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Clothing taxes and hotel subsidies: Dumb and dumber

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Even if extending sales tax to clothing can be done at a lower rate and thereby make the overall sales tax rate lower, this is a regressive tax being proposed by the DFL.

Two items in the news point again to foolish decision making by some elected officials, especially when it comes to economics and business.

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David Schultz

The first is continued insistence by Sen. Tom Baak and the DFL to impose a sales tax on clothing. Recall that Gov. Mark Dayton initially suggested this idea earlier this year in his tax plan version 1.0. He proposed it along with a business-to-business tax on various services. Both the clothing tax and the B2B were so unpopular that he repudiated both. Now the Senate wants to move forward with the clothing tax even though the governor and the House DFL are opposed. This political opposition should be enough to suggest it is a bad idea, but there are other reasons to oppose the clothing tax.

High resistance to clothing tax

First, while a tax on clothing is not unheard of in other states, it is not something that has been done yet in Minnesota. Perhaps the public could get accustomed to it over time, but right now there is a lot of resistance to it among the public. 

Second, even if extending sales tax to clothing can be done at a lower rate and thereby make the overall sales tax rate lower, this is a regressive tax being proposed by the DFL. If clothing is taxed but there is no extension of the sales tax to B2B services, then this is definitely an overall less progressive tax than before. This is a tax that will weigh more heavily on the poor. It is a tax that soccer moms will notice when buying school clothing for their children.

Third, this is a tax that might also hurt Minnesota businesses. Currently many Minnesota businesses are hurt by Internet companies which do not have to collect sales tax. With clothing not taxed the impact for sales of this type is less. However, enact a clothing sales tax and businesses with a physical presence in Minnesota will be hurt because Internet businesses will have a tax advantage. Perhaps this tax advantage will disappear if the U.S. Congress agrees to allow states to tax Internet sales. However, at present the change in tax law seems foolish and it risks hurting places like Mall of America that do a brisk job in terms of tourist and destination sales.

The second issue is a call for the City of Minneapolis to subsidize the building of a new hotel in the city. The city aspires to becoming a major convention city, and some believe that adding another 1,000 rooms will do that.

Subsidy fever

In many ways the city is becoming captured by subsidy fever. First the public pays for Target Field and now it is going to be on the hook for the new Vikings stadium. The Convention Center loses money and the Target Center would like a handout as well. With all of these demands for the public  to subsidize, it is not a surprise that a hotel wants the money too.

However, remember that hotels are private businesses. The public should generally not be in the business of giving tax dollars to private businesses. If there truly were a market for another 1,000 units it would be profitable for private investors to build it. If the public were to subsidize this hotel, what would likely happen is what has transpired in other cities – the other hotels suffer and often close. It gives unfair competition to one developer or hotel over another.

The logic of the subsidy here is a Field of Dreams “If you build it they will come” belief. It is a belief that by building another hotel more tourists will flock here. Yes, to Minnesota, a state with a cold six (or more) months of winter that wants to compete against San Antonio, Texas, and other Sunbelt cities.

Little evidence that such strategies work

There is little evidence that Field of Dreams development strategies work. As I have pointed out in my recent book, many other cities have built convention centers, aquariums, and other tourist attractions with the hope of luring people to their cities. One city doing this makes sense; multiple cities doing it dilutes the effect and increases the competition, thereby lessening the chance that such a tourism strategy will work.

This is where Minneapolis is headed too. Some seem to believe that instead of investing in neighborhoods, schools, and quality of life, sports, convention centers and hotels are the key to the city’s economic development. But any strategy relying heavily on public subsidies is questionable. 

David Schultz is a professor at Hamline University School of Business, where he teaches classes on privatization and public, private and nonprofit partnerships. He is the editor of the Journal of Public Affairs Education (JPAE). Schultz blogs at Schultz's Take, where this article first appeared.

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Comments (6)

Clothing tax is NOT more regressive

David, I think you are wrong about the so-called regressivity of the slaes tax on clothing.

Dee Long (certainly no conservative) did the studies many years ago and found that a sales tax on clothing would make the overall sales tax MORE progressive because the rich tend to buy much more expensive clothing. We could do even better by adopting Dayton's original plan of taxing clothing sales of $100 or more.

A sales tax on clothing would bring much-needed stability to state revenues. Better yet would be a sales tax on services. Myron Frans makes an excellent case for it given the shift in consumer demand from goods to services over the years.

We need a serious rethinking of the sales tax in Minnesota. As it is now, it is based on patterns of economic activity that no longer exist.

