OHIO WHOLESALE MARKETERS ASSOCIATION 88 East Broad Street, Suite 1240 • Columbus, Ohio 43215 phone 614.224.3435 • fax 614.224.0551 email [email protected] ...
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OHIO WHOLESALE MARKETERS ASSOCIATION 88 East Broad Street, Suite 1240 • Columbus, Ohio 43215 phone 614.224.3435 • fax 614.224.0551 email [email protected]

House Bill 64 Testimony Beth Wymer, Executive Director March 4, 2015 Chairman McLain and members of the House Ways and Means Committee, thank you for the opportunity to provide my membership’s perspectives on the tax increases and policy changes proposed in House Bill 64.

OWMA’s core membership is wholesalers who supply products to convenience stores, mom-n-pop corner stores and similar retailers. With few exceptions, the Association’s distributor members are Ohio-based family-owned businesses that have served their communities for one or more generations, but there are out of state wholesalers who sell into Ohio as well. Wholesalers in this industry carry competing brands from competing manufacturers, and they compete against each other for retail accounts. It’s a very difficult business, to say the least. Wholesalers to c-stores are high volume low profit margin businesses, with the typical wholesaler having a pretax profit margin of about one percent. The commercial activities tax did not reduce the tax burden for the wholesalers based in Ohio. In fact, they’re telling me they pay more in CAT taxes than they previously paid in the tangible personal property tax and corporate franchise tax, with some reporting that their tax liability under the CAT tripled. The additional CAT liability in House Bill 64 limits their ability to add employees or reinvest in their businesses.

OWMA’s wholesale members sell much more than just tobacco, but the tobacco category accounts for 70 to 80 percent of a typical wholesalers overall sales volume. So in addition to this budget hitting them with a higher CAT rate, it is hitting up to 80 percent of their business with tobacco taxes that are paid first by wholesalers, before the products get to the retailer and eventually to the consumer.

Wholesaler Costs and Cash Flow Knowing a little about wholesaler cash flow is important to understanding how they are uniquely impacted by tobacco tax increases.

Major manufacturers require that wholesalers pay for cigarettes before they’re delivered to the wholesaler’s facility. These payment terms range from three days in advance of delivery to C.O.D. Popular brands of cigarettes cost in excess of $2,400/case (60 cartons) and a typical midsize wholesaler is running about 598 cases of cigarettes through their warehouse each month.. In addition to manufacturer prepayment terms, wholesalers deal with minimum quantity requirements on their orders. About a year ago when I testified before this committee, I shared that a tobacco product manufacturer had just announced that orders must meet a 1000 case minimum at an average cost of $430,000 per order. Those types of requirements put an immediate squeeze on cash flow and they aren’t unique to tobacco manufacturers. Manufacturers of popular candy/snack brands, whose products also go through my members warehouses, have also moved to minimum orders. The point of this background on manufacturer-wholesaler relationships is to show you that as manufacturers are working to improve their efficiencies and bottom lines, the wholesalers ability to maintain positive cash flow is constantly challenged. Next comes the cash flow challenges associated with being the state’s tax agent and front end payer of the cigarette tax to the state. The cigarette excise tax is actually an immediate tax on wholesalers who must buy cigarette excise tax stamps from the state and affix the stamps to each pack of cigarettes before selling the product to retailers. The stamp is proof that the tax has been paid. At today’s tax rate one roll of tax stamps, Representing the wholesale distribution channel for tobacco, candy and general merchandise since 1942.

which stamps only 50 cases of cigarettes, costs the wholesaler $36,825 --- that is $37,500 face value of the tax stamps on the roll, minus the wholesalers stamping compensation which I will address later. HB 64’s cigarette tax increase of $1.00/pack increases the full value of one roll of stamps to $67,500.

Let’s do the math on a wholesaler at 598 cases a month, needing 12 rolls per month. At today’s $1.25/pack tax rate, that’s a cost to the wholesaler of $441,900 for cigarette tax stamps in just one month. The monthly stamp costs jump to $810,000 under House Bill 64. OWMA’s largest wholesaler reports needing more than 150 rolls of tax stamps per month – their cost will to more than $10million per month. Please keep these costs in mind as I talk about May and June.

Wholesaler cash flow challenges peak every year in May and June. In the first ten months of the fiscal year they can buy the tax stamps on 30-day credit. However, in May and June they are required by law to pay for the tax stamps at the time they’re ordered from the state. In May, wholesalers are paying double, ie paying for the stamps ordered on credit during April and also remitting payment with each stamp order placed in May, and then also remitting payment with stamp orders in June. These businesses take interest bearing loans/lines of credit to make sure the state gets its cigarette taxes. The cigarette excise tax is the only excise tax that must be remitted up front to the state in part of the fiscal year. Excise taxes on beer, wine and motor fuel are all due by a specific date of the month for the previous month’s taxes, and this applies for all twelve months of the fiscal year. In other words, the state is using Ohio’s cigarette wholesalers, but not other remitters of excise taxes, to balance the state books at the end of each fiscal year.

