Michigan’s aging sales tax needs a makeover

Jacqui Broughton

Michigan continues to struggle year after year with budget deficits that have resulted in cuts to K-12 schools and the elimination of many vital programs. One way to stop making such drastic cuts is to revisit extending the sales tax to more services as Gov. Jennifer Granholm proposed today.

A majority of states have taken steps to raise revenue during this recession to help avoid the very cuts Michigan has made. While we did raise the income tax, temporarily, it’s time for us to consider a permanent solution.  The cuts-only approach has failed time and time again to close the ongoing budget gap as needs increase, as we note in a new League paper on sales tax on services.

As consumer spending habits change, the sales tax has failed to keep pace. Michigan, unlike many other states, taxes just 26 services, or less than 20 percent of all services that could be taxed, according to the Federation of Tax Administrators. However, spending on non-taxable services, such as entertainment and spa services, accounts for over half of all consumer spending. Failing to tax these services means the state forgoes billions of dollars in potential revenue each year.

The Michigan Department of Treasury estimates that taxing all service transactions at the current sales tax rate of 6 percent would yield over $10 billion annually. If all business-to-business, nonprofit and medical services transactions were excluded from taxation, the potential annual yield of a sales tax on services would be approximately $1.65 billion.

In addition to increasing revenue, placing a sales tax on services is a more equitable way of taxing consumption. According to a 2007 study by the Institute on Taxation and Economic Policy, Michigan families with the lowest incomes (less than $15,000/year) devote more than 7 percent of their income to sales taxes while the top 1 percent of Michigan families (income of $365,000/year or more) spend just 1 percent of their income on sales taxes.

Much of this is due not only to the fact that lower-income families spend a higher percentage of their disposable income on goods such as clothing, but because Michigan also taxes goods everyone uses, such as gas and electricity, but not luxury items such as pet grooming.

Previous attempts to expand the sales tax to more services have failed, due in part to haphazardly selecting what services would and would not be taxed. However, recent polling shows public support growing as Michigan residents begin to see the impact that declining revenue is having on their children’s education and their local police and fire departments.

Expanding the sales tax to services is only one part of the revenue solution. Instituting a graduated income tax and taking a closer look at closing business tax loopholes are just two of many other options that can be explored to help Michigan remain viable.

— Jacqui Broughton

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