TAXES

Taxing the Service Sector

There are no good reasons -- only political reasons -- why states should collect sales taxes on hammers but not on the services of people who wield them.
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Welcome to Florida. No, this is not the Florida of the travel brochures and real-estate supplements, that paradise of orange groves, palmettos, and mile-long beaches. Rather this is Florida the Boomtown -- highly urbanized, ethnically diverse, growing so fast that by the year 2000 it may be the third most populous state in the Union, surpassed only by California and Texas.

The two Floridas -- Florida the vacation paradise and Florida the business paradise -- have been quietly at war with each other for years. But on one issue they have been united: opposition to new taxes. As a result, Florida is something of a tax paradise as well. It is one of only seven states in the nation with no form of personal income tax, and that by constitutional prohibition. What's more, property taxes are held sharply in check by a sacrosanct "homestead" exemption, which has long since outlived its original purpose of attracting settlers to a sparsely populated southern backwater. Even the state's gasoline tax is among the lowest in the country -- 9.7? to the gallon.

But a cloudy fiscal reality has now cast its shadow on the Sunshine State. Florida desperately needs new roads, sewers, schools, and hospitals. Its prisons are so crowded that some convicts serve some of their time at home. On the environmental front, there are serious problems with groundwater contamination and polluted lakes. And although Florida's cities are generated one of the largest underclass populations in the nation, its welfare spending ranks last among the 50 states.

It is a matter of fact, not opinion, that Florida's $18-billion state budget cannot meet even the minimal needs of a growing economy. Deficit spending is no option -- like the income tax, it is constitutionally proscribed. And the revenue crunch is only likely to get worse as the population swells. Last year, the State Comprehensive Plan Committee, a brain trust of economic strategists, concluded that Florida's state and local governments will have to raise $53 billion in new taxes by the turn of the century if it is to live up to its civic responsibilities and fulfill its ambitions.

And so it came to pass last spring that Florida's staunchly antitax political leaders conspired, in secret and then in public, to ram a new tax through the legislature. To be precise, it wasn't really a new tax -- it was the old 5% sales tax. For nearly 40 years Florida had been levying the sales tax on transactions involving tangible merchandise. Now, it proposed to extend the tax to intangible services, raising $1.2 billion a year in added revenue by 1989.

Extending the sales tax was not a wholly original idea. The Florida initiative was one of the first shots in a new tax war coming soon to a state near you. With the service sector now dominating the American economy and providing most of the country's economic growth, there is a certain economic logic, if not fiscal imperative, to extending the sales tax to service transactions. A recent study by the National Conference of State Legislatures puts it unemotionally: "Sooner or later, states will be forced to tax services more heavily, if they are to avoid ever-higher sales tax rates, reduced reliance on the sales tax, or a permanently diminished rate of revenue growth in total."

Last year alone, a dozen states considered enacting sales taxes on services. Hawaii and New Mexico have taxed them, in various forms, for more than 50 years. South Dakota began taxing professional services in 1965, then broadened the base considerably in 1979 to take in everything from massage parlors to funeral services. Texas passed a halfhearted service sales tax last summer. Even in Congress, there is talk about a "consumption" tax or value-added tax, which are fancy ways to describe a national sales tax.

But so far it has been the Florida initiative that has drawn the angry backlash and generated the national attention. For so clumsy was the political handling of the issue, and so economically flawed, that the fallout has caused politicians in several other states to abandon similar efforts. In the annals of public policy, the Florida fiasco will go down as a model of how not to go about raising revenues from new sources. And in the process, a good idea will have been given a bum rap.

The Floridians' first mistake was to exempt from their new tax the most common of consumer service providers -- barbers, hairdressers, dentists, travel and insurance agents. The logic there was impeccably political -- to keep the new tax as well hidden as possible from the largest number of voters, and avoid the ire of professional groups with large memberships and powerful lobbies. But the effect was to create the accurate impression that the service tax would not be applied fairly and evenhandedly. The rationale for extending the sales tax to services, after all, is that there is no reason why the state should tax the sale of a lawn mower but not the services of the guy who pushes it. By granting its long list of exceptions, however, Florida's tax writers all but advertised the fact that they were willing to bow to political pressure and invited intensive lobbying efforts by other industries demanding to be added to the list of exemptions. Those who were unsuccessful later formed the vanguard of a statewide movement to repeal the tax altogether.

