Faculty Working Paper 93-0178 330 STX: B385 1993:178 COPY 2 Tax Treatment of Production Inputs Under State Sales Taxes The Library of the JAN g 1934 John F. Due Department of Economics University of Illinois Bureau of Economic and Business Research College of Commerce and Business Administration University of Illinois at Urbana-Champaign BEBR FACULTY WORKING PAPER NO. 93-178 College of Commerce and Business Administration University of Illinois at Urbana-Champaign December 1993 Tax Treatment of Production Inputs Under State Sales Taxes John F. Due Department of Economics Digitized by the Internet Archive in 2011 with funding from University of Illinois Urbana-Champaign http://www.archive.org/details/taxtreatmentofpr93178duej TAX TREATMENT OF PRODUCTION INPUTS UNDER STATE SALES TAXES Abstract While state sales taxes are commonly regarded as levies upon consumer spending, in fact a substantial portion of the impact of the tax rests initially upon inputs into business activity, an overall estimate of 41 percent. This paper stresses the importance of excluding production inputs so far as possible, in terms of avoidance of economic distortions and undesired haphazard distribution of final burden. The major obstacles to doing so are reviewed, particularly the administrative one of the difficulty, under a retail tax, of distinguishing between sales for consumption and production purposes, the large revenue from including production inputs, and the political preference for placing tax burden elsewhere than on individuals as voters. TAX TREATMENT OF PRODUCTION INPUTS UNDER STATE SALES TAXES John F. Due A retail sales tax should in logic apply to all sales made for consumption use by the purchaser and exclude all sales of production inputs — purchases for use in production — unless there are compelling reasons to the contrary. Any exclusions from tax of transactions for consumption purposes — usually called exemptions — violate the principle of universality and can be justified only for strong reasons. Taxation of any production inputs can be warranted only if compliance and administrative considerations make taxation imperative. This rule of universality of taxing consumption transactions and complete exclusion of transactions in production inputs was not recognized in the earlier days of the sales tax, but has come to be accepted at least in degree — the trend to acceptance due in part to the worldwide use of value-added taxes, one of whose greatest merits is the ease of excluding production inputs from tax. The Importance of Excluding Production Inputs from Tax There are several major reasons for excluding from tax all production inputs, so far as possible: First, taxes on production inputs will not constitute a uniform percentage of tax in relation to consumer expenditures on various goods, or deviate from uniformity in a desired pattern, as some goods require, for optimal efficiency, more dollars of various production inputs than others. Families with relatively high preferences for those goods bearing more input tax in their prices will be discriminated against. and will tend to shift to other goods. If some consumption goods are regarded as justifiable to exempt, they will bear some tax on their inputs.^ This effect may be regarded as acceptable, if the service provided (e.g., banking) is difficult to tax as the customer is not directly charged. Secondly, the tax on inputs will alter somewhat the choice of production methods, as inevitably some methods attract more input tax per unit of output than others. Replacement of old equipment will be delayed if new equipment purchases incur tax. Some inputs, especially capital equipment, will be taxed more heavily than others, relative to the prices of consumer goods produced, thus altering production input patterns.^ Thirdly, firms will be given incentive to manufacture needed production inputs themselves, since tax will apply to the purchase of such goods, but only to materials if the firms produce the goods themselves. Finally, producers in states which free fewer production inputs than other states will be placed at a competitive disadvantage relative to firms in states that tax a smaller portion of production inputs.