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.
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.)
