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Tax experts, economists say Dayton’s business sales tax is a bad idea

Most tax policy experts would endorse — at least in concept — DFL Gov. Mark Dayton’s proposal to expand Minnesota’s sales tax to clothing and consumer services, and lower the tax rate from 6.875 percent to 5.5 percent.

Broadening the sales tax base would modernize the tax code to reflect our service-oriented economy, stabilize the sales tax as a source of revenue and reduce the inequities that result from the current law — taxing products, but not services that fulfill similar needs.

“Generally speaking, the broader the tax base and the lower the rate, the better off you are,” says Mark Haveman, executive director of the Minnesota Center for Fiscal Excellence (formerly the Minnesota Taxpayers Association).

But Haveman and other tax policy wonks strongly question the wisdom of Dayton’s plan to extend the sales tax to business-to-business services, including accounting, advertising, architecture, computer, design, employment, engineering, legal, management consulting and business support services.

“It is very rare when all economists agree,” says John Spry, a professor of business economics at the University of St. Thomas and an expert on state tax policy. “But I am still trying to find an economist who studies this area who thinks taxing business-to-business services is a good idea.”

Not surprisingly, leaders of the business community have strongly opposed the proposal, saying it would make Minnesota products and services less competitive and drive jobs out of the state.

“The business-to-business tax doesn’t make sense for economic reasons, for fairness reasons or for practical reasons,” says Bill Blazar, senior vice president of the Minnesota Chamber of Commerce. “There’s nothing progressive about it.”

Proposal ‘clarified’

Late last week, top aides to the governor attempted to “clarify” the proposal, saying it never was intended to apply to services performed by Minnesota firms that are “delivered to another state.” This had gone unmentioned by Dayton’s revenue commissioner, Myron Frans, during nearly four hours of testimony before the House and Senate tax committees.

Source: Research Department of the Minnesota House of Representatives

Frans told lawmakers that the governor was proposing to extend the sales tax to business-to-business services, as well as consumer services, as a matter of fairness. “If I as a consumer am paying taxes on legal and accounting services, why shouldn’t businesses do the same?” he asked.

The commissioner also dismissed concerns that the proposal would cost Minnesota jobs.  “Gov. Dayton often says, ‘We’ve been hearing for 30 years that businesses are going to leave.’ Well, Minnesota is here. We have a thriving business economy. We’ve got great businesses. We have not seen evidence that [business] flight occurs when these kinds of changes are made.”

Dayton also seized upon the proposal because it is a lucrative source of new revenue. It appears that about three-fourths of the $2 billion in new revenue from the sales tax expansion is generated by the tax on business-to-business services, based on administration budget documents. The Revenue Department did not respond to a request for the specific revenue estimates and other information.

Economists and tax policy experts object to the idea of taxing business-to-business services for multiple reasons, chief among them that it results in “tax pyramiding.”

Laura Kalambokidis
Laura Kalambokidis

“If there’s a product or service that has multiple stages of production, when taxes are applied in stages, then you are applying a tax on top of a tax,” explains Laura Kalambokidis, a University of Minnesota economics professor and tax expert.

Kalambokidis says the classic example is “the baker who buys the flour, pays a tax on it, and then sells the bread to the consumer. Then you apply the tax on the sale to the consumer, so it ‘pyramids.’ It’s building so that you have 5.5 percent or whatever on the inputs. That then gets baked into the price of the good. The more stages of production, the more time it happens if every input is taxed.”

As a result, critics say, such proposals unfairly tax some products and services more than others by imposing varying levels of taxes on business inputs as well as the general sales tax on the final product.

A related problem is that the tax is not transparent to the taxpayer, one of the key principles of sound tax policy espoused by groups such as the Tax Foundation, nonpartisan tax research group based in Washington, D.C.

“It’s a bad tax — it’s a hidden tax,” says Arthur Rolnick, an economist and former senior vice president of research for the Federal Reserve Bank of Minneapolis. “It’s going to end up distorting business decisions.”

Tax, not business, decisions

Both Spry and Kalambokidis echoed these criticisms, saying the tax could result in businesses making decisions for purely tax reasons and not sound business reasons.

“A business that uses a lot of legal services and usually purchases those services outside of their own firm might just decide they will hire lawyers and bring that in-house,” says Kalambokidis. “They might be making that decision because of the tax consequences, and not because that is the best choice for their business. That is one of the inefficiencies that could arise.”

The business-to-business tax could be particularly hard on small businesses, which may have no option other than to contract for accounting, legal, payroll and other services.