^ ^This is shown clearly in Table IV-8 of a study of the Iowa Tax Policy Economics Group, KPMG Peat Marwick, A Study of the Iowa State and Local Tax System (Washington, DC, 1993). ^Joulfaian, David and James Mackie, "Sales Taxes, Investment, and the Tax Reform Act of 1986," National Tax Journal . Vol. 45 (March 1992), pp. 89-106. ^It is reported that Intel moved various activities out of California because of the taxation of production inputs. production inputs. Almost all European countries, Canada and most countries in Latin America and Southeast Asia have moved to the value- added form of sales tax, which in general excludes all production inputs from tax. This may be offset to a limited extent by shifts in foreign exchange rates, but in any event production efficiency will be lost. The Obstacles There are several obstacles in the path of eliminating all production inputs from the tax. First is the operational one, the problem for sellers of distinguishing between sales for consumption and sales for use as production inputs. Many commodities can be used for either purpose. The buyer, in fact, may not always know at the time of purchase what the use will be and some goods may be used partly for each purpose: a farmer's pickup truck, for example. The second is the very substantial amount of revenue that can be obtained by including at least some production inputs. A third has been the widespread failure to recognize the importance of excluding production inputs from tax. Finally, there is a major political problem: voters and legislators frequently favor taxes that apply to "business" rather than to individuals as income earners or consumers, even though it may be rather obvious that tcixes on purchases by business firms tend at least in part to be reflected in the costs of consumer goods. The exclusion is portrayed as a "break for business," "a way in which business gets away without paying its fair share." Methods of Excluding Production Inputs There are several methods by which production inputs can be excluded from the tax. First, the definition of taxable sale may be established in such a way as to exclude many such inputs. Secondly, various production inputs may be specifically exempted from tax regardless of use in particular instances. Thirdly, purchases by firms of specified categories, or all categories, for use as production inputs may be excluded from tax. Finally, as under the value-added type of sales tax, firms, while paying tax on all purchases, may receive a credit against tax due on their sales for tax paid on their inputs. This approach would, of course, convert the state retail sales taxes to value-added taxes; as noted in later chapters, this would create major problems of an interstate nature. Accordingly, it will not be considered in this chapter, which deals strictly with retail sales taxes. Exclusions by Virtue of the General Definition of Taxable Transactions; Sales for Resale The usual wording of the sales tax laws (except Hawaii) is that the tax applies to sales at retail, defined as sales for use or consumption and not for resale. Thus, any purchase made for purposes of resale is excluded from tax; such transactions are of course sales of production inputs. There are, however, a number of problems about what constitutes a sale for resale. For example, if the vendor purchases items for use in the rendering of services, the purchase is typically not regarded as a purchase for resale — particularly if the service 5 itself is not taxable. This issue is a complex one and has resulted in a number of court cases. From the days the taxes were first introduced, questions arose about whether or not various inputs into the manufacturing process were purchases for resale or not. The typical interpretation, which remains today, is that the purchase of any good that becomes a component part or physical ingredient of the final product is a purchase for resale and thus is automatically excluded from tax. Thus all raw materials, semi- finished goods, and parts which are incorporated into the final product are free of tax upon purchase by the manufacturer because they become physical ingredients of the final product. This rul6, while clear-cut in most instances, is not free of interpretative problems. Most often controversies have centered around whether the item purchased actually enters into the final product or merely facilitates the production of it. State courts have ruled in different ways, in some instances on the basis of whether or not the ingredient was essential for the production, in others only if the item was a recognizable component of the final product, under the so-called primary purpose text. Examples include various items used in steel production which do not primarily become ingredients of the final product. There are also borderline questions with regard to purchases for use in real property construction, in photocopy and related activities, and for rental of property. In some states the purchaser of goods to be rented or leased has the option of paying tax on the purchase or buying ^Jerome R. Hellerstein and Walter Hellerstein, State Taxation , Vol. 1 (Boston: Warren Gorham Lament, 1992), pp. 14:5-14:7. tax free and remitting tcix on the rentals. But a few states tax both transactions . These borderline cases and differing court interpretations illustrate the