Do You Want a Tax With That?

Pamela Hahn, a licensed cosmetologist for 44 years, says Michigan's proposed tax on hair salon services could further hurt a recession-damaged industry and push more stylists to forego renewing their licenses and instead work off the books in their own homes. If there are fewer legitimate businesses paying into the state coffers, "how does that help?" she asks.  

Secretary of the Michigan Cosmetologists Association in Lansing, Hahn says salons are closing down completely because people are cutting back, and many can't afford to get their hair done. "There has to be a better way, what I don't know, but what do we pay these government people for if they can't figure it out?"

Hairdressers like Hahn are fighting the same fight that funeral home directors and other businesses are waging in Pennsylvania against sweeping proposals to add sales taxes to an array of services that most states currently don't tax.

With tax revenues at a historic low and federal stimulus dollars drying up, states like Michigan and Pennsylvania are eying adding a sales tax to some of the 180 servicesthat states could be taxing, ranging from pet grooming and dating services to dental and legal services. The change would be a fundamental shift in states' tax systems, but the proposals are already running into stiff opposition from the business community.

"There is little rhyme or reason why we tax some items or services and wholly exempt others, except that in years past someone lobbied to secure favored treatment for themselves at the expense of others," Pennsylvania Governor Edward Rendell said when he unveiled a sweeping proposal that would reduce the basic sales tax from 6 percent to 4 percent, but would apply it to 74 goods and services currently exempted. The package from the term-limited former mayor of Philadelphia encompasses personal and business services, including funeral homes, advertising, accounting and plumbing services.

"If you do your own laundry, the laundry detergent is subject to the sales tax. But if you have your laundry done, it's sales-tax free," Rendell, a Democrat, said as he laid out a litany of current exemptions that he said "defy logic."

States have long taxed goods, like cars and appliances, since the 1930s, bringing in nearly 35 percent of the general revenue for the 45 states that have a sales tax. (Alaska, Delaware, Montana, New Hampshire and Oregon don't have one.)

But the shift in the U.S. economy from producing goods to services has meant fewer tax dollars flowing into states that have been slow to tap the service pool. Hawaii, New Mexico, South Dakota and Washington state tax more services than other states, according to the most recent data available, a 2007 survey from the Federation of Tax Administrators, a group representing state tax authorities.

Estimates of the revenue states could reap by expanding the sales tax to services vary widely, but it's easily in the billions of dollars nationwide. New Jersey, for example, expanded its sales tax to roughly a dozen services in 2006 to include tattooing, tanning and private detective services, and has collected more than $400 million in new revenue each year, a 5 percent increase in sales tax receipts.

Some two-thirds of the country's $13 billion economy is service-related, most of which states don't tax, says Sujit CanagaRetna, a senior fiscal analyst at the Council of State Governments. He says taxing services "moves state tax systems into the 21 st century" and away from the outdated system that states have used for the last 70 years.

California, Illinois, Massachusetts and Virginia probably could increase their sales tax revenue by more than a third if they broadly taxed services purchased by households, such as landscaping services, health club memberships and car washes, according to Michael Mazerov, a senior fellow at the Center on Budget and Policy Priorities , a Washington, D.C., group that examined states' options for expanding sales taxes on services in a 2009 report.

A handful of states, among them Arkansas, Connecticut, Ohio and Nebraska, did levy sales taxes on additional services as they began to recover from the 2001 recession, but the changes were largely incremental, not comprehensive like the plans in Michigan and Pennsylvania.

States back then took the slow approach because taxing services is politically explosive and a few well-publicized debacles have made others leery of trying. Florida, for example, passed a far-reaching tax on most personal and business services in 1987 only to repeal it the following year because of intense business opposition. Massachusetts approved a sales tax on certain services in the summer of 1990, and it was canned by the following spring. And more recently, Maryland in 2007 added what was dubbed the "tech tax," which was rescinded before it took effect after the computer industry mounted an aggressive campaign against it.

No one knows the battles over service taxes better than Michigan Governor Jennifer Granholm who is once again trying to levy a sales tax on certain services - even though her 2007 tax on some services lasted just six hours before it was dumped.

Granholm, a Democrat who is in her last year in office because of term limits, says her new plan will hopefully have a better shot, because it is "modeled after something the business leaders of Michigan have said is something they would like to see happen." But she admits, "it's going to be a tough sell."

On the other hand, the Business Leaders for Michigan, a group of top executives from the state's largest job providers, says Granholm's proposal doesn't go " far enough, fast enough to make us more competitive." Likewise, state Rep. Tonya Schuitmaker, a Republican, says the governor's proposal is better than her earlier attempt, but the latest version still "places a target on the back of everyday taxpayers, the people who are struggling most in our economy and who can least afford a tax hike."

Kentucky and North Carolina are among other states where taxing services is on the agenda this year.

Kail Padgitt, an economist with the Tax Foundation, says that, in theory, most economists support a broader tax base and lower rates. "But it's very political how it is done," which brings up the issue of fairness. A sales tax, he says, should tax a final sale, not a good or service in a business's supply chain. For example, a sales tax on a financial service that a business pays would get added to the price of that business's product, which essentially then would result in a tax on a tax, he says.

He calls another tax measure that Maine voters will take up this June "imperfect." While lowering the state income tax rate, it would expand sales taxes to an array of services - but specifically exempt some. It excludes ski lift tickets , for example, a lucrative business in the state that is clearly a "final sale and should be included," Padgitt says

Maine voters will weigh in on the new tax because of intense opposition from businesses and Republicans. As soon as the Democratic legislature approved and Democratic Governor John Baldacci signed the sweeping tax changes into law last June, the GOP started gathering signatures to repeal it. "It's a giant tax shift," says Jay Finegan, a spokesman for the House Republican leadership. He says the new tax would place a burden on thousands of businesses that never had to collect sales tax before. Plus, Maine's neighbor, New Hampshire, doesn't have a sales tax, which will encourage people to cross the state border to get work done cheaper. "It's a sham," he says.

Pennsylvania state Rep. Stan Saylor, a Republican, agrees that expanding the sales tax to more services needs to be considered as the U.S. enters more of a service economy. "However, such a proposal should not be debated on the grounds of generating more tax revenue for government spending," Saylor says. "It should be debated on the principles of good tax policy. Unfortunately, that is not what is happening in Pennsylvania."

The Pennsylvania Funeral Directors Association, which represents 1,100 of the 1,600 licensed funeral homes in Pennsylvania, opposes the proposed tax on its business, which it calls a tax on families in mourning. "In a tight economy, grieving families don't need to face the added charge of sales taxes on funeral services and merchandise at the time of death of a loved one," the group said.