Business Energy Tax Cuts are a Bad Idea

Business Energy Tax Cuts are a Bad Idea

- in Progressive Voices

By John Quinterno

Manufacturing and agricultural firms in North Carolina pay lower tax rates than other businesses on energy purchased for use in production. Nevertheless, several recent legislative proposals have called for eliminating the energy taxes paid by manufacturing and agricultural enterprises. While an economic argument can be made for repealing those taxes, doing so would reduce state revenues, raise questions of tax fairness and discourage energy conservation.

North Carolina currently levies a tax of three percent on sales of electricity. Agricultural and manufacturing firms, however, pay a lower sales tax rate on the electricity bought for production purposes. Agricultural businesses pay a sales tax rate of 2.83 percent, and, as of July 2007, manufacturers pay a rate of 2.6 percent. These industries also receive preferential tax treatment for purchases of piped natural gas and fuel.

An economic argument can be made for affording special tax treatment to the inputs, like energy, used by businesses in the production process. Taxing inputs, runs the argument, may lead to “tax pyramiding,” which is when the input tax gets passed along to an end customer who in effect pays more in taxes for the finished product. Additionally, taxes on business inputs may create incentives that result in an inefficient allocation of economic resources.   

Like any question of tax policy, the economic rationale behind the elimination of energy taxes should be weighed against questions of revenue adequacy, tax fairness and competing policy concerns. North Carolina’s public leaders consequently should consider carefully the wisdom of exempting favored industries from various energy taxes. Three concerns in particular merit special attention.

First, exempting manufacturing and agricultural firms from energy taxes would reduce the amount of tax money flowing into the state’s coffers. According to the legislature’s Fiscal Research Division, fully eliminating those taxes would cost some $45 million per year – an amount equal to 2.4 percent of general fund spending in fiscal year 2006. In light of the state’s growing number of needed public investments, public leaders should carefully consider the impact of terminating this revenue stream.

Second, eliminating energy taxes for favored industries raises questions of tax fairness. Why should the manufacturing and agricultural industries be treated differently from other industries? Why would the state not tax the energy that certain industries use as business inputs but levy full taxes on the energy that other firms use as business inputs? Where is the logical consistency in exempting an agricultural producer from taxes on the energy used to grow food yet taxing the energy used by the grocer who sells that food? Given the knotty questions of fairness surrounding energy taxes, it is hardly surprising that those taxes have attracted the attention of the legislature’s own State and Local Fiscal Modernization Commission, a body charged with developing proposals for reforming the state’s revenue system.

Finally, proposals for exempting certain industries from energy taxes need to be weighed against other policy concerns, especially those related to the conservation of natural resources. By effectively making the cost of energy cheaper, eliminating energy taxes likely would do little to encourage conservation and instead might encourage greater energy consumption on the part of certain energy-intensive industries.

While an economic argument for eliminating the energy taxes paid by manufacturing and agricultural enterprises in North Carolina exists, such a policy raises larger questions of revenue adequacy, tax fairness and energy conservation. If North Carolina’s public leaders fail to carefully weigh all of the intertwined issues, the state could wind up with an energy tax policy that works well in theory but not necessarily in practice.

John Quinterno is a Research Associate at the N.C. Budget and Tax Center