illogicality of confining the exclusion from tax to items actually becoming physical ingredients. This may make sense to lawyers; it makes no sense from an economic standpoint. What is relevant is whether purchase price of the items constitutes a cost element in the production of the product. Unfortunately the early sales tax laws, and particularly that of California, held to the strictly legal test of physical ingredient or component part. But as time has passed there has been increased acceptance of the cost" rule and broadening of the exclusion, but there are still many limitations. Containers One of the most vexing issues relating to business inputs is that of containers, broadly defined. The most common rule is that non- returnable containers are sold with the product and thus the purchase by the retailer is a purchase for resale; in a few instances, however, the retailer is regarded as the consumer and is taxable on the purchase. Because the status is not entirely clear under the resale rule, most states have enacted statutory provisions; typically the sale of the ^To add a personal note: the efforts of the senior author 40 years ago to convince Dixwell Pierce, Secretary of the California State Board of Equalization, and influential in the development of that state's sales tax, of the illogicality of the physical ingredient rule came to nought. Pierce, an extremely capable administrator, was a lawyer. container to the vendor is defined as a sale for resale, the price to the consumer being considered to include the cost of the container.^ Normally the term container is interpreted to include all usual forms, such as wrapping paper, twine, etc. This rule is generally confined to nonreturnable containers. Returnable containers, when sold to the user, are typically subject to tax; they are used to facilitate transfer of goods but do not remain with the customer. But this is not always the case; under the laws of some states, returnable containers can be purchased by the distributor free of tax. When a deposit is required on bottles and other returnable containers, the deposit is in theory at least not subject to tax, and no refund of tax is given when the bottle is returned. States differ on the question of whether paper containers served with fast food are exempt under the general container rule.^ Consumables And Fuel One group of states has simply added so-called "consumables"-goods consumed in the production process but not becoming physical ingredients, as a specific exemption from tax. The exact coverage varies somewhat. The Minnesota statute is very specific in exempting from the tax the receipts from sale or use of "all materials so used or consumed in industrial production of tangible personal property intended to be sold ultimately at retail, whether the item used becomes an Tax free status of containers is subject to some restrictions in Arkansas, Hawaii, Idaho, Minnesota, Missouri and West Virginia. Various court cases relating to containers are explored in detail in Hellerstein and Hellerstein, State Taxation , op. cit. , pp. 14-60 to 14-83. Note Burger King v. State Tax Commis . . 51 NY 2d 614 (1980). 8 integral part of the property produced." General exemptions appear in 24 states: Connecticut, Georgia, Idaho, Indiana (direct consumption in direct production only), Iowa, Kentucky, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, New Jersey, Ohio, Oklahoma, Pennsylvania (direct use only), Rhode Island, South Carolina, Tennessee, Texas, Vermont (catalysts), Virginia, West Virginia, and Wisconsin (manufacturing only) . Limited exemptions are provided in North Carolina, Alabama, Colorado and Kansas, and minor ones in Washington and Wyoming. Extension to consumables avoids some of the fine distinctions between physical ingredients and consumables, but is not significant in production costs except in a few industries. Similar considerations apply to industrial fuel and electric power. Eighteen states tax electricity used in production, 25 states tax other fuels. In general, states exempting consumables also exempt fuel. The picture is so complicated that it is not feasible or worthwhile to provide details here. The various tax services provide detail by state. The numerous interpretative problems that arise with these categories are of course products of excluding certain categories from the tax, but not all production inputs. In part, however, the problem is more fundamental, that of distinguishing between production and consumption use of various goods. This task is somewhat simpler under a value-added tax — but by no means absent, as firms will take credit for tax paid on goods accjuired for consumption use. Industrial Machinery and Eqxiipment The earliest sales tax states applied the tax fully to industrial