The excise tax also impacts account receivable liabilities. There is no law requiring that wholesalers be paid on delivery for cigarettes or other tobacco products (there is such a law for beer/wine) so based on payment terms with retailers, it’s about 14 to 20 days from the time the manufacturer debits the wholesalers bank account for the cost of the cigarettes until the wholesaler is paid by the retailer; during this time, the wholesaler carries the entire cost of the cigarettes and the excise tax. Increasing the tax increases the value and risk of nonpayment associated of the wholesaler’s account receivables. Wholesalers are still obligated to remit the taxes to the state, even if the retailer doesn’t pay for the taxed product.

Loss of Stamping Compensation vs Changing Wholesale Mark-up HB 64 eliminates the wholesaler cigarette stamping compensation “in exchange” for including the cigarette excise tax in the wholesale cigarette minimum markup. The stamping compensation and the mark-up are in place for two completely unrelated reasons, and OWMA has not given its support to what is in HB 64.

The budget documents have referred to the stamping compensation as “early payment discount” and “cigarette tax stamp discount”. It has also been stated that these businesses shouldn’t be rewarded for paying their taxes on time. These are not the wholesalers’ taxes --- these are the state’s taxes and the wholesalers are doing a service for the state at significant cost to their businesses. If they fail to remit the taxes, they can lose their cigarette or OTP license. The cigarette stamping compensation of 1.8% of the value of stamp (2.23 cents) only partially covers wholesaler costs associated with stamping. The costs include stamping machines; maintenance and insurance on the machines; supplies needed for the machine; electric to run the machine; and personnel.

Several years ago the state told wholesalers they would be responsible for covering the costs of having the tax stamps shipped to their warehouses and the state justified shifting this expense to the wholesalers with the comment “they get that 1.8%.”

Just this past Friday, the state shifted another cost to the wholesalers – at a time when they want to completely eliminate compensation to the wholesalers -- with an announcement that effective immediately, the wholesaler would be responsible for the full face value of any stamps lost or damaged in transit to them. The state has always considered the value during shipment to be the paper, and not the stamp itself until it is delivered to the wholesaler. In the notice to wholesalers, the Tax Department indicated they would include UPS or FedEx coverage if requested by the wholesaler, or the wholesaler should get their own insurance coverage for their stamp shipments. Wholesalers are checking with their business policies to see if they are already covered or if they

can add coverage and at what cost (Attachment 1). In the meantime, UPS and FedEx will provide coverage at a cost to the wholesaler of more than $300/roll shipped and the maximum coverage allowed through these carriers doesn’t even cover more than one roll of stamps.

The Department’s response? Yes, we know it’s very expensive; yes, we know the shipper maximum coverage isn’t enough for more than one roll of stamps so if a wholesaler orders more than one roll and wants the carrier coverage, we’ll just ship every roll in their order separately; and wholesalers can pick-up their stamps at the Department --- this only makes sense for wholesalers based in Columbus or who deliver into the area but quite honestly, wholesalers who don’t pick up their own stamps tell me that their drivers are at enough risk with stamped cigarettes in their trucks and they don’t want to add to that risk by putting rolls of tax stamps in their trucks. The fact is that rolls of tax stamps very rarely get lost or damaged in transit, but when they do get lost it’s typically because a package wasn’t sealed securely by the shipper, which is the state. And lost rolls are typically recovered at the UPS or FedEx facility. Why should the wholesalers be held accountable for poor packaging? This is just another unjustified cost shift to the wholesalers at the same time that House Bill 64 is eliminating their compensation. Also, keep in mind also that in May and June the wholesalers are financing the cigarette tax for the state --I’m not aware of any line of credit with an interest rate that is less than the wholesaler stamping compensation rate of 1.8 percent. Wholesalers are not making money on the stamping compensation, but it does rightfully help cover their costs. So why wouldn’t we gladly walk away from the stamping compensation in exchange for a change in the cigarette minimum mark-up that you’ve been told is even more beneficial for wholesalers?

First, Ohio’s wholesalers do support a minimum price/mark-up law on cigarettes. Cigarettes are a high volume part of their business (70% to 80% of sales dollars at wholesale) and the law, which has been in place for more than 60 years, is intended to protect wholesalers and retailers against predatory pricing. Second, Ohio’s wholesalers have always advocated for including the cigarette tax in the wholesale mark-up, which would be consistent with other states that have mark-up laws.

What you’ve been told is that House Bill 64 is making a simple swap of the stamping compensation for the change in how the mark-up is calculated. However, there’s more to it. House Bill 64 is completely repealing the current cigarette minimum price law which is also currently being challenged in the court, and replacing it with a completely new mark-up law that will also likely be challenged in court, in which case, the change in the mark-up could also be lost.

