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 $1.7b budget gap in FY09
• 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 +
• $550m in budget cuts (not yet made)
• Need more if slots fail on ballot
Maryland
• PIT top rate of 5% for taxable income between
$200k and $350k; 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 $1.4b budget gap in FY08 (beg.
10/1); $2.6b 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 = $760m temporary
• Substituted new, “MI Business Tax” — hybrid
CIT/gross receipts tax — for repealed SBT
• Enacted, then immediately repealed, a sales tax
on select services = $614m
• For repealed sales tax on services, substituted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, B2B 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