machinery and equipment, even though used to produce taxable goods. California set this precedent, and most of the other early sales taxes were greatly influenced by California. Only two of the earlier sales tax states exempted this category, the important industrial states of Michigan and Ohio. Since 1945, however, the trend has been toward exemption; most of the post World War II sales taxes exempted the category initially, and slowly other states added the exemption. As of 1993, the picture is as follows: Fully Taxed: California, Nevada, South Dakota, Washington, Wyoming, Hawaii, District of Columbia Partial Taxation: Colorado (purchases over $1000 only exempt) Nebraska: Replacement only New and Expanded Industry only: Florida Georgia Kentucky Louisiana (special contract only) Mississippi Missouri Utah Lower rate than basic: Alabama, IJ5 Mississippi, lij New Mexico (h basic rate) North Carolina, 1 North Dakota, 3 Texas, refund, currently 75 percent of tax paid, tax on the category to be phased out. Exempt : All other states The geographic concentration is significant, though less so than in the past. The states still fully taxing include the Pacific Coast states:- Hawaii, Washington, California; Nevada and Wyoming; and South Dakota. The southern states tend to restrict the exemption to new or 10 expanded industry, though in fact this often means most or all, and to apply lower rates rather than complete exemption. The exemption states, originally confined largely to New England and Mid Atlantic, now include a much wider spread. The trend has been slowly but steadily toward exemption. In 1971, 22 states applied the full tax; in 1983, 12 states; now only 6 do. There has clearly been a domino effect, particularly as exemption moved westward in the Midwest. When one state provides exemption, there is strong pressure in neighboring states to do so, for fear of losing manufacturing activity. Evaluation of Exemption of Machinery In principle this exemption is warranted because this category constitutes a major element in cost of manufacturing, with no logic for taxation of it. Thus the argument relating to discrimination relative to other states and countries is significant. Directly and immediately this taxation constitutes an addition to the cost of real investment and presumably has some influence in lessening total real investment. This is completely contrary to the philosophy of a sales tax of taxing consumer spending. The failure of a number of states to exclude this category reflects the general reasons for tcucing production inputs. First, a considerable cunount of revenue is lost. Secondly, taxation of purchases for business use in lieu of higher tcuces on consumption good always has political appeal, however illogical this approach may be. Thirdly, taxation of industrial machinery facilitates "export" of taxes by manufacturing states to other states — competition allowing. Finally, 11 the exemption does create its own share of borderline cases and administrative problems, as well as compliance problems. There are differences among the states with regard to the coverage of the exemption; frequently, exemption applies only for machinery and equipment used directly in the production process. The various interpretational problems can be outlined briefly, based on Hellerstein and Hellerstein: 1. Delineation of manufacturing. Questions arise about the exact coverage; for example, printing has been held not to constitute manufacturing. 2. Exact coverage of scope of the firm's manufacturing activity. In most states equipment used for loading and unloading, and for movement of goods in warehouses is not exempt, but that used to move goods within the manufacturing process are. Some states, such as New York, have adopted a much broader view, the so- called integrated plant approach, which includes under the exemption various items which, while not used directly in changing the physical form, are part of the overall manufacturing. The term "used directly" in manufacturing has been the subject of much of the controversy. Questions also arise about the status of computers. In some states they are exempt if they are used directly in the manufacturing process, as they are in lumber milling, but not for general office use. Equipment used in the rendering of services is usually not covered by the exemption, as provision of services is not considered to be manufacturing, as for example, a New York decision holding that equipment used by GTE Automatic Electric Co. is not used in "manufacturing" but in the provision of services.' ^ GTE Automatic Electric Co. v. Director of Revenue , 720 SW 2d (MO 1989) . 