The arguments hurled against the service tax by the specific industries would have been laughable if they had not been so effective. In a state where housing prices had been climbing at the rate of 15% per year, for example, you had real-estate agents complaining that a 5% tax on their traditional 6% commission -- adding 0.3% to the price of a house -- would force young couples and empty nesters to give up the dream of owning their own houses. The result: the legislature exempted from the tax all brokers' fees on residential property. Then there were the lawyers -- they of the $100-an-hour fee -- arguing that an extra $5 an hour would deny ordinary, hardworking citizens "access to the courts." The result: an exemption for legal fees paid by plaintiffs in child support, bankruptcy, and civil rights cases, as well as defendants in criminal cases who were later acquitted. (Apparently, tax breaks for convicted criminals had no constituency.)

Under other circumstances, you might expect a vigilant press to expose these hypocrisies, but the state's media were right in there demanding their own exemption. A sales tax applied to advertising sales, argued the Florida Press Association, was nothing less than an unconstitutional restraint on the right of free speech. When the legislature turned aside its far-flung constitutional argument, the group filed suit in federal court.

By the time the orgy of hyperbole and arm-twisting was completed, the Florida legislature had produced a new sales tax law with no fewer than 41 exemptions. The bill itself ran to some 170 pages. When the state revenue department went to write up its preliminary analysis of the thing, that document came to 844 pages -- so big that the department could afford to print only 100 copies.

Besides being vast, unwieldy, and transparently unfair, Florida's version of the service sales tax suffered from a second major problem: it had overreached itself. As written, the new tax would cover not only bona fide Florida transactions, but also sales by national and international companies that, directly or indirectly, had Florida components to them. Whether such an extraterritorial sales tax is constitutional is a matter open to dispute -- the New Mexico Supreme Court didn't think so back in 1956. Whether it was politically astute, however, is no longer at issue.

In the Florida case, the most controversial aspect of this extraterritorial provision concerned the national advertising sales of the major TV and radio networks, and national publications such as this one. In each case, Florida proposed to tax that portion of advertising sales that could be attributable to their Florida viewers and readers. The idea generated not only the opposition of the national media and advertising agencies, but also their customers, who number most of the large corporations in America. Together, these opponents mounted something of a national boycott against Florida, including cancellation of conferences and sales meetings that hit directly at the state's key tourist industry, and generated -- not surprisingly -- almost weekly stories about the "sales tax debacle" in the national press.

Meanwhile, from within the state, Florida businesses were discovering their own problem with the service tax -- namely, that in many instances it was turning out to be much more than a 5% tax after all. Originally, the sales tax was conceived as a one-time levy collected from consumers at the point of sale. But as structured,, the Florida tax was being collected at every point along the business chain. Thus a business that itself was purchasing taxable goods and services was building those taxes into the price of its products -- and then collecting 5% on top of that at the time of sale. The result was a form of double taxation, or a pyramiding of taxes on top of taxes. Other states have had some success avoiding the pyramiding problem by exempting many business-to-business transactions from the sales tax, but Florida, desperate to squeeze as much revenue as possible out of its new, exemption-ridden tax, decided not to follow their example.

What with all these problems, it was not surprising that Florida's Republican governor and some Democratic legislative leaders soon declared themselves unalterably opposed to the sales tax on services, and began maneuvering to repeal it. But their retreat still left the state short of revenue, and shorter still of options. Desperate for new sources of funds, Florida's leaders finally reached for an old chestnut, and in December lawmakers raised the existing tax on tangible goods from 5% to 6%. An unfair and regressive tax was thus made more unfair and regressive.

"Clearly the state needs the money," says Jim Brainerd, a lobbyist for the Florida Chamber of Commerce, which is not exactly your typical tax-and-spend organization. "You can argue about how much it needs, or how the money is spent, but there is a need for more revenue. A service tax is not necessarily a bad way to raise it. But the way they went about it -- it's really been a mess."

What is the moral of this Florida tale? It is not, as some ideologues and interest groups suppose, that a sales tax on services is a bad idea. Rather, the lesson is that a bad sales tax on services is a bad idea. Human nature particularly opposes any new tax, or even an old tax on new things, but reason dictates against such prejudice. Sometimes a new tax is simply the best among a set of distasteful alternatives -- the fairest and most efficient way to raise needed revenue. Forty years ago it was the hardware store owner and restaurateur who predicted that the sales tax and meals tax would complicate their bookkeeping and cripple their industries, but they and their customers seem to have survived and even prospered. Now come the real-estate agent, the lawyer, and the newspaper publisher with some of the same predictions of dire consequences. History would suggest they are wrong.

Last updated: Feb 1, 1988




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