You could make the same argument

on regressivity about any class of goods subject to the sales tax, from food to cars. The fact is that a $1.00 tax on a $20 pair of jeans at Target is harder on the lowest 10% than a $5.00 tax on a $100 pair of jeans is on the upper 10%.

David:You make a good point

David:

You make a good point but miss my point. I agree that we need to bring sales tax into the 21st century by going after services. People, especially the more affluent, consume more services than they do goods. Dayton's original plan, as did Ventura's back in 1999, made sense in seeking to tax many services to broaden the base, lower the overall rate, and make it more progressive. As soon as Dayton gave up on B2B taxes it no longer made sense to go after clothing. You cannot impose new taxes on clothing while not do the same for businesses. The result is a more regressive tax. Moreover, some argue that there should be a rebate or credit for the poor. Bad idea. The poor are then asked to upfront the tax and get it rebated later. What Baak is missing overall is that the economics of making the sale tax more progressive requires going after services that the wealthy are more likely to consume and he is not doing that here. Finally, he misses the political message here--we want to tax clothing that the poor and middle class buy but exempt businesses and affluent from new service taxes. This is hardly the message that a progressive or liberal DFL should be endorsing.

I disagree

Everything has to start somewhere. Setting a lower limit on the value of an item that can be taxed, especially a necessity like clothing, can take a regressive tax and make it progressive. That is the case with clothing valued at $100 or more--and if it makes you happy, bump it up to $150 or $200. You can argue that it's not fair to ask the poor and middle class to pay more while allowing the rich to float by. But it makes little sense to claim that if you can't have one, you shouldn't have both. That's the kind of thinking that cuts off your nose to spite your face. Why can't you tax clothing if you don't tax B2B? There is no clear reason other than your claim that it just shouldn't be done or that Minnesotans must somehow get used to a clothing sales tax, and therefore it doesn't make sense to impose one if you don't tax B2B. That kind of logic, if there really is one, baffles me.

I also don't recall the other David claiming that it would be a good idea to rebate the poor. While I can't speak for him, I agree that it's a dumb idea. But that's not what he's talking about. He's talking about setting a lower limit on the value of an item before it can be taxed, as originally proposed by Dayton. It really can't be that terribly difficult to exempt a $50 pair of tennis shoes while taxing a $1000 pair of Italian loafers. It's probably even possible to exempt a shopping cart full of clothing items that each cost less than $100, but total more than $100, so school clothes shopping each fall shouldn't be subject to taxation in MN.

While it's possible that those of us who are confused at your message simply don't get the economics, it would seem unlikely. There must be some more compelling rationale that you're not providing because what you are providing is...well...not compelling at all. One must wonder if there is a hidden business agenda for this change of heart by Dayton, and many others that normally would view this sort of change as necessary.

I saw Lori Sturdevant's Star

I saw Lori Sturdevant's Star Tribune piece from yesterday with analysis from the state describing the clothing tax as not being regressive. Interesting numbers and if valid they might demonstrate that my argument about regressivity is wrong. I can admit that. However, do keep in mind that the Senate bill does call for a rebate to the poor and I stick to my argument that taxing clothing up front and then asking the poor to apply for a credit or rebate is burdensome on the poor. Moreover, my original argument was also a political one--the tax is unpopular and will not be well received by soccer moms, and it also seems politically wrong to push for the clothing tax while abandoning the B2B tax because powerful interests opposed the latter but not necessarily the former. Finally, I do wonder if an analysis of of clothing tax regressivity was done in a way that did not factor in other changes in the sales tax code. By that, viewed in isolation introduction of a clothing sales tax might not be regressive but view the additional tax in conjunction with no additional taxes on services and I wonder if one can reach the conclusion that it is not overall less regressive. I do not know the answer here but would like to see data. Overall, I do agree as I noted that the sales tax system needs to be brought into the 21st century but starting to do that with taxing clothing does not seem like a politically smart first step and it certainly not necessarily a great revenue generator compared to taxes on other services.

Politics

Sometimes what the people want and what they don't want are conflicting. If we want roads without potholes, bridges that don't collapse, to decrease traffic congestion, make sure children are fed and given medical treatment, make sure the working poor aren't living on the streets, then we must find a way to pay for it. If it upsets soccer moms to pay a little extra on their Abercrombie clothing rather than some shirts from Target, it's just a little bit too bad. The overall result of making the system work might be that political parties get turned on their ears. However, it's my point of view that a position in government is about governing, not making sure you get re-elected.