In part, the tax is not on most people's radar screens because most of what they spend their money on is not subject to sales tax. Necessities (food for home consumption, medicine, utilities) are exempt in most states. So is real estate and such intangibles as stocks and bonds. And so are services. If someone gets their ears pierced, visits their lawyer or has their lawn mowed, they aren't likely to pay a sales tax for the service.
That may change. As the 2004 legislative season approaches, lawmakers in nearly two dozen states are considering proposals that would expand the sales tax base to include many services. In most states, the lawmakers are driven by a desperate need for more money to run their governments. To raise sales tax revenue--which is always more politically palatable than raising income taxes--legislation is being readied to tax a few services. Typically, these involve slapping the tax on car and appliance repair and veterinary services.
In California, Idaho, Maryland, New Mexico and Virginia, however, lawmakers are looking at including services as part of comprehensive tax reform. If a state were to expand its sales tax to include many-- if not most--services, it would gain the ability to lower overall tax rates. This follows a time-honored tax principle: Make the base broad and keep the rates low. Besides, taxing everything at low rates minimizes complexity and economic distortion.
Legislators trying to put the touch on services are on the right track. But they should proceed carefully. Taxing services is not as simple as it sounds. Attempts several years ago in Florida and Massachusetts resulted in firestorms of protests that snuffed out the efforts.
What those states learned was that the first hurdle to taxing services is politics. No one who provides services supports such levies on their own product, and that's doubly true for professional and other high-end services. Attorneys, insurance agents, doctors and Realtors have substantial clout and the wherewithal to stop legislation in its tracks. It would not be long before lawmakers hear sad tales of how a tax on services will prevent hard-working folks from seeing a lawyer or doctor and stop people from realizing the American dream of owning a home. Of course, campaign contributions make the argument even easier to understand.
People who sell lower-end services don't like taxation of their work, either. But the dog groomers, tattoo artists and landscapers just don't have the political juice that state bar associations or medical societies have. So it is upon the services provided by these small- scale businesses that an expanded sales tax will likely fall.
Is imposing the tax on more pedestrian services and excluding the high-end and professional services so bad? On one hand, most of those professional services are actually purchased by businesses. A cardinal rule of sales taxation (a rule largely ignored) is that business purchases should not be subject to the sales tax. On the other hand, is it fair to tax car repairs or haircuts but exempt financial and accounting services? Poor folks spend a much higher percentage of their income on the former.
More important, high-end services are where the money is. Imposing the sales tax on car washes will not raise nearly as much money as taxing advertising. Furthermore, high-end services are administratively easier to tax. Accountants, lawyers and doctors tend to keep meticulous records, and there are few cash transactions. The state will not have such luck with the kid who babysits or shovels the snow. Most revenue officials I have spoken with groan when the talk turns to enforcing a sales tax for cash businesses. Yet it is precisely where the new taxes will land.
From a tax policy standpoint, the correct approach is to expand the sales tax to all services purchased by consumers and exclude all services purchased by businesses. This would allow a state to dramatically lower the overall tax rates and more important, significantly strengthen the sales tax. Unfortunately, sales tax legislation in the coming legislative session is not likely to accomplish those goals.
