Should the state expand the sales tax to include services? That’s the $300 million question before a legislative tax study committee this fall.
The idea was originally floated by the Blue Ribbon Tax Study Committee in 2011, but quickly sank when Gov. Peter Shumlin declined to support it. (As the governor is fond of saying, he can see New Hampshire from his house, i.e., he is all too aware of how the Granite State’s no-tax policy affects businesses on the Vermont border.)
The notion was exhaustively explored in House Ways and Means that year, but it never saw the light of day on the House floor. The subject was not discussed with any vigor last session.
So why bother with another study when the idea of extending the sales tax to services is universally unpopular among pols in Montpelier?
Lawmakers appear to recognize Vermont has a long-term structural problem: The state has a growing service economy and a declining goods-based economy. Retail sales have fallen over the last 35 years, and consequently, the sales tax base has shrunk.
Tom Kavet, the state Legislature’s economist, says the state has also further eroded the sales tax by creating a number of exemptions. In addition, the state has not been able to make taxation of online goods and services compulsary because of loopholes in the federal law and resistance from local Internet purveyors.
As a result, the sales and use tax as a percentage of gross state product has fallen from nearly 2 percent to 1.2 percent over the last 35 years.
Kavet’s trend data show the state has had to raise rates to keep sales tax revenues constant. If the rate had remained at 3 cents (the original sales tax rate through 1978), the amount of revenues raised by the sales tax would be about $150 million, or half of the total the state brings in now.
The sales and use tax, which has been pegged at 6 cents for nearly 10 years (it went up a penny in 2003), raises about $300 million to $340 million a year.
The Blue Ribbon Tax Study Commission attempted to address that structural problem two years ago. The commission proposed cutting the sales tax from 6 cents to 4.5 cents. The lower tax, in this scenario, would be extended to all consumer-purchased services with limited exceptions for certain health and education services and business-to-business transactions. Sales tax exemptions for goods would be eliminated with the exception of food and prescription drugs. (The state now has exemptions for clothing and shoes.) The commission also pushed for aggressive tax collection on Internet purchases (in coordination with other states), which would raise about $40 million to $50 million.
The sales tax rate could go even lower (below 2 percent), some experts say, if the state taxed all goods, including food and medicine. The commission also put taxation of natural resource extraction (water, sand and rock) on the table.
Last week’s Sales Tax Study Committee meeting was deja vu all over again, as lawmakers heard from economists, experts and a former member of the commission — many of whom spoke two years ago. The experts testified about the technical and political complications facing reform.
Rep. Janet Ancel, the chair of House Ways and Means and the study committee, said it was premature to say anything definitive about the study committee’s pending recommendations or future tax reform legislation. The study committee will submit a final report to the Legislature in January.
“What we were looking at are ways of defining the sales tax base,” said Ancel. “I think the main takeaway is that we have a fairly narrow base. If we are able to broaden it, we may be able to lower rates … but we can see that it’s not easy to do. But I think it’s a discussion we ought to have. I think lowering the rate would be worth doing.”
Ancel said it would be difficult to find the political will to broaden the base while at the same time keeping Vermont’s economy competitive.
“None of this discussion has been about raising revenue,” Ancel said. “It’s about making things more fair and preserving revenue. It’s really whether the [tax] code is the best it can be, and I’m sure it can be improved.”
Bill Schubart, a retired businessman and member of the Blue Ribbon Tax Commission, said the slow pace of reform was reasonable under the circumstances. Lawmakers have had more pressing issues to address, such as health care reform and rebuilding the state in the aftermath of Tropical Storm Irene.
“It feels to me like what they’re trying to do is: What can we realistically bring to the Legislature that has some chance of passage, in amending the tax code?” said Schubart. “I think everybody knows that it needs amending. It’s way too complicated.”
Schubart argued for increased legislative oversight of tax expenditures, or exemptions for certain taxes that are counted as a loss against state revenue. He proposed sunsetting the exemptions every three years, subject to legislative review.
Jill Sudhoff-Guerin, a lobbyist at KSE Partners, said sunsetting tax expenditures could potentially be very controversial. “Everyone is going to have a personal opinion on why they should not have to pay tax and why their expenditure has value,” said Sudhoff-Guerin. “It’s going to be a very political process … but if you listen to Schubart and Kavet, really, they’re saying that this is where we lose all our money.”
Examples of tax expenditures include property tax exemptions for public, religious and charitable buildings.
Sudhoff-Guerin said lawmakers hadn’t yet studied tax expenditures in sufficient detail and she doubted the Legislature would take up the issue in the coming session.
The committee heard from Kavet, a state fiscal policy analyst from the Center on Budget and Policy Priorities, a state tax representative from Washington state, and a Canadian professor. The study committee, which is tasked with considering sales taxes, Internet sales and service taxes and cloud computing taxes, will meet twice more in October.
Two years ago, the commission also recommended shifting the income tax base from Taxable Income to Adjusted Gross Income. That suggestion is not under discussion in this fall’s legislative study.
Editor’s note: Nat Rudarakanchana contributed to this report.