As states continue to struggle with the after-effects of the Great Recession, state policymakers are searching high and low for a revenue structure that will increase their state’s economic competitiveness. Just this year in several states, plans have surfaced that propose to reduce state income taxes and shift the tax burden to the sales tax by broadening the base to include services and increasing the rate. While economists generally agree that consumption-based (e.g., sales) taxes are more efficient than income taxes, extending the sales tax to services generally may have the opposite effect of that intended, since typically 70%-80% of such an expansion are taxes on business-to-business services and therefore not taxes on consumption at all. Indeed, taxing business-to-business services raises a host of problems, including:
- Arbitrary and hidden differences in effective sales tax rates on different goods and services that distort consumer choices;
- Distortions in how firms are structured and operate;
- Violations of horizontal and vertical equity principles;
- Detrimental impacts on a state’s business tax competitiveness; and
- Extremely difficult compliance, sourcing and definitional burdens for taxpayers and tax administrators alike.
Seeking to improve a state’s economic and business climate competitiveness is a laudable goal, but it cannot be achieved by increasing the sales tax on business inputs, either through taxing business services or by increasing rates in existing sales tax systems, which already tax nearly 44% of business inputs in their bases.
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