12 Transportation Equipment The tax treatment of transportation equipment varies somewhat among the modes of transport. Trucks are usually taxed, unless they are to be used primarily in interstate commerce (in Iowa, for example, if 25 percent or more of the mileage will be outside the state) . Mississippi and Alabama tax trucks at rates lower than the basic figure. Railroad rolling stock is by law taxable in most states but in fact is not taxed because it is immediately placed in interstate commerce and the states cannot tax it. A few exempt it outright; Minnesota is an exception to the usual rule: tax is applied on a pro rata basis, of the rail line's ton mileage in the state compared to that of the whole system. South Dakota applies a lower rate to most taxable railroad purchases. Commercial aircraft is in general never taxed. Inputs Used In Agriculture; Nondurables Variation is substantial in the treatment of inputs purchased for use in agriculture. Idaho, Indiana (direct use), Massachusetts, Michigan, Minnesota, New Jersey, New York, Ohio, Pennsylvania (direct use), Virginia, and West Virginia have broad exemptions that exclude virtually all purchases for farm use except motor vehicles and improvements to real property. Other states restrict the exclusion narrowly. Oklahoma for a time provided none at all. ^ South Dakota does not apply tax to purchases for state-owned track, of which it has a substantial mileage. 13 Feed, Seed, Fertilizer . These items are in part or entirely exempt in all states except Hawaii (in which sales of livestock feed are taxed at a low rate). The exact treatment varies, however: 1. Farm use ; By far the most common rule excludes from tax sales of livestock feed, seed, and fertilizer to persons engaged in production of farm products for sale.^ A few of these states seek to narrow the coverage to actual commercial farming, as distinguished from persons incidentally producing and selling farm products. Connecticut provides exemption only if the farm's sales exceed $2 500 a year. Maine interprets the definition broadly to exclude all vegetable seeds. Many of these states, for example, Idaho, Georgia, Kansas, Kentucky, New Jersey, New York, and Utah, require the farmer to provide an exemption certificate to the supplier. Others, such as Washington, do not. Washington does require that farmers sign a resale certificate. No state requires registration of farmers, unless they regularly make retail sales. 2. Goods used for production of food ; California, Nevada, and Rhode Island follow a different approach. Items purchased for the production of food for human consumption, whether or not by a farmer, are exempt. This rule was an outgrowth of California's exemption of food and was taken over by other states. Thus, an individual can buy vegetable seed, feed for a pet hen, or fertilizer for a vegetable garden tax free, but flower seed or fertilizer for lawn or flower beds is taxable. Nevada restricts Plants and trees receive similar treatment as seeds in most, but not all, states. Nonfruit trees and flower plants are almost always taxed. 14 the fertilizer exemption to sale for commercial production of food. 3. Variations on one or more items ; Several states provide, often for no apparent reason, different treatment for one of the three items : a. Colorado: all feed and seed exempt; fertilizer exempt for farm use only. b. Connecticut: all seed and fertilizer exempt; feed exempt on "food for human consumption" basis. c. Tennessee: all feed exempt; farm use rule on seed and fertilizer. d. South Dakota: farm use for feed; seed or any fertilizer exempt when sold in specified quantities. This rule is designed to simplify the delineation of sales to commercial farmers from others. Fertilizer and commercial feed must be registered with and approved by the state department of agriculture. 4. Broad exemptions : Alabama, Mississippi, North Carolina, and Vermont exempt all or virtually all sales of feed, seed, and fertilizer. In North Carolina, the fertilizer exemption is confined to commercial fertilizer, but in fact applies to virtually all. 5. Restrictive exemptions ; In two states, the exemption is drastically restricted; a. Arizona; fertilizer is fully taxable. Livestock feed is subject to a 0.468750% wholesale tax in lieu of the retail tax. b. District of Columbia: no exemption, since it has no farming activity. 