Sales Tax on Services Is Bad Policy

Should Michigan extend its sales tax to services as a way to close the state’s budget deficit? To an emerging coalition of special interest groups and Lansing lobbyists, the answer seems to be yes. But to many struggling, taxpaying families and small businesses who are tired of seeing government grow faster than their own incomes, the prospect of higher taxes is understandably unsettling. It’s also bad policy, pushed by at least some people who stand to benefit every time government raises taxes.

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Just who is spearheading this tax hike coalition is itself quite revealing. The Michigan Education Association (MEA) — the state’s largest union of custodians, cooks, bus drivers and teachers — is the chief organizer. A spokesman for the Michigan Chamber of Commerce rightly labeled the coalition as "a front group for a greedy, selfish union that has benefited greatly from higher and higher government spending on K-12 education during the 1990s."

The MEA is the same organization that contracts for support services at its own headquarters in East Lansing to save money but opposes school districts that want to do it to save money for school kids. It’s the same organization that uses its members’ compulsory dues to pursue a frivolous, anti-free speech lawsuit against the Mackinac Center. It’s the same organization that refuses to support repeal of the 1965 Prevailing Wage Act, which would save Michigan public schools $150 million annually, perhaps because union dues and political clout are more important to it than education in the classroom. And while it’s quick to call for higher taxes to balance the state’s budget, the MEA has yet to offer advice to hard-pressed Michigan families as to where they should cut their household budgets to pay those higher taxes.

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 broad range of productive service activities encompasses everything from finance to advertising to recreation to lawn mowing to legal advice to dry cleaning to barbering. A new tax on any number of those services would almost surely become a permanent stream of new revenue that would be used for more than just budget balancing in the near-term.

Even if revenue from taxing services went to deficit 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 the lion’s share 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.

Governor Granholm and the Legislature can pursue any number of courses as they navigate today’s troubled fiscal waters. On the one hand, they could ignore the difficulties faced by the state’s citizens and simply raise taxes as the MEA wants. That would drive people and businesses elsewhere and in the long run, undermine the state’s financial health for many years. Until the early 1990s, that’s what Michigan often did, prompting the all-too-familiar line that the last person to leave the state should turn the lights out. On the other hand, the Governor and the Legislature could follow the example of most of the state’s citizens who know what to do when times are tough. They make tough decisions.

To date, Governor Granholm as well as many key Republicans are focusing on spending cuts, not tax hikes. That’s commendable. It’s leadership. And it’s right for Michigan. As Senator James Barcia (D-Bay City) put it, "I don’t see the will or the advisability of raising taxes. We’ve got to have Michigan learn to live within its means."

All across Michigan, citizens are coping with the challenges of an ailing economy. And they are coping by reexamining their spending. They are re-prioritizing, and doing without some things they’d love to have. They are hiring less, spending less, taking fewer and shorter vacations closer to home. They are stretching further the dollars they have, and generally exerting the discipline necessary to weather the storm. Why should state government do otherwise?

Lansing lawmakers would do us all a favor if they would pronounce the sales tax on services idea "dead on arrival" and stick to the most important task at hand, which is curtailing spending to meet a revenue shortfall. If they need any help in identifying superfluous, counterproductive state programs and activities, the Mackinac Center can provide them with hundreds of millions of dollars’ worth.

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(Lawrence W. Reed is president of the Mackinac Center for Public Policy in Midland)