Should Michigan impose a sales tax on services? It's an idea which so far hasn't gone much beyond a few whispers in Lansing. It's also an idea which doesn't deserve to.
The rapid growth of the economy's service sector--encompassing a broad range of activities from finance to advertising to barbering--looks like a tempting and undertaxed target for professional revenue-enhancers everywhere. Of the more than 17 million new jobs created since 1982, more than 80 percent have been in the service fields.
When the State of Florida extended its 5 percent sales levy last year to most services from legal advice to lawn mowing, 240 new full-time enforcement positions had to be created. Massive and expensive public "education" programs were planned to dispel confusion and raise the expected first-year compliance rate on only 65 percent. But the tax never made it to its first anniversary. It was killed by an outraged citizenry, a chastened legislature and a thoroughly embarrassed governor.
In the recent school finance reform debate in Lansing, a provision in the reform package which would have specifically banned any extension of the Michigan sales tax to services was yanked out by legislators wanting to "reserve the option." The Florida experience should have made it plain that the whole idea is a dud. Unfortunately, it may have taught some solons in Lansing nothing more than how to go about getting the tax and keeping it. As a result, any future Michigan sales tax on services is likely to result from a divide and conquer strategy. The revenue-enhancers may go from accounting to zipper repair, grabbing one service at a time, until they end up giving us precisely what the Sunshine State rejected when it was offered up all at once.
Though most states levy some form of sales tax on at least a few services such as lodging, only three have anything that could be called broad-based and comprehensive: South Dakota, New Mexico, and Hawaii. Since the repeal in Florida, no other state has extended its regular sales tax to the service sector. The arguments against it are compelling.
Taxing services 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.
Economists have shown that sales tax collection and compliance costs rise as the size of the business decreases. Small, family-run firms like restaurants or grocery stores experience compliance expenses that can be four to five times greater than those incurred by their bigger competitors.
It also stands to reason that since the vast bulk of new jobs is generated by small, entrepreneurial firms, any new service sales tax in Michigan would yield new revenue in the short-run, but at a sacrifice to long-term economic development. And it would do nothing to reverse the state's image as an expensive place to do business.
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 extension 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 the many 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.
Finally, a statewide survey conducted last spring for the Michigan State Chamber of Commerce asked a cross-section of 800 residents for their opinions on the issue. A resounding 78 percent opposed a services sales tax; only 15 percent of those polled supported it. With that kink of lop-sided majority, Michiganders are clearly not in the mood to embrace tax-induced higher prices on the services they buy.
Imposing the sales tax on services is a bad idea. Unfortunately, that's no guarantee that some in the legislature won't try to make us think it might actually be a good one.
Mr. Reed is President of The Mackinac Center, a private, non-profit educational and research organization in Midland. Permission is hereby granted to print or broadcast this article, in whole or in part, with appropriate credit given to the author and to The Mackinac Center.