6. Full taxation ; Hawaii taxes fertilizer, seed, and livestock feed. Pet food, in the sense of prepared dog, cat, and similar food is taxable. Nominally in many states, feed for ponies and horses is 15 tcLxable, but in fact, when bought through regular feed dealers, it is often not reached. It is impossible to distinguish at time of sale between the oats a farmer buys to feed a pet pony and those to feed hogs. Most of these items are comparable to physical ingredients used in manufacturing and there is obvious justification for the exception. But unlike most ingredients used in manufacturing, these are also sold at retail for consumption use. It is impossible in practice to distinguish the use accurately in all cases, especially when farmers purchase these categories in small quantities in usual retail stores; control is easier when farmers are buying in bulk from farm supply stores. The leakage, however, is probably not very significant. Livestock Sale of farm livestock by individual farmers is never taxed, and, in fact, sale by commercial dealers is rarely taxed. In Wyoming, livestock is interpreted not to be tangible personal property and thus is not subject to tax at all. In most states, sale for farm use is excluded by law. Sale of pets and race horses (other than to farmers) is typically taxable. North Carolina specifically taxes horses and mules at a reduced rate (1%). Insecticides Most states that exempt feed, seed, and fertilizer now exempt insecticides and similar items when sold for farm use or for producing food. These items are not as yet exempt in Arizona, Arkansas, 16 California, Colorado, Hawaii, Nevada, and Wyoming. Several of these states restrict the farm exemption in other ways as well. Farm Machinery and Equipment Just as there has been a trend toward exempting industrial machinery, so has there been a trend toward exempting agricultural equipment. The pattern is as follows, but there are some exceptions to the policy noted: Fully Taxed: California Florida Louisiana Maryland Nevada New Jersey Washington (except irrigation) Wyoming Hawaii Taxed at Reduced Rates: Alabama, 1^% Minnesota, 2*5% Mississippi, 3% New Mexico, ij the basic rate North Carolina, 1% North Dakota, 3% South Dakota, 3% The reduced rate is essentially the product of a political compromise: raising some money but meeting in part the demands of the farmers for lighter treatment. The pattern has changed little in the last decade. Special Rules: Nebraska: taxable, but refund Connecticut: cost in excess of $2500: exempt. Georgia: exempt for new and expanded operations. The remaining states, 26, provide complete or primary exemption. This contrasts with the picture in 1982, when 33 states taxed the equipment fully. 17 The reasoning on farm equipment is basically the same as on industrial equipment, with the added element that individual farmers of most crops have no control over their prices, and therefore cannot directly shift the tax. The primary objection is the usual interpretative and control one. Drawing a sharp line between taxable and exempt items is not easy, especially items which may be used for both farm and nonfarm purposes, such as certain types of tractors. Replacement parts, such as batteries, create particular control problems, as they may be identical to ones used for nonfarm purposes. If the exemption were extended to items such as hand tools, effective control would be impossible because vendors and state auditors cannot distinguish between farm and nonfarm purchases. Accordingly, typically such items are not exempted. Administrative Requirements Exemption of production inputs is controlled somewhat differently from that of other exemptions. While the rules differ aunong states, there are several common patterns: Sales for Resale ; On sales for resale, most states — all except six' — require the purchaser to issue a resale certificate to the supplier. These take the form of blanket certificates when issued to regular suppliers, one cer^.ificate covering all eligible purchases. A sample is shown in Fig. 1. When a firm purchases from other than the regular supplier, it must issue a separate certificate for that purchase. The blanket certificates are usually valid indefinitely. Alabama, Colorado, Hawaii, Mississippi, Oklahoma, and West Virginia. Fig. 1 Form 3 J. 5 Minnesota Department of Revenue (,^ 7;9ij Sales and Use Tax Resale Exemption Certificate I, the undersigned purchaser, hereby certify that I am engaged in the business of selling, leasing or reniing (Ltst Items sow, leased or rented) and that the tangible personal property described below that I will purchase, lease or rent from; Seller's name Address will be resold, leased or rented by me. However, if any such property is used for any purpose other than reten- tion, denwnstration or display, while I am holding it for sale, lease or rental in the regular course of business, I understand that I am required to report and pay the tax on the purchase price of that item. Please give a detailed description of the property purchased for resale: Check applicable box: D Single purchase certificate D Blanket Certificate If blanket certificate is checked, this certificate continues in force until cancelled by the purchaser. If the purchaser uses this property for other than exempt purposes, and fails to file a sales