Michigan legislators are considering expanding the state sales tax to include businesses in the service industry as a way to generate added revenue for the state. With Governor Jennifer M. Granholm and a financial advisory panel scheduled to meet throughout the month to address a state budget deficit that is expected to be close to $1 billion for the current year—and possibly twice as large in 2008—many business owners are wary of how those discussions might affect them. If extended, the sales tax  could be imposed on a large number of the 142 currently untaxed services in the state, including salons, dry cleaners and golf courses, and possibly even extend to legal and accounting services.

As with the broader U.S. economy, Michigan has seen a decades-long shift from an industrial economy toward a more service-oriented one. At the same time, the Michigan tax base has not been expanding and the state's tax revenues have been declining for the past six years. Given those changes, the sales tax in Michigan does not reflect the present structure of the economy, said Okan Kavuncu, an economist at Public Sector Consultants, a public policy firm in Lansing. "We have an uneven playing field right now," says Kavuncu.

Taxing services could bring in approximately $8.5 billion a year for the state, according to Kavuncu. "If the state taxed all services, it would be able to solve every single problem it is now having," he said, noting that he personally does not support extending the sales tax as the only solution.

Some business owners like Paul Hense, president of Hense and Associates, a CPA firm based in Grand Rapids, Mich., say the state shouldn’t be looking to them to make up the budget shortfall. "In these types of situations," Hense said, "we end up as a collection agency for the state."

Although Hense believes that a tax on his accounting services would not hurt his business, he expects opposition to the tax to gather momentum. "There's going to be a huge battle because the question is: the state needs the money, who are they going to get it from?" Hense said.

On January 10, Governor Granholm appointed an emergency financial advisory panel of former public officials to discuss new tax reform policies. In addition to confronting the state's fiscal crisis, lawmakers are feeling pressure from last year's repeal of the Single Business Tax (SBT), a value-added tax on businesses that will be phased out starting in 2007. While many in the business community pushed for the elimination of the SBT, the question remains of how to effectively replace the tax without hurting the entire business community.

Tricia Kinley, Director of Tax Policy and Economic Development at the Michigan Chamber of Commerce, says the state is in need of some major tax restructuring, which she believes should be accompanied by government restructuring and a plan that will use tax payer's dollars more effectively. The Michigan Chamber has long objected to expanding the sales tax to cover services.

Kinley noted that the impact of such an expansion would not only increase costs for consumers, but also for business owners purchasing services for their company. The burden "will be disproportionate for small businesses," she said. Larger companies are more likely to be able to afford an in-house attorney and save on costs, for example, whereas smaller businesses generally retain outside legal help, putting those small businesses at a disadvantage when competing against other big businesses. Taxing more services "will drive up the cost of products that small businesses sell to consumers and might discourage customers from buying their products," Kinley said. Michigan businesses would also be at a competitive disadvantage with neighboring states, she added.

Granholm has not yet laid out her thoughts on the proposed tax, but has reportedly refused to rule it out. Business leaders say any move to extend the sales tax will likely face harsh public scrutiny and be challenged by small-business owners. "At the end of the day, it probably doesn't have enough support to pass on its own," said Robert Fowler, President and CEO of the Small Business Association of Michigan.

Granholm will announce her plan for solving the state budget crisis during her State of the State Address in early February.