The state also could have problems administering and enforcing the tax, particularly when it comes to collecting it on the purchase of services by Minnesota businesses from firms located out of state. In cases where the supplier of the service does not have a Minnesota presence, the Minnesota buyer would be required to report the transaction and pay a “use” tax equal to the state sales tax.

Large Minnesota businesses with offices in other states could respond by relocating certain functions to other states or contracting for services out of offices located elsewhere.

Spry envisions the Revenue Department “sending use tax auditors into businesses in Minnesota and saying, ‘We’d like to see all of your legal bills or engineering bills or services bills.’ How successful they will be in collecting the use tax is kind of hard to say.” 

He also suspects the state would need “a whole series of court cases” to delineate how the tax would be applied. “It boggles the mind.”

Finally, studies suggest that the business-to-business sales tax would fall most heavily on lower income residents, making the state’s tax system more regressive. That’s the opposite of the goal being pursued by the governor, who is proposing to raise income taxes on the top 2 percent of wage earners and make the tax system more progressive.

Incidence of 2008 taxes imposed on businesses, by population decile

rate of business tax paid per income decile
Source: Minnesota Center for Fiscal Excellence
Studies suggest that the business-to-business sales tax would make the state’s tax system more regressive.

Every two years, Revenue Department researchers conduct what they call a "tax  incidence study," showing how the burden of all state and local taxes is distributed among all income groups. The study includes business taxes passed along by businesses and indirectly paid by consumers.

The most recent study, completed in 2011 for taxes paid in 2008, found that Minnesota’s three major taxes — income, sales and property — were increasing progressive from the second decile until the top decile of taxpayers, where the tax burden dipped from 8.3 percent of income to 7.8 percent of income. (A new incidence study is expected to be released in March.)

However, if you look just at business taxes paid by individual taxpayers, the story is just the opposite. The burden falls from 15.3 percent for the lowest decile of wage earners to just 1.8 percent for the top decile.

“Business taxes are the primary reason for regressivity in Minnesota’s tax system,” Haveman says. If Dayton’s business-to-business sales tax is approved, he says, future incidence studies “very likely again will suggest that the wealthy are not paying their ‘fair share’” — even after the income tax increase on the top 2 percent.

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Comments (34)

The real rate is 7.125%

The real sales tax rate is 7.125% in the metro area not the 6.875% claimed in the article.

Either way it is already high and I applaud the writer to help her audience understand the simple fact that MN does in fact compete with neighboring states. I might add that MN must also compete with zero income tax states such as Florida, Texas, South Dakota, Nevada, Alaska and Washington.

I just made this using public data. Use at your own risk.*

Mike: Your comment deserves clarification on local rates.

To reiterate from below: the rates in the 7-county metro are 6.875% (Scott & Carver), 7.125% (Ano, Dak, Rams, and Wash), 7.275% (Henn), 7.625% (St Paul) and 7.775% (Mpls). There are roughly 30 general local rates throughout the state and a host of other special rates.

Here is a public sector solution provided by the Minnesota Department of Revenue, a Sales & Use Tax Calculator: http://www.revenue.state.mn.us/businesses/sut/Pages/SalesTaxCalculator.aspx

The data that drives this calculator is available as public data at this link (http://www.revenue.state.mn.us/businesses/sut/Pages/streamlined_sales_ta...) as the separate "Rates & Boundaries" files as required by the Streamlined Sales & Use Tax Agreement per M.S. 297A.99 Subd. 10 which you can find on the Revisor of Statutes website:

"Subd. 10. Use of zip code in determining location of sale. The lowest combined tax
rate imposed in the zip code area applies if the area includes more than one tax rate in any
level of taxing jurisdictions. If a nine-digit zip code designation is not available for a street
address or if a seller is unable to determine the nine-digit zip code designation of a purchaser
after exercising due diligence to determine the designation, the seller may apply the rate for the
five-digit zip code area. For the purposes of this subdivision, there is a rebuttable presumption
that a seller has exercised due diligence if the seller has attempted to determine the nine-digit
zip code designation by utilizing software approved by the governing board that makes this
designation from the street address and the five-digit zip code of the purchaser. Notwithstanding
subdivision 13, this subdivision applies to all local sales taxes without regard to the date of
authorization. This subdivision does not apply when the purchased product is received by the
purchaser at the business location of the seller"

A private sector solution would use this public data and decode it and format it in a more usable format for private business.

