The Merits of Senate’s Sales Tax Reform
For over a year leading up to the 2013 legislative session, State Revenue Commissioner Myron Frans was touring the state making the case for tax reform. One of the Commissioner’s principal pitches was for the need to reform Minnesota’s sales tax. The Senate omnibus tax bill—Senate File (SF) 552—takes up the mantle of sales tax reform.
The sales tax in Minnesota is applied almost exclusively to goods, while nearly all services are exempt. This creates a problem in terms of state revenue collections, because consumer services are increasing as a percentage of all consumer purchases, while consumer goods are decreasing. This point is illustrated in the graph below, which is taken from Commissioner Frans’ tax reform presentation.
In 1950, the sale of goods comprised 61 percent of consumer purchases, while services comprised 39 percent. Over time, the relative position of goods versus services gradually shifted. By 2010, goods comprised just 33 percent of consumer purchases, while services had grown to 67 percent. By taxing goods to the near exclusion of services, Minnesota’s sales tax collections are linked to the shrinking segment of consumer purchases, thereby contributing to the decline in sales tax revenue.*
To rectify this problem, Governor Dayton’s original budget released last January proposed expanding the state’s sales tax base to include a wide variety of services, as well as items of clothing in excess of $100. This broadening of the sales tax base coincided with a reduction of the state’s sales tax rate from 6.875 percent to 5.5 percent. With one notable exception, the Governor’s original proposal did exactly what economists recommend: broaden the sales tax base and lower the tax rate. Broadening the sales tax base and lowering the rate adds stability to revenue collections and makes the tax system fairer by treating all purchases similarly.
However, the Governor’s original budget also did one thing that economists do not recommend: it taxed business-to-business (B2B) transactions. While economists generally favor expanding the sales tax to consumer services, they are reticent about expanding the tax to B2B transactions. By applying a sales tax to each business transaction, the tax load “pyramids” or accumulates with each transaction. In response to criticisms, the Governor removed all major sales tax changes from his revised budget, including both the B2B sales provisions (which economists do not like) and the tax on consumer services and the rate reduction (which economists do like).
The Minnesota Senate has resurrected the concept of sales tax base broadening, stripping out most (but unfortunately not all) of the unpopular and undesirable taxes on B2B sales. A partial list of the items that would be subject to the sales tax under the Senate proposal includes:
- Personal services, such as tattoos, piercings, haircuts, spa services, event planning, personal shopping, personal concierge services, etc.
- Repair labor for farm machinery, motor vehicles, and other tangible personal property
- Admission to exhibitions
- Digital products, direct satellite services, and digital video recording services
- Over the counter drugs
- Goods purchased on-line through retailers that have Minnesota-based affiliates.†
The Senate tax proposal also reduces the sales tax rate from 6.875 percent to 6.0 percent. In addition, the Senate tax proposal includes a clothing sales tax credit for eligible filers of $60 for a married couple, $30 for all other filers, $30 for the first dependent claimed, and a reduced amount for subsequent dependents.‡ The credit phases-out for households with incomes in excess of two times the federal poverty guideline.
The standard rap against the sales tax is that it is regressive. However, the sales tax base expansion in the Senate tax bill—combined with the rate reduction, the new credit, and other changes—is revenue neutral. Thus, the sales tax provisions of the Senate tax bill should do nothing to make Minnesota’s tax system more regressive. In fact, after taking into account the clothing credit which directs tax relief to low-income households, the sales tax provisions of the Senate tax bill may make Minnesota’s sales tax and overall tax system less regressive than it currently is. Combined with the income tax provisions in the Senate bill, the overall impact of the Senate tax bill is undoubtedly progressive.
The Senate omnibus tax bill reinserts needed sales tax reforms into the 2013 tax discussion. These reforms would broaden the sales tax base, stabilize state revenue collections, and reduce the state sales tax rate—all without increasing (and possibly reducing) the regressivity of Minnesota’s sales tax. For these reasons, the sales tax provisions of the Senate tax bill deserve serious consideration during the final weeks of the 2013 legislative session.
*Other the last decade, state sales tax collections have declined in inflation-adjusted dollars per capita and as a percentage of total state tax revenue. This decline occurred despite an increase in the state sales tax rate from 6.5 percent to 6.875 percent as a result of the Legacy Amendment to the state’s constitution approved in 2008.
‡Assuming a sales tax rate of 6.0 percent, a credit of $30 would be sufficient to offset the state sales tax on $500 of clothing purchases annually.