or use tax return dedanng the taxable use of such properly with the intent to evade the tax, the purchaser will be subject to the full penalty of the law. Contractor-retailer: D In order to be valid, a contractor-retailer primarily engaged in retail sales must check this box if the following statement applies: "I hereby certify that I am a contractor-retailer engaged in retail sales, construction, alteration, repair or improvement of real property and that I am reporting and will pay my sales and use tax liability directly to the Commissioner of Revenue." Penalty: The law provides that any person who uses an exemption certificate for property with the intent to evade payment to the seller of the tax applicable to the transaction shall be subject to a penalty of $100, payable to the commissioner of revenue, for each improper use of an exemption certificate. M.S. 289A.60. Purchaser's Business Name Signature of Authorized Purchaser Address Title City State Zip Code Date Purchaser's Sales and Use Tax Account Number If no number, state reason Note: Sellers must keep this certificate as a part of their records. Slock No 21000SO Incomplete certificates cannot be accepted. 18 Legally they cover only purchases of goods made for resale, not other purchases made by the firm, though in fact this rule is not always followed. The basic rule is that only registered vendors may issue resale certificates, and the certificate must show the registration number of the purchaser. While the certificates are not essential for operation of a retail sales tax, they facilitate control, providing auditors with a systematic record for purchases for resale, and discouraging (but not preventing) firms from buying, tax-free, items which they do not resell (a shoe store buying a TV set, for example). When certificates are misused, in the sense of purchases being made tax free when they are not for resale, the usual policy is to hold the buyer responsible if the purchases are of a type normally handled by the buyer for resale. If this is not the case, some states hold the supplier responsible. But what is known as the "good faith" rule has now become almost universal: if the supplier accepts a certificate in good faith, the buyer is solely responsible. Thus the supplier is not expected to police the use of the commodity, but a few states still hold the vendor liable in the event of misuse, and a supplier not having a valid resale certificate is almost always liable for tax. The resale certificate is also used for the purchase of materials which become physical ingredients in production. Industrial Equipment ; Several states requi ■ i special certificate for purchases of industrial equipment (Fiv^ 2). f Fig. 2 Illinois Department of Revenue ST-587 Machinery and Equipment Exemption Certificate identify the seller The seller must keep this certificate. Name Address 5/vvip^f Number and street City State ZIP identify the purchaser (or lessee) Name Phoi.o i^ Address Date of purchase (or lease) Numtjer and street Month Day Year City State ZIP identify the equipment* you are purchasing (or leasing) * Equipment includes machinery and repair/replacement parts Type of equipment Serial no. Identify how you will use this equipment Check the appropriate box. D I state that this equipment will be used primarily in the manufacturing or assembling of tangible personal property for wholesale or retail sale or lease. D I state that this equipment will be used primarily in agriculture production. D I state that this equipment will be used primarily for coal exploration, and related mining, off highway hauling, processing, maintenance, or reclamation. n I state that this equipment will be used primarily for oil field exploration, oil field drilling, or as oil field production equipment. D I state that this equipment will be used primarily in graphic arts production. Sign below Under penalties of perjury, I state that I have examined this certificate and that it is true and correct. Purchaser's signature Date You may photocopy this form or you may request additional forms by writing us or calling our Springfield office weekdays between 8:00 a.m. and 5:00 p.m. Our address and telephone number are below. ILLINOIS DEPARTMENT OF REVENUE PO BOX 19010 SPRINGFIELD IL 62794-9010 { 217 785-3707 "^ *$ outlined by tlie Registration and Licensing Division and has been approted by ttw Rxms Uiimen ie i it Carter. IL-492-3002 #• R€CVCL£0 ^^ PAPf R 19 Farm Purchases ; Since fanners are typically not registered, the resale certificate approach is not usable. A few states do require that farmers provide their suppliers with an exemption certificate, or indicate on invoices that the purchase is for farm use. Sales between unregistered farmers (for example, livestock, grain, hay) are not subject to