Voters in Missouri will be asked to make an important choice in November: Should the sales tax apply to services? Dubbed the “Taxpayer Protection Amendment,” Amendment 4, pushed by the Missouri Association of Realtors, would prohibit adding any “service or transaction” to the state or local sales tax base if it was not taxed as of January 1, 2015. If proponents of Amendment 4 get their way, the Missouri legislature and governor would not be able to add any new service to the sales tax base, stifling the state’s ability to properly reform its 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. code.
The broad exemption of services is a historical accident, not an intentional policy choice. When Mississippi passed the nation’s first 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. in the early 1930s, the economy was largely compromised of goods. Service transactions represented a very small part of the economy, so they were not included in the sales tax statute. As other states copied Mississippi’s structure, services were broadly exempted in all states.
However, the economy of 1930 Mississippi differs greatly from the economy of 2016. Services comprise a large part, approximately two-thirds, of the current United States economy. By not including these service transactions, state sales tax bases are increasingly narrow, leading to higher rates than otherwise necessary.
States continue to explore expanding their 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. to include services. North Carolina’s dramatic tax reform of 2013 included such changes. Governor Wolf in Pennsylvania proposed taxing services in 2015. Texas already taxes a number of personal services, such as dry cleaning, landscaping, and barber services. (A more complete list of states that tax services can be found in our 2017 State Business Tax Climate Index.)
If Missouri voters limit the state’s ability to include services in its sales tax base, the state’s options for tax reform become more limited. As the sales tax base continues to erode, the state will need to find revenue in other places, with no good solutions. It could raise the sales tax rate, but Missouri already has the 14th highest sales tax rate in the country. It could raise its individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. , but it has the 19th highest individual income tax rate, and is tied with California for the most brackets in the country. The state’s corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate is around the national average, but raising that makes little sense as the corporate income tax is one of the most harmful taxes to economic growth.
Proponents of the amendment are various service providers, concerned that their services could be taxed for the first time.
States should continue to explore ways to tax services, with the necessary considerations for business-to-business transactions. Eliminating the ability of Missouri to expand its sales tax base in the future will hamper the state’s ability to reform its tax code in the future, limiting the ability of the state to compete regionally and nationally.