As Gov. Mike Pence embarks on what he says will be an effort to simplify Indiana’s tax system, it’s important to consider how a sales tax on services might fit into the picture.
Currently, Indiana — and the vast majority of other states — imposes a sales tax on products, such as jeans or coffee. But they don’t tax most services, such as dry cleaning and haircuts.
There are a few exceptions. Indiana taxes utility services, for example. But for the most part, the state’s $7 billion annual take from sales taxes comes from payments made on so-called tangible goods.
Expanding the tax to services is a “largely untapped source of revenue,” according to a study done several years ago by the Indiana Fiscal Policy Institute. That could be new revenue, or it could be money used to lower other taxes.
For example, policymakers could consider broadening the tax base to include services but reducing the overall rate so that the pair of jeans actually costs
a little less but having them hemmed costs a little more.
But expanding the sales tax to services is a controversial idea. In some states that have debated or even tried it, officials have backed off quickly, worried about both the public outcry against a tax on services as well as the difficult administration.
There are a number of complicated questions about the issue, many of which were outlined in the Indiana Fiscal Policy Institute report. Here are just a couple:
What services should be included for taxation and which should be exempt? For example, legal and health care are two of the most expensive services individuals face, and taxing them would bring in substantial revenue. But both industries would fight fiercely for exclusion, and many public policy leaders say that health services in particular are essentials that shouldn’t be taxed, much like the current sales tax exempts food for at-home consumption.
Should services one business provides to another be taxed? According to the policy institute, business-to-business taxes could influence decisions about whether a firm outsources services or provides them in house.
Plus, there’s the issue of forcing thousands of small firms across the state to begin collecting taxes. Individuals who cut hair and photograph weddings and bake cakes — people who don’t generally have office staff — will suddenly have the administrative task of collecting and remitting taxes.
There are advantages to a sales tax on services as well.
The service sector is expanding. The fiscal policy study reports the base “is very large, is growing faster than the base of tangible personal property and is likely to continue to grow faster.”
Some observers say it’s more likely to capture taxes from people who can afford
to pay them. Services generally are more likely to be optional purchases.
And, as mentioned above, an expanded tax base could mean a reduced overall tax rate. That could be especially attractive in Indiana, where the sales tax rate is 7 percent, the second-highest in the nation.
For those reasons, the debate about expanding the sales tax on services is one worth having. That doesn’t mean it’s worth doing. But no discussion about revamping the tax system is complete without considering it.
Lesley Weidenbener is the executive editor of TheStatehouseFile.com, a news website powered by Franklin College journalism students.