Revenue to the Rescue: Taxing Services in the States

State governments are in for a rough year, according to a recent report from Center on Budget and Policy Priorities. "For fiscal year 2013, the fiscal year that begins July 1, 2012, 29 states have projected or have addressed shortfalls totaling $47 billion."

Can the states stanch the bleeding? Last week, we noted a partial remedy: closing the loophole on untaxed Internet sales, which costs states and localities about $24 billion a year in revenue.

Another solution, equally contentious, is a tax on services. A few years ago, CBPP explained the benefits of such taxes:

Most states could improve their sales taxes and their tax systems in general with some expansion of the tax base to include services. Levying sales taxes on services makes state tax systems fairer, more stable, more economically neutral, and easier to administer. Moreover, because state sales taxes are a major source of funding for schools, universities, health care, public safety, and other functions of state and local government, adding services to state sales tax bases can help states maintain their support for those functions, for instance during an economic downturn when state revenues are declining. Broadening the sales tax base can also avert other, less sound tax increases that otherwise might be enacted when a state needs new revenue.

A few states have already adopted services taxes, including Delaware, Hawaii, New Mexico, South Dakota and Washington, and it appears others may get on board.

A couple of bills pending in the California legislature could, if enacted, significantly impact states' revenue stream. Per the California Taxpayers Association, AB 2540 [pdf] would "expand the sales and use tax base to include 27 specified categories of services," including astrology, tarot, and palm reading, carpet cleaning and shoe repair. Another measure, AB 1963 [pdf], is even more inclusive.

A tax on services has also been endorsed by a group of business and civic leaders known as the Think Long Committee, and is included in their proposal for some $10 billion in new taxes annually. The Committee echoes the argument made by CBPP, that more stable flows of tax revenues are desperately needed, especially in California which depends heavily on taxing the incomes of top earners -- incomes which can be quite volatile. In arguing for a services tax, the Committee also notes that:

California’s $2-trillion economy is no longer dominated by manufacturing and agriculture, but is primarily composed of services and information activities. Yet, California’s tax code is so outdated that nearly $1 trillion -- that is, roughly half -- of the state’s economic output is not taxed. While we tax the sale of a donut eaten in a coffee shop, we don’t, for example, tax the sale of legal, consulting, accounting or architectural services. In essence, those who produce goods such as donuts or machinery are subsidizing those who produce services and information.

The trend, such as it is, isn't limited to the West Coast. In Maryland (projected 2013 shortfall: $1 billion), the House is debating a tax that would impact "cable TV service, tanning salons, gyms, beauty shops, barbers and even dating services." No surprise, this has incurred fierce opposition from business owners.

One hopes that Maryland's lawmakers and their brethren across the country keep their eyes on the prize: fiscal solvency, which would help ensure the continued existence of the public services that serve so many of their citizens.