tax or to any certificate requirement. As noted, the exemption of various farm inputs inevitably gives rise to some evasion, as many of the items may be used for both farm and nonfarm purposes. The certificates do not ensure perfect enforcement, in part because audit is usually not worth the time and cost. This suggests that exemption by type of commodity, e.g., vegetable seed, is preferable to the farm use rule. Control almost of necessity must be the same as for consumer goods exemptions. The Relative Proportion of the Tax Applying to Sales for Business Purposes Various studies suggest that the percentage of the tax borne initially by business purchasers, that is, the portion on business inputs, is substantial. A study by Raymond Ring based on 1979 data showed an overall average of 41 percent, but with a range from 18 percent in Maryland and 20 percent in Virginia to 65 percent in Wyoming and Louisiana.^ The variation reflects differences in the taxes and the economies of the states. A Texas survey in May 1979 showed an estimate of 58 percent of the tax applying to business ^"The Proportion of Consumers and Producers Goods in the General Sales Tax," National Tax Journal . Vol. 42 (June 1989), pp. 167-79. 20 purchases. A recent Iowa study, based on current data, concludes that 39 percent of the tax is borne initially on business purchases.^ Iowa exempts both food and industrial machinery. Certainly the tax is not purely a levy directly related to consumption, though presumably much of the tax on production inputs is reflected in higher prices of consumption goods made with these inputs. Exemptions in Enterprise Zones Primarily in an effort to stimulate economic activity in poorer areas of the state, especially in the metropolitan central cities, the majority of the states have provided legislation for the establishment of "enterprise" zones, in which special tax concessions, including ones for sales taxes, are provided. Table III-l provides a general summary. In most states for an area to be declared an enterprise zone, it must meet various criteria designed to show that it is essentially a depressed area. In most states the exemption is limited to building materials and machinery and equipment, and primarily to the manufacturing sector. But some of the exemptions are far broader. In New Jersey, enterprise zone retail sales are taxed at a concessionary rate. The provisions generally have an expiration date, and at least three states, Maine, Minnesota, and Mississippi, have already allowed their programs to terminate. ^Texas Controller of Public Accounts, Fiscal Notes , May 1979, pp. 1-2. ^KPMG Peat Marwick, A Study of the Iowa State and Local Tax Structure (Washington, DC, 1993), p. IV-II. 21 The provisions are much more complex than this table suggests; the table is designed only to give a general picture. A nationwide total of some 3,172 zones have been established; Louisiana has the most, 1,553, or nearly half the total. This development has the advantage of excluding more production inputs from the sales taxes, but it does so in a highly discriminatory way. Most tax administrators regard it as one further exemption nuisance in the sales tax operations, one that would be unnecessary if production inputs were more generally exempted. I-JD. 17-38 22 Table III-l Enterprise Zone Sales Tax Concessions Arkansas California Colorado Connecticut Florida Hawaii Kansas Illinois Kentucky Louisiana Michigan New Jersey New York Tennessee Texas Virginia West Virginia Wisconsin Source: U.S. Zone Businesses Eligible for Tax Concessions Manufacturing, warehousing, certain computer firms Manufacturing Manufacturing Manufacturing Manufacturing Manufacturing, wholesaling, repairs Manufacturing, other nonretail if create 5 jobs or more, retailing in cities under 2500, and others All firms in the zone All eligible businesses All eligible businesses New and expanding firms All eligible firms Commercial and industrial All eligible firms Designated projects Any qualified business Any qualified firm Any qualified firms Department of Housing and Urban Update , August 1992. Commodities on Which Exemption (or Refund) of Sales Taxes are Provided Building materials, machinery and equipment Machinery All purchases Machinery and parts Building materials, business property, energy Exemption from sales tax on gross proceeds Purchases Purchase of building materials and some ocher purchases Building materials, machinery and equipment Building materials, machinery and equipment All purchases All materials, all tangible property Building materials Building materials, machinery and equipment Refund: machinery, equipment, building materials All purchases Building materials, equipment and machinery Building materials, and equipment De ve 1 opment , State Enterprise