I've just accomplished this as a single, private citizen. This type of private activity has the potential to reduce private compliance costs and public administrative and enforcement costs. There are additional steps that can be taken and this is for demonstration purposes only. To all who may use it, please read the disclaimers, heed their warnings and use this document at your own risk.

http://www.futureslog.com/uploads/ZipCodeRatesMN.pdf

I make no claims to to the validity or accuracy of the data herein. I seek no benefit and do this solely for the benefit of the state of Minnesota, but again, use at your own risk.

~Bob

As a self-employed person whose clientele is almost entirely

out-of-state, even overseas, I have not been able to find any information about an important point.

If I run a retail business and sell to an out-of-state customer over the Internet or through a mail order catalog, then there is no sales tax on that purchase. Would the same be true for my sales of translation services to out-of-state and international customers?

If all or most of my customers were in-state, I'd be fine either way, since all my competitors would be paying the same tax. However, I'm in a field with an international market (translation), and there is strong downward pressure on prices already.

To be consistent, sales of both goods and services to out-of-state customers should be subject to the same rules, but I am unable to find any information about this.

Better Headline: "Conservative groups don't like taxes"

Quoting the Chamber of Commerce and Taxpayers League, or whatever they're calling themselves now, saying they don't like the idea of taxes is a "dog bites man" story.

The article may as well have been about the NRA opposing gun restrictions.

New economy employee

As someone who has been self-employed for more than a dozen years, I see the sales tax on professional services as putting a burden on folks who, after being layed off from a corporate job, put out their own entrepreneurial shingle and sell their time.

I just see it as a extra 5% income tax on my work. Not quite fair when compared to people who work for wages. Seems that tax fairness would mean that people who are selling their time, employees or consultants, should be treated equally.

Ginny

Has anyone EVER heard of or read of a proposed income tax that was welcomed by the ones it affected? Especially business, which speaks louder than most of us.
Frans says it never was intended to apply to services performed by Minnesota firms that are “delivered to another state.” Unless I'm reading this wrong, state-to-state business would not be affected. If so, a couple of the statements and quotes in this article are inaccurate.

Alternative "Plan C: Higher Sales tax (7.0%).

No one is talking about a higher sales tax, I think that is a mistake. This alternative should be strongly considered. The common wisdom as Mark Haveman says is "lower rate and broader base".

Here's my take: I don't buy all this fuss about the need for a lower rate. Why? The current tax on "tangible personal property" is basically for physical items used in the state. The difference in margins of the nearest states where our major populations are, mainly (1) Metro-Wisconsin and (2) Fargo-Moorhead.

Here's a sales tax plan no one is considering:

(1) Increase the rate to 7.0% for simplification. The current rate is an error in oversight related to the legacy amendment. We didn't realize a 3/8 increase would extend the decimal place to the hundred-thousandths place, which is bad for business because a lot of software can't even handle it and it's frankly hard to calculate, especially when you add local rates (Mike D.: the rates in the 7-county metro are 6.875% (Scott & Carver), 7.125% (Ano, Dak, Rams, and Wash), 7.275% (Henn), 7.625% (St Paul) and 7.775% (Mpls)

(2) Increase the base by adding select consumer services to supplement things like lawn/garden care (FS 121), laundry (FS 120), massages (162) building cleaning and maintenance (FS 112).

Let's add these basic consumer services:
(a) hair and skin care services
(b) entertainment services
(c) vet services
(d) taxis
(e) other personal services

The added benefit is that a lot of these are "cash" jobs where it's easy for sellers to hide income, so it will support income tax enforcement through sales tax remittance and enforcement.

(3) Increase the statewide liquor tax from 2.5% to 3.0% AND allow liquor to be sold on Sundays. People pay to drink pure and simple and they do it every day. Once again, simplify the rate and take our revenue back from Wisconsin by allowing liquor sales on Sunday.

(4) Allow gay marriage because I guarantee you: a lot of gays will have expensive weddings, deservedly and they will spend money in this state that is taxed and create jobs.

(5) Optional: Legalize marijuana and tax the hell out of it. Like liquor, people smoke it and would love to pay a ton of tax on it. Right now, most pot-smokers who smoke more than what I understand to be a standard retail unit of $60/per month (as in >=13 and spend >=$780) are tax evaders because they currently owe use tax on these purchases which exceed the individual purchase threshold of $770.

There you have it: Bob's "Alternative Sales Tax Plan". Who's with me?

(A) Better Social Policies
(B) A more 21st century base that includes discretionary consumer services
(C) Higher Revenue
(D) Easier compliance for sellers and purchasers
and
(E) More efficient administration for the state that probably could not accommodate the base increase as proposed by the Governor in terms of either education/outreach or audit/enforcement.
(F) Is for freedom: to marry, to imbibe, to purchase, to smoke.

A 7.0% rate IS competitive in the 21st Century, I'd like to see someone argue against that... (Like Minnesotans won't buy the the things they need and the services they use!) Also, (i) Ignore the income tax increases and (ii) reform the ridiculous property tax system according the Property Tax Working Group recommendations.

My humble opinions as a private citizen.

~Bob Helland
onemantaxplan @ gmail.com

(Anyone who says they will go to Wisconsin or North Dakota to buy these type of items ignores (a) the cost of traveling and how inefficient and costly that is (it would kill the savings margin) for these consumer services; and (b) even if you go there and buy tangible personal property and return to the state, you tehcnically owe VARIABLE RATE USE tax for your purchases (the difference between MN and the other state)

Page 14 of the MN Sales & Use Tax Instruction booklet:
Variable-rate purchases
If you bought items in another state and paid sales tax at a rate lower than Minnesota’s rate, you owe the difference between the Minnesota rate and the rate paid to the other state

Follow-up on Income and Property taxes and Sales Tax Bonus

For those who read me as a regressive-taxing "conservative think-tank", consider these points:

(1) If you also read the Property Tax Working Group final report you would concede these two points I am in support of:

(i) By reducing the classifications, you eliminate the class disparity (read: unfairness) for renters by classifying apartments (currently 1.25%) the same as residential homesteads (1.00%). This shifts the property burden back on homeowners and businesses, instead of an effective 25% higher load on top of renters, young people, low-income people and anyone who is nowhere near having equity in their home-ownership. There is no wealth in renting.

(ii) The report calls for an expansion of the EXISTING property tax refund (PTR) program instead of these selective gimmicks like the $500 homeowners rebate whereby the state buys equity in the property of people who are almost by definition more wealthy.

(2) Rather than increase some of the highest income tax, who is talking about lower the rate of the lower brackets. A couple people, but with the reduced burden achieved through the Sales & Use Tax reform I propose above, we could do that without necessitating and increase in higher brackets and reducing the burden on the lower brackets.

(Bonus) Swallow this bitter pill: let's tax Farm Machinery and Capital Equipment at 2% and reduce the insensible Capital Equipment refund claim which adds to administrative costs. Prior to July 1, 2000 Farm Machinery was taxed at 1.0%. We don't live in a 19/20th Century Agrarian economy and most of you do not eat food grown locally in Minnesota. Why so much preferential treatment for Ag? Look past Dodge trucks and Dirty Harry and see that you are giving tax incentive to major corporations who can afford this increase while keeping Minnesota food exports competitive.

Governor Dayton: Please crunch the numbers on these proposals and the initial comment and let's see how balanced our revenue systems are and whether or not they exhibit fairness. They will also be easier to comply with and more efficient to administer.

~Bob Helland

(P.S. I want to run for Governor myself someday.)

I'm not sure about this tax pyramid claim

The factor that seems to be overlooked is final sale price is much higher, it's called a mark-up. I can see that we're double taxing, but why is that a problem? And if we lower the over-all sales tax we're lowering the over-all impact. When I have film and photos processed as a photographer I don't pay the sales tax. I charge the sales tax when "I" sell the photos to my customer.

Let's say I spend $50 processing photos and sell them to my customer for $100. Let's say for the sake of simplicity that the sales tax is 4%. I pay $2.00 sales tax and then charge $4.00 so the total sales tax paid is $6.00 or 6%. We're not paying same sales tax twice so we're not doubling the sales tax. Why is this worse than having a higher sales tax at the final point of sale? By the way, business can deduct the sales taxes they pay so I don't even see why there would be much price pressure.

And the tax incidence studies don't tell us how much business taxes individuals pay, they tell us whet the over-all tax burden is by decile. Individuals don't pay business taxes, businesses pay business taxes. Getting back to my example, I pay the first sales tax, my customer doesn't pay that tax, I'm not charging my customer a higher tax rate to cover my tax expenses. Will I pass the cost along? Maybe maybe not but remember my cost is only $2.00. Some industries have 300% to 400% mark ups so you'd be talking about a dollar or less on a $100 sale even with our actual tax rates.

The book work isn't that complicated either. I don't know, I see these people declaring it a bad idea