Sales Tax Base Expansion Proposals Rising

February 11, 2010

Piggybacking on the post below about Pennsylvania Governor Ed Rendell’s proposal to expand the sales tax, I wanted to highlight two great articles on the subject.

First, this article from the Wall Street Journal looks at what is becoming a trend of proposals to expand the sales tax to services:

The consumption of services, at about $6.1 trillion a year, accounts for about two-thirds of total consumer spending, yet services aren’t widely taxed by state and local governments. This is rooted partly in history: Sales taxes in the U.S. began to spread around 75 years ago when the service sector was a smaller share of the economy, and legislators have generally found it easier to raise existing sales tax rates than to extend the tax to new areas.

As the service sector’s share of the economy has grown, so has its influence. “Whenever you [propose a service tax] everybody who is in that profession shows up in the lobby and protests it,” said William F. Fox, a University of Tennessee economist. “That proves extremely difficult to overcome.”[…]

Services aren’t the only potential source of new tax revenue. Cities and states across the country have pushed levies on everything from sugary sodas to grocery bags. But with revenue sinking, state and local governments are scrambling for funds—and the service sector is a tempting target.

Second, this article from Manhattan Institute scholar (and former Tax Foundation economist) Josh Barro:

Sales tax is intended to be a consumption tax, and an ideal consumption tax is applied to all consumption, exactly once, at the same rate. Such a tax is said to be neutral: not creating tax advantages for particular products, industries, or corporate structures.[…]

Services make up approximately two-thirds of our consumer economy, but most states apply sales tax to few or no services. They also often exclude “necessity” goods from sales tax bases, including grocery food, clothing, and medicine.

Meanwhile, states tax some intermediate sales between businesses. The Council on State Taxation (a trade group for multistate businesses, including retailers), estimates that 44% of sales taxes are paid by businesses, not consumers. (The COST study includes gross receipts taxes that intentionally apply to intermediate sales, but even traditional sales taxes include significant intermediate taxation.) These taxes become a component of consumer sale prices, a phenomenon known as “tax pyramiding.” So, much consumption is double – or triple – taxed while most consumption goes untaxed entirely.[…]

With 48 states facing budget deficits, many legislators simply want to broaden the sales tax base without offsetting tax cuts. Unlike Maine’s initiative, this isn’t pro-growth tax reform. However, it is preferable to many other options that legislatures consider to raise more revenue.[…]

Where a tax increase is politically inevitable, it’s better to choose one that imposes less economic damage, has at least some impact on all taxpayers, and reduces the economic distortions of taxation. Extending sales taxes to services can fit this bill.

The full piece is worth a read. Check it out here.


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