Should Michigan extend its sales tax to services? In the wake of the failure in June of Proposal A, some lawmakers see taxing services as a way to finance property tax reductions that may emerge as part of a new school finance reform package.
The message from Proposal A's demise, reinforced by widespread millage defeats two weeks later, would seem to suggest that Michiganians are leery of tax shifts and probably downright hostile to any net tax increases. As a whole, they have become rightly disdainful of the notion that the problem with public education is that it doesn't spend enough. They're tired of seeing government grow faster than their own incomes. Extending the sales tax to services will be a tough sell, no doubt about it.
As heavy industry declined, the Michigan economy's service sector grew during the 1980s. Nationally, service industries accounted for as much as 80 percent of the more than 18 million new jobs created between 1982 and 1990. This broad range of productive activities encompasses everything from finance to advertising to recreation to lawn mowing to legal advice.
Expanding the sales tax base, which presently excludes food and medicine, to include services is a tempting plum for legislators longing for those heady days when money flowed into Lansing like water. The trouble is, Michigan hit its "tax wall" in the 1980s--the point at which taxes began to shut down businesses and drive out people--and the Engler years of tax and spending cuts were long overdue. If lawmakers can convince the citizenry that bowling alleys, dry cleaners and barbers aren't "paying their fair share," then maybe the money spigot will be turned on again.
Even if revenue from taxing services went to property tax reduction dollar for dollar, however, this is still an idea that carries substantial baggage.
When the State of Florida extended its 5 percent sales levy in 1987 to most services, 240 new full-time enforcement positions had to be created. Massive and expensive "education" programs were planned to dispel confusion and raise the expected first-year compliance rate of only 65 percent. But the unworkable tax never made it to its first anniversary. It was killed by an outraged citizenry, a chastened legislature and a thoroughly embarrassed governor. That experience is a major reason why you can count on one hand the number of states which levy a broad-based and comprehensive sales tax on services.
Taxing services in Michigan would have especially detrimental effects on small businesses, which routinely contract out for bookkeeping, accounting, office equipment repair, janitorial, legal, computer and a host of other service activities. A large competitor can often provide such things in-house, thereby avoiding a sales tax on them. This should concern us, since at least three-quarters of new jobs are created by small businesses.
Economists have shown that sales tax collection and compliance costs rise as the size of the business decreases. Small, family-run firms experience compliance costs that can be four to five times greater than those incurred by their big competitors.
A 1987 study by the American Legislative Exchange Council pointed out that the regressive impact of the sales tax on low income people would be further magnified with its application to services. It would show up in their medical, dental, and legal bills, for instance. Taxes on construction services would surely price some of them out of the housing market.
Adding Michigan's service firms to the sales tax rolls would dramatically boost the state's own administrative costs. Florida's short-lived tax instantly increased the total number of registered vendors by 75 percent. In Iowa, the figure was 60 percent. Inevitably, the normally high rate of delinquency and audit costs that all states incur when they deal with smaller firms would only worsen.
Michigan already has sales taxes on more than a dozen services, including airport parking, telephone calls, shoe repair, equipment rentals, even funerals. On top of that, the Single Business Tax operates much like a sales tax on many service businesses. The voters are saying loud and clear that they don't want tax-raising schemes; they prefer things like a straightforward property tax cut, education reform that brings less bureaucracy and more bang for the bucks, and continued restraint on state spending.
Lansing lawmakers would do us all a favor if they would pronounce the sales tax on services idea "dead on arrival."