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MN Sales Tax Proposal: Will it Broaden Base or Simply Build a "Pyramid"?

author photo of Annette Nellen

Governor Dayton of Minnesota wants to increase the top income tax rates, lower property taxes and lower the sales tax rate.  All in the name of fairness and addressing an "outdated tax system." (Governor's blog post of 1/22/13.) Per the post:

"Governor Dayton’s budget delivers on his pledge to reform our state’s outdated tax system, making it fairer for all Minnesotans. The governor’s budget delivers $1.4 billion in direct property tax relief through a $500 rebate for Minnesota homeowners. It asks the wealthiest 2% of Minnesotans to pay their fair share in income taxes, and delivers the largest reduction to the state sales tax rate in Minnesota history."

Delving into the sales tax item more uncovers a proposal to not just reduce the rate, but broaden the base. A slide presentation on the Star Tribune website apparently prepared by the Governor, explains the proposed base broadening as follows:

"Largest Reduction in Sales Tax Rate Ever 2014
•20% sales tax reduction for everyone, dropping the state rate to 5.5%
•Our sales tax rate drops from 7th- to 27th-highest among states
•A modern tax code for the 21st century – new lower sales tax rate applies to:
–Minnesota e-fairness sales, digital products
–Selected goods and consumer services, including clothing (items over $100)
–Business services such as legal, accounting, specialized design and business support services"

CBS Minnesota has a list of the proposed items to be brought into the sales tax base - here. It includes the usual sales tax base expansion items - digital products and specified personal services, such as wedding planning. But, it also includes some items that should not be part of base expansion, such as items purchased by businesses including advertising and accounting services.

To avoid pyramiding of the tax, businesses should not pay sales tax. Pyramiding is where sales tax paid by businesses are included in the pricing of the goods and services they sell and sales tax is charged again. Applying sales tax to services purchased by businesses also raises issues of where to tax the services when they are used in more states. This was the problem that led to repeal of a broadened sales tax in Florida and Massachusetts many years ago. (See Nellen, Obstacles to Taxing Services — Are They Insurmountable? AICPA Corporate Tax Insider, 2/28/08.)

Sales tax base broadening should apply to consumption by individuals - personal services, digital downloads, and entertainment. While the base is broadened, the rate should be reduced and sales tax on business purchases should be phased out.

States need to have a plan for such base broadening. If they do not provide enough lead time for the businesses who will have to start collecting sales tax for the first time, such as personal trainers, implementation will fail.  The government should also do some public outreach to better inform the public of the benefits of a broader base and lower rate - namely equity and economic development (businesses will also have a lower sales tax rate).

We'll see what happens in Minnesota.  Certainly, Governor Dayton's plan to modernize the sales tax makes sense. Why continue to only tax 20th century type of consumption rather than also 21st century type consumption? Also, changed consumption patterns are continuing to erode state sales tax bases that only cover consumption of tangible personal property. As noted by Governor Dayton:

"In 1950, Minnesota consumers spent 61% of their income on goods rather than services. Today, Minnesota consumers spend just 33% of their income on goods rather than services. Expanding the sales tax base to reflect Minnesota’s modern economy is a fair solution that will help stabilize state revenues."

For more on reasons for base broadening and ways to implement it, please see http://www.21stcenturytaxation.com/California_Tax_Reform.html#Sales_and_Use_Taxes.

What do you think?

Other recent “Sales Tax Policy - Tales & Trends” posts by Annette Nellen, CPA, ESQ:

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