The stamping compensation, and the wholesaler OTP collection compensation, are “tax expenditures”. The current ‘value” to the state at the current tax rate is approx $12 million for the cigarette stamping and $1.5 million for OTP tax collection. Given the costs for the wholesalers, the pending lawsuit on the current markup law and likely legal challenge if the law is changed as proposed, retaining the compensation is a priority for OWMA and its members.

Tobacco Tax Category Increases: OTP Challenges Wholesalers are the front end tax payer and tax agents for the other tobacco products tax. This tax is calculated using the manufacturer price to the wholesaler. The wholesaler remits the tax each month, based on shipments they received from manufacturers the prior month. As with cigarette taxes, if the retailer does not pay the wholesaler for the product the wholesaler is still obligated to remit the tax to the state.

One of the biggest challenges and frustrations when it comes to other tobacco products is the reality of untaxed OTP flooding into Ohio from lower taxed states, primarily from Pennsylvania which does not tax other tobacco products. An OTP trafficker sourcing product from Pennsylvania has an immediate 17% price advantage over Ohio’s wholesalers who are abiding by the law and collecting/remitting OTP taxes to the state. These OTP traffickers sell to retailers, who know they are buying untaxed product, but they are happy to buy it cheaper than it would be from an Ohio taxpaying wholesaler. Then, they buy some of the same product from a taxpaying wholesaler, just so they’ll have an invoice available if enforcement agents stop by, and mix the untaxed product in with the taxed product. It’s very easy, very profitable and very hard to detect. House Bill 64 more than triples the OTP tax rate --- taking it to 60% -- which will do nothing more than give

the already illegal operators more incentive to come into Ohio, and it will put Ohio’s taxpaying wholesalers at more of a disadvantage all while costing the state tax revenue that should otherwise be collected.

New Vapor Tax House Bill 64 also puts a new tax on vapor products, specifically to the liquid (or solid) that contains nicotine whether it’s already part of the device or refills. There are others here to talk directly to the tax increases so I’d just like to point out that the section added with the new tax also includes two direct wholesale impacts that we oppose in addition to the taxes: 1. a new $1000 license fee for our wholesalers to sell the products – they already pay $1000 for a cigarette license and $1000 for an OTP license; and 2. A required level of detail on retail invoices that will cost wholesalers thousands of dollars in inventory and invoicing programming, not to mention updating of their systems as prices and products change. We expect that applying the OTP tax to e-cigarettes will drive more sales online, meaning Ohio won’t receive the expected tax revenue.

OWMA is part of a broader coalition that includes the Ohio Association of Convenience Stores and Ohio Council of Retail Merchants, Ohio Grocers Association, Ohio Petroleum Marketers and Convenience Stores Association, Associated Food and Petroleum Dealers, manufacturers and others. Based on the experiences of the businesses we deal with, what we know about this industry and how the market responds to higher excise taxes, we are sure that Ohio will not see reliable/sustainable levels of revenue from these tax increases. What cannot be ignored is that… Cigarette and OTP taxes are regressive and impose a greater burden on the poor. Almost 50 percent of Ohio smokers and more than 40 percent of other tobacco product users have a median annual household income of less than $25,000. They are already paying over $1billion in tobacco-related taxes and applicable sales taxes (FY2014).

The state will lose tax paid sales as consumers along the borders go out of state and go online, and this obviously also means reduced sales and profitability for Ohio’s wholesalers and retailers.

When Ohio’s cigarette tax increased by 70-cents/pack in 2005, border counties in Ohio saw a decrease in pack sales ranging from 17.9% along the Indiana border to just short of 37% along the West Virginia border. At the same time, sales in Indiana counties that border Ohio increased by 14% and in West Virginia by 24%. Ohio sales along the Kentucky border dropped by 18.5%, but sales just over the border in Kentucky increased by 26%.

Keep in mind that “cross border” is not limited to state borders. The internet has broken the border barrier and tax free cigarettes are available from a range from overseas websites. Even with shipping costs, major brands through these sites cost less than 50 percent of the cost from an Ohio store at today’s tax rate. Attached to my testimony are examples of some of these online sources (Attachment 2). Smuggling also needs to be added to the reasons for revenue loss, and a recent editorial in the Columbus Dispatch speaks to that point (Attachment 3).

Lost Sales = Lost Jobs When the tax increases are fully implemented, gross profits lost to Ohio retailers and wholesalers are expected to exceed $209 million due to the decline of cigarette, other tobacco products, and sundry (tie-in) sales. It is estimated that more than 1,600 Ohio retailer and wholesaler jobs could be lost due to these tax increases, when fully implemented. Mr. Chairman and members of the committee, I know I have covered a lot and I thank you for your patience and attention. There is much more that could be said but at this point I will thank you for your time, and I will do my best to answer any questions.

Attachment 2 Re: sample of online resources for tax free tobacco

http://www.cigs-shop.net/ http://www.mycigaretteshop.net/ http://globalcigs.com/ http://www.dutyfreedepot.com/buy-duty-free-cigarettes.htm

Attachment 3