Like any proposed change to the tax system, Governor
Dayton’s tax proposal is the subject of many debates. As part of Dayton’s “Fair and Balanced Tax
System” the state sales tax rate would drop to 5.5% but the tax base would be
drastically increased to include clothing and services (including business-to-business)
1. This new tax base and rate is estimated to
raise $2.083 billion1. There are many issues that opponents have
identified like regressivity and pyramiding, but others like “tax decisions,”
use payments, and the decline of border cities may lead to decreased adequacy
and a continued budget deficit.
Sales tax is generally regressive. In the past, Minnesota has fought
regressivity by exempting necessities, helping low income families spend less in
taxes as a percent of their income. While the overall tax plan will help make
Minnesota more progressive, the sales tax base expansion is definitely more
regressive than the current system2.
The increased sales tax is intended to cross-subsidize a $500 property
tax rebate1.
We’ve discussed tax pyramiding in previous blogs; it’s the
concept that at each stage of production the product is taxed, adding cost to
the product. This cost is then passed on
to the consumer. Tax pyramiding may
result in lower purchasing power as costs rise.
With lower purchasing power, the state should expect fewer purchases and
lower sales tax.
Another criticism of Dayton’s base expansion is that it may
force internalization of services to avoid the business-to-business services
sales tax. The example given by a
University of Minnesota economics professor: “A business that uses a lot of
legal services and usually purchases those services outside of their own firm
might just decide they will hire lawyers and bring that in-house3.” If this becomes reality, the services the
state anticipates taxing, will no longer be taxable and the state forfeits that
income.
Part of the proposed sales tax is a tax on services. These services will range from haircuts to
over-the-counter drugs, legal work to bank charges4. For many of these newly taxed services, they
will be sold by an out of state firm.
If the buyer and seller are located in Minnesota, a regular sales tax
will apply with the seller collecting the tax and paying it to the state. But, if the buyer is in Minnesota and the
seller is not, the buyer is responsible to pay the sales tax to the state. And when the seller is in Minnesota but the
buyer is not there is no applicable sales tax.
These different scenarios may result in some administrative difficulties
in collection.
Border cities may be additionally concerned with the tax
base expansion. There is very little
research that measures the impact tax-exempt items have on sales in border
cities, but it is easy to imagine that if Minnesota cities do not continue to
have a large tax advantage, some portion of their sales will decline. Even with the 20% decline in the sales tax
rate, a 5.5% is still higher than the four bordering states3.
With all these concerns, it is easy to see where the base
expansion may lead to revenue projection shortfalls. There will still be many opportunities to
avoid the tax through on-line purchases and out of state service purchases. We should all be wary of the projections
based on the expanded base.
4.
http://www.revenue.state.mn.us/tax_reform/Documents/Sales%20Tax%20Base%20Broadening.pdf
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