Expanding Sales Tax to Services is Bad Tax Policy


In Augusta, there are rumblings about expanding the sales tax base to include services in order to increase revenue. Some want to spend the revenue increase, others want to reduce other taxes such as dropping the top marginal income tax rate. However, expanding the sales tax to services not only violates the principles of good tax reform, it would also be economically destructive. On net, it would be very difficult to undo the harm caused by sales tax base expansion–even if all the revenue raised went to reducing other taxes. The reason why sales taxes are bad economically is due to “tax pyramiding” caused by the taxation of business inputs–I discuss this in more detail in my recent sales tax report. Another report by the Council on State Taxation (COST) also comes to the same conclusions.

The COST report states: “The current state and local sales tax system is similar to an iceberg. Not only is it a slowly drifting accumulation of many years of legislative actions, but also a large portion is hidden from view. The current sales tax is not grounded in rock-solid tax policy principles of fairness, simplicity, equity, and efficiency. Over 40 percent is submerged by the taxation of business inputs, whose costs is generally hidden and unrecognized in the form of higher consumer prices and/or reduced state economic development. The current system is a clear impediment to state economic development efforts and a drag on companies subject to our complex system of state taxation.”
The COST report also finds that one reason states have been reluctant to apply the sales to services is because so many services are business services. The report states: “There are important reason why almost all states have chosen not to impose a sales tax on business services, including: 1) the challenge of determining where the use of services occurs and the potential for multiple taxation, 2) the economic distortions and inefficiencies that are created by pyramiding of the sales tax on business services, and 3) the detrimental impact of taxing business services on a state’s economy.”
In addition, expanding the sales tax to services would dramatically move the sales tax toward becoming a gross receipts tax. A gross receipts is perhaps the worst form of taxation possible as discussed in another recent blog post.