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Will states eventually have to apply sales taxes to services?

August 15, 2017

Article courtesy of MIRS News Service

(BOSTON) — Back when state governments first started collecting sales taxes, purchases of goods made up two-thirds of the economy. 

Today, services make up two-thirds of the economy while goods purchases have dropped to one-third, said Scott Drenkard, director for state projects for the nonprofit Tax Foundation. 

“If you want to tax final consumption, you want to make sure that you are taxing all goods, all goods and services. You need to tax everything. You need to tax food. You need to tax groceries. You need to tax health care services. But most states don’t apply these rules broadly enough,” he told lawmakers gathered in Boston for the annual National Conference of State Legislatures (NCSL). 

But Maureen Riehl, of MultiState Associates Inc. in Alexandria, VA, sounded a cautionary note. 

“Any place that has attempted it in the last 30 years has either quickly repealed it or suffered dire consequences there,” Riehl told those in attendance Sunday. “And that is because the invention of the sales tax by Mississippi and other states in the ’30s was designed to be done only on tangible personal property, even though it has evolved into a bundling of property and services . . . If you don’t know where that service is being performed, how are you going to source that? Who gets the benefit of the tax? And it hurts your economy locally.” 

To that point, Michigan attempted a sales tax on select services in 2007 during the four-hour government shutdown, but the after significant resistance from the industry, the tax was repealed two month later in favor of a surcharge on the Michigan Business Tax.

The advent of the Internet has made things even more difficult. 

“If all of a sudden you are taxing legal services, well maybe I can just go online, get my will done online and you can’t tax that because you don’t know who did it for me,” she said. 

The pro-con discussion took place in a session entitled “Is Taxation of Services Inevitable?” 

Drenkard contended that if the states expanded their base for the sales tax, they could lower their rates. Mississippi was the first state to use a sales tax and other states followed suit in the ’40s, ’50s and ’60s. Most began at one to two percent. Today, most states are at four or five percent, some as high as eight or nine. Many states have become reliant on the tax. 

Michigan’s sales tax is 6 percent and while it is applied to goods, food and prescriptions are exempted. It does include a few select services, such as telecommunications and hotel rooms. Other services like legal services and engineering work are not included in the sales tax. 

And when legislators go looking for additional revenue, they look to a rate increase rather than expanding the base, Drenkard said. 

Michigan lawmakers attempted in 2007 to expand the base to include other services, but it proved so unpopular it was repealed two months later. 

Drenkard said most states exempt at least some goods — 33 exempt groceries, 45 exempt prescription drugs. 

“You need to apply the sales tax to gasoline if you want to have the broadest possible base, yet 42 states exempt it and only three states apply the sales tax to gasoline,” he said. 

Michael Mazerov, senior fellow at the Center on Budget and Policy Priorities, said the sales tax is regressive, meaning it places a higher burden on low-income earners. And expanding the tax to include services won’t solve that problem because low-income people have to spend money on services, as well. 

Riehl said many states are considering applying the tax to services. This year, 44 bills to expand the base have been introduced in 24 states. Last year, 19 states saw the idea pushed in 29 bills, she said. 

But she contended the sales tax as it applies to goods still has problems, since lawmakers and businesses have trouble figuring out what items ought to be taxed. And the increasing popularity of Internet sales have further complicated collection. 

Until those problems are resolved, she recommended against applying the sales tax to services. She called the idea “foolhardy.”

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