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Potential Colorado Ballot Measure Shows How Not to Design a Sales Tax

5 min readBy: Jared Walczak

Colorado voters have only been asked to approve a new taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. at the ballot box once before, and that was to legalize and tax marijuana. Therefore, HB 1242, which cleared the House and is pending in Senate Finance, represents something new in Colorado taxation. The legislation, which would require voter approval, increases the state’s sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. rate by 0.62 percent, raising about $600 million per year to provide additional transportation funding.

Whatever the merits of additional transportation funding, or even raising taxes for the purpose, the bill—scheduled for a Senate Finance Committee hearing next week, where it may be greeted with greater skepticism than it experienced in the House—represents a curious, and in many ways flawed, approach to taxation. It misses opportunities to improve the state’s tax code and would instead double down on some of its inequities and inefficiencies.

Here are five things to know about HB 1242.

It Ignores Better Options for Transportation Funding

Colorado’s 22-cent per gallon tax on motor fuel places it in the bottom quarter of states on gas tax rates. The great advantage of motor fuel taxes is that they closely approximate a “user-pays” regime, with drivers (and those purchasing goods shipped by road) bearing the cost of infrastructure spending roughly in proportion to their contribution to both congestion and road wear-and-tear. If Colorado needs additional revenue for roads and bridges, it would make far more sense to raise the gas taxA gas tax is commonly used to describe the variety of taxes levied on gasoline at both the federal and state levels, to provide funds for highway repair and maintenance, as well as for other government infrastructure projects. These taxes are levied in a few ways, including per-gallon excise taxes, excise taxes imposed on wholesalers, and general sales taxes that apply to the purchase of gasoline. than to hike the general sales tax.

It Results in a High Overall Sales Tax Rate

At first glance, Colorado’s sales tax is astonishingly low, levied at a rate of 2.9 percent. This is not, however, a reflection of low reliance on sales taxes, but rather on the degree to which tax and spending authority in Colorado is devolved to localities. The average local sales tax rate in Colorado is 4.6 percent (the third highest average local rate in the nation), yielding an above-average 7.5 percent average combined state and local sales tax rate.

Once state, county, municipal, and special district sales taxes are added together, thirty-two Colorado jurisdictions have combined sales tax rates above 8.0 percent, led by Winter Park (in Grand County), with a rate of 11.2 percent. It is in this context that increasing the state sales tax rate, as proposed in HB 1242, is rather significant. If the 0.62 percent sales tax rate increase were adopted, the average combined rate would jump to 8.12 percent.

It Misses an Opportunity to Improve the Sales Tax BaseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.

Colorado’s existing sales tax base is unusually narrow, exempting some goods and including very few services. Across the country, most sales tax bases are heavy on goods and light on services, reflecting the economies that existed when they were first adopted, but Colorado takes this imbalance to extremes. Of 168 categories of services identified by the Federation of Tax Administrators, Colorado only taxes 14, the fewest of any state in the country. At the upper end of the spectrum, Hawaii taxes 166, New Mexico 164, Washington 157, and South Dakota 152.

With the service sector comprising 80 percent of Colorado’s economy, this means that the sales tax falls on a small (and declining) share of economic activity in the state, keeping rates high to account for an unnecessarily narrow base which favors some industries over others. Before considering rate increases, Colorado legislators should contemplate broadening the sales tax base to reflect a service-oriented 21st century economy.

It is Not Very Temporary

Although the proposed rate increase is billed as temporary, it’s set to run twenty years—an incredibly long time for a temporary measure. It has been said, borrowing from Milton Friedman on government programs, that there is nothing so permanent as a temporary tax. Whether that’s true, it seems unlikely that, after twenty years of growing accustomed to the higher rate, legislators who weren’t around when it was adopted would be willing to let it expire without a fight.

On a historical note, this wouldn’t be Colorado’s first experiment with temporary taxes. The entire sales tax, created in 1935, was supposed to sunset in 1937. That was eighty years ago, but who’s counting?

It Bifurcates the State’s Sales Tax Base

Colorado’s sales tax is complicated. In most counties, the state collects the local sales tax and remits the revenue back to county government, though Denver and Boulder counties administer and collect their own sales taxes. Cities with a home rule charter are also eligible to administer their own sales taxes. There are also metropolitan districts and special districts and authorities.

Cities and towns without a home rule charter (termed “statutory cities”), along with special districts, must adopt the state sales tax base, but are entitled to opt into any of eleven enumerated exemptions. Home rule jurisdictions, meanwhile, have eighty-nine potential exemptions from which to choose. There are 294 taxing jurisdictions, but many overlap, yielding 756 areas with different local rates and bases. A business processing sales in multiple locations must determine what is in the sales tax base in each location, applying only the state sales tax on some items, only the local sales tax on others, and both the state and local sales tax on many more.

This new proposal starts the state down the path of splitting up the state sales tax base as well. Rather than simply increasing the state sales tax rate from 2.9 to 3.52 percent, the bill would create a new 0.62 percent sales tax on top of the existing tax, but impose it on a slightly narrower base, one that excludes aviation fuels. This doesn’t add a great deal of complexity in and of itself—the community of people purchasing aviation fuel is small and specialized—but it introduces a new wrinkle to the state sales tax, and may open the door to further divergences from base uniformity in the future, a departure from the legislature’s stated desire to adopt a uniform sales tax base.