Modernizing the Tax Sales Tax System or Just Another Tax Hike?

State and Local Tax

By Jack Stewart

As state legislators and governors argue over new budgets, you will often hear or read stories about the need to modernize the sales tax system.  The justification for modernizing the sales tax system cited by state officials and some experts is that the U.S. economy has shifted from manufacturing tangible personal property to a service based economy.  As such, the theory goes, states are losing significant revenues, and therefore we must modernize the sales tax system by expanding the sales tax base to services.

But is this true?  Does a service based economy result in less sales tax revenue?  Are states losing revenue or is it just an excuse to raise taxes to meet growing state budgets?

While we have definitely become more of a service-driven economy, we still purchase a lot of tangible personal property.  Given what we have stored in our closets and garages, and in self-storage facilities, it appears that we still purchase a lot of tangible personal property.  Furthermore, considering the necessity of electronic gadgets in today’s society, it is hard to believe that we purchase less tangible personal property today than we did yesterday.  The main difference between today and yesterday is that a lot of what we are purchasing today is manufactured in other countries and not in the United States. 

As long as consumers continue to purchase products, in most cases, sales or use tax will be due and collected.  Currently, while there are issues with sales or use tax collection regarding some remote sales made via the internet, more and more remote sellers are collecting sales and use tax.  Furthermore, data from the U. S. Census Bureau appears to indicate that overall state tax collections of selected sales and gross receipts taxes between 2008 and 2014 have more than doubled. 

A service based economy does not necessarily generate less sales tax revenue than a manufacturing based economy.  Reduced sales tax revenues are usually the result of a softening economy where consumers are purchasing less—and not necessarily related a shift in the base of the economy.

Furthermore, many experts tend to overlook that service providers generally have few, if any, sales and use tax exemptions, while most states have some type of exemption or reduced tax rate for manufacturers.  States with these types of exemptions enable manufacturers to purchase machinery and equipment, raw materials and other items free from tax or at a reduced tax rate.  Most service providers pay tax on all tangible personal property that they purchase and consume in the performance of their services.  Generally, there are few, if any, exemptions that apply to service providers, with the exception of a resale exemption in some limited circumstances. 

Historically, states have resisted expanding sales tax to services due to sourcing difficulties and the possibility of tax pyramiding, where taxpayers essentially pay a tax upon another tax.  The resistance, however, appears to be eroding, and some states during the previous economic downturn added more services to their tax base.

Although the economy currently appears stable, states and legislatures are facing difficult decisions regarding the funding of various programs while at the same time addressing the issue of underfunded state and local pensions. 

While there is a need and a number of valid reasons to modernize the sales and use tax system, the expansion of the tax base to services is more of an attempt to generate additional tax revenue to meet the escalating cost of state and local government than it is a valid attempt to modernize the system. 

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