A New State Fiscal Crisis Is Sales Tax

A New State Fiscal Crisis Is Sales Tax on Services Part of the Solution? Iris J. Lav, Deputy Director Center on Budget and Policy Priorities www. cbpp. org CTBA Fiscal Symposium January 29, 2008

States in Deficit

What to Do To Balance Budget? • Reserves if available • Tax Increases • Budget Cuts

Tax Increases vs. Spending Cuts Economist Peter Orszag (now CBO director) and Nobel Prize winner Joseph Stiglitz: • “…tax increases on higher-income families are the least damaging mechanism for closing state fiscal deficits in the short run. ” • “Reductions in government spending on goods and services, or reductions in transfer payments to lower-income families, are likely to be more damaging to the economy in the short run…”

Two States Have Increased Taxes Already

Maryland • Confronting $1. 7 b budget gap in FY 09 • Includes unfunded education reform Governor proposed package of tax increases and spending cuts and called Nov. special session. Outcome: • $1. 35 b tax increase package + • $550 m in budget cuts (not yet made) • Need more if slots fail on ballot

Maryland • PIT top rate of 5% for taxable income between $200 k and $350 k; added two higher tax brackets with 5. 25% and 5. 5% rates • Increased sales tax rate from 5% to 6%CIT rate increased from 7% to 8. 25% • Expanded sales tax to include computer services (controversial; will be major push to repeal) • Doubled cigarette tax to $2/pack • Efforts for wider expansion to services unsuccessful

Michigan • State faced $1. 4 b budget gap in FY 08 (beg. 10/1); $2. 6 b if SBT had been allowed to phase out • Raised taxes by about $1. 6 billion; cut spending $400 million • Averted government shutdown at last minute

Michigan • Increased its flat PIT rate from 3. 9% to 4. 35%, just shy of original rate in 1999 = $760 m temporary • Substituted new, “MI Business Tax” — hybrid CIT/gross receipts tax — for repealed SBT • Enacted, then immediately repealed, a sales tax on select services = $614 m • For repealed sales tax on services, substituted 22% corporate surcharge – sunsets 2017

Why Not Sales Tax on Services?

All Were Too Many! • Gov. Granholm began by proposing a 2 percent tax on non-excluded services purchased by businesses and the general public Exclude: • health care and educational services, • day care services purchased by governmental units and non-profits, • purchases related to research and computer systems design, and • admissions to zoos, museums and amateur sports events • Was projected to yield $1. 47 billion annually • Defeated by Republican-controlled Senate on a 22 -16 party-line vote

Some Were Too Few! • Gov. Granholm then proposed taxing about 56 selected, enumerated services – some business, some personal • Enacted 10/4/07 – repealed 12/1/07 • Argument against: “This is a random selection of services” • Business objected • Maryland had similar experience trying to do 4 or 5 services

New Jersey Did it Recently • In 2006, extended to 9 new service categories - raising $332. 3 m per year • List quite similar to repealed MI list • Included digital property, landscaping, investigating and security services, information services, storage space, limo services, tanning, massage, and tattooing, health club memberships, parking

Others Did it Recently • Arkansas in 2004 – added 15 service categories for $23 m annually – Passed in a special session to fix “inadequate” and “inequitable” education funding, along with rate increase • Ohio in 2003 – added 7 service categories for $62 m annually • Nebraska in 2002 – added 8 new service categories for $19 m annually

Lessons about Services • If you want a relatively broad expansion, try to get prior buy-in from businesses – In Illinois, sales on services looks good in comparison to GRT • Avoid including services that are purely or largely business to business transactions – Like GRT, B 2 B causes pyramiding

Lessons about Services • There has not been a successful expansion to professional services in recent years – Only HI, NM, SD tax professional services under their very broad, long standing sales taxes • Be careful of touchy personal services such as funerals

Worth Trying to Do! • Residents’ effective tax rate should not be determined by whether they choose to buy a lawn mower or hire a lawn service • Sales tax revenue growth will lag unless the range of goods and services taxed properly reflects the economy • At a minimum, personal services used by higher income residents should be taxed