The Most Hated Tax in America

In the past few years, there have been multiple special sessions, several committees, at least two Texas Supreme Court decisions, and a heck of a lot of Texas-sized headaches over this tax.

By those who despise it, it’s been called complex, unfair, “the worst business tax in the nation,” and “the strangest hybrid tax.” Those who are in favor of it aren’t inclined to publicly state why they actually like it, for obvious reasons.

Big Jim for the Win

So how did this all come about? Well, it all stated with a fellow named Big Jim.

Big Jim, also known as James Stephen Hogg, was a skilled lawyer, corporation wrangler, and the 20th governor of Texas. Back in his day, the public was weary of corporations because of their propensity to attempt to form trusts and monopolies. These were the times of the Sherman Antitrust Act and the Interstate Commerce Act. This was the Progressive Era.

Out of the Progressive Era came new laws and measures to protect the public from a big, new kind of scary entity called the corporation. One of the consequences of the industrial revolution was massive amounts of wealth. And, unfortunately, a side effect of massive amounts of wealth is corruption. Proponents of progressive politics adamantly worked to expose business dishonesty, waste, and scandal. Politicians worked to represent middle class interests by proposing laws that would protect free enterprise. These elements are critical in the backdrop and foundation of the Texas Franchise Tax.

No one can say for sure exactly what Big Jim was thinking in 1891 when he suggested the Texas Franchise Tax, but it makes sense considering what was going on in America. He was considered a populist and–at the time–the American people were reluctant to warm to big business. The economic argument behind the proposal was, that because corporations enjoy limited liability and are incentivized to take chances that would be too risky for solo business owners (and enjoy gains because of those risks), they should be required to pay a fee.

The franchise tax wasn’t actually enacted until 1893. This first version of the Texas Franchise Tax was an annual flat $10 fee on all corporations doing business in Texas. Big Jim’s term ended in 1894 and as he left office, so did his fine-tuned balance of conservatism and advocacy for the middle class. History would remember Governor Hogg fondly and, even though his proposal would lead to one of the most hated taxes in America, Big Jim would not be blamed. His legacy lats as a governor of the people and for the people.

This was never more evident than three years before his death, in 1903, when he addressed a packed house in Austin, Texas. He covered various topics, ranging from his terms as governor to railroad mergers. A few lines could summarize his character:

“It will be a glorious day in Texas when in obedience to the will of the people, our representatives shall be free from such contaminating influences. If tonight I were in the paradise of heaven I should look like grief upon these conditions in Texas. If tonight I were in the seething crater of perdition I should look with pity upon the conditions as they are not in Texas, which, if continued, will make Texas hell itself. Let us have Texas, the Empire State, governed by the people; not Texas, the truck-patch, ruled by corporate lobbyists.”

Big Trouble in Texas

Unfortunately, James Stephen Hogg’s vision for Texas would not be reflected in the franchise tax that he created. As these kind of things often do, over the next decades, the Texas Franchise Tax started to grow in amount and scope. In 1969, 76 years after the birth of the tax, it was taking $3.25 on every $1,000 of net capital and $2.00 on every $1,000 of debt.

It wouldn’t stop there. In 1987, trouble started brewing after oil prices fell and the Texas economy wasn’t looking too good. Sage Energy Company, a Texas-based energy company, filed a lawsuit with the state claiming that the franchise tax violated the Texas Constitution on grounds that the state used inconsistent methods for calculating the amount of taxes due, allowing some companies to use a more preferential method for calculation.

Sage Energy Company won the lawsuit and received a substantial refund of the taxes it paid from the state. This court ruling had a massive influence on the rulings that shaped the tax in the years to come. By 1991, the franchise tax accounted for only 4% of Texas revenue (an amount that was usually closer to 10%). This had the state nervous as a fly in a flue pot, and, in 1991, rules started changing.

Beginning in 1992, Texas started taking whichever was greater of $2.50 per $1,000 on capital of 4.5% on all profits (including an compensation paid to corporate officers). This caused revenue from the franchise tax to greatly outpace projections based on early tax data, with inflation and population growth taken into account. But savvy business owners, lawyers, and accountants weren’t about to succumb to that kind of double taxation. Loophole schemes like the “Delaware Sub” and the “Geoffrey Loophole” were devised, and things got more slippery than a pocketful of pudding.

The Delaware Sub was a tax-avoidance technique that involved a company incorporating in Delaware and then doing business as an LLP (or other untaxed entity) in Texas to avoid the franchise tax. the Geoffrey Loophole was equally as crafty. This situation entailed a Texas corporation paying all of their profits to an out-of-state business entity, eliminating any surplus income that would be subject to the franchise tax.

In 2004, the Texas Comptroller put the nix on these methods in case more companies follow suit, thus making the franchise tax obsolete. One year later additional laws came into effect that required more types of legal business entities to pay more money. Only businesses with less than $1 million in total receipts would be exempt from the tax.

Things only got worse in 2006 when, as the closure of public schools loomed, Texas overhauled its public school finance budget. Cigarette taxes were raised and the food ol’ franchise tax was rebooted in a massive effort to come up with more funding. Over the next decade, companies would continue to bring lawsuits against the state claiming that franchise tax was unconstitutional. In 2015, out of the 100 bills regarding the franchise tax filed with the legislative session, over a dozen of them aimed to repeal it entirely.

Nothing is Certain… Except Taxes

Needless to say, it’s complicated. The Texas Franchise Tax is still wildly unpopular, but that hasn’t changed the fact that, even now, every single organization that is legally recognized as a business in Texas has to pony up and give to Caesar what is Caesar’s–even if that’s a big chunk of change or just a bunch of paperwork, a headache, and a few not-so-nice words.