6 billion — the high end of the net tax increase that sources say the Blagojevich administration is considering — Mr. Crosby says business taxes would rise to 52.7% of total taxes and 6.5% of Illinois' gross state product, exceeded only by states such as Alaska and Wyoming, which rely heavily on taxes from oil, gas and coal extraction.

Even if a gross-receipts tax resolved the state's immediate budget crunch, business owners warn it would be counter-productive in the long run, creating a drag on the Illinois economy. Taxing receipts instead of profits would impose an additional cost on unprofitable startups that don't yet pay corporate income taxes, and on firms investing in research, new products or additional capacity, thus discouraging economic growth.

"If you're not profitable, because of investment or expansion, that's when you really get hit," says Michael Moses, financial services director for S&C Electric Co., one of the biggest remaining manufacturers in Chicago, with 1,750 employees on the North Side. A 1% gross-receipts tax "would at least triple and probably quadruple our tax liability," in good times and bad.

Critics say one big problem with a gross-receipts tax is "pyramiding," in which the tax ratchets up the cost of goods at each stage of production. Proponents of the tax say that problem is overstated. For Mr. Moses, it's clear that many of S&C's Illinois-based suppliers would just have to absorb the tax if they want to keep their customers.

"If we could get the same material from an outside supplier, that's an easy business decision," Mr. Moses says.

Manufacturers aren't the only ones grappling with the implications of a gross-receipts tax. Retailers such as grocers and pharmacists, who operate on low profit margins and high volume, would be especially hard hit.

"This would probably put us out of business," says Michael Gersten, owner of Morse L Drugs in Chicago.

It's possible that several tax rates could be proposed, a step other states with gross-receipts taxes have taken to account for different levels of profitability in certain industries and to ease the pyramiding effect. But that introduces complexity, making compliance and tax collection more difficult, which undercuts a major reason for switching to a gross-receipts tax in the first place.

Lawyers and accountants likely would see some new business from explaining the new tax to their clients. The downside is that professional services firms — which currently pass through profit to owners or partners, where it is taxed as personal income — would pay the new tax themselves. And they'll have a hard time passing a gross-receipts tax along to clients, says Paul Boken, executive director of Chicago-based law firm Hinshaw & Culbertson LLP.

With about $160 million in revenues, a 1% gross-receipts tax would reduce Hinshaw's profits by $1.6 million, or 4%. Effectively, "it's raising the income tax on partners of the firm," he says.

©2007 by Crain Communications Inc.

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