Taxing Services

Growing up, my parents used to grumble that the more things change, the more things stay the same — this even holds true for sales taxes. The Federation of Tax Administrators recently updated its data about states and sales taxes on services. The FTA data reveals that despite the economy incorporating more service based consumption, states’ sales tax bases pretty much remain the same:

Since the 1996 survey, most states made only minor changes adding or removing a few selected services from the sales tax base. However, in 2002, Nebraska policymakers enacted legislation eliminating exemptions for certain services taxable in neighboring states.

This news is especially troublesome for low- and middle-income families. The smaller the tax base (caused by exempting certain items such as services) the higher the tax rate will have to be in order to sustain a given amount of revenue. This is a major equity concern because sales taxes are the most regressive taxes levied. Ignoring the increasing role that services play in overall consumption, states are making a regressive tax even more regressive. Alternatively, if states don’t raise their rates to offset the negative revenue impact of a shrinking sales tax base, they won’t be able to provide the services that taxpayers expect.

Simply put, the economy is changing and local tax policy needs to reflect this. Ignoring increased consumption of services will result in higher sales tax rates which will make tax systems more regressive. Or absent any sales tax rate increases (or increases of any taxes in lieu of), vital services will have to be cut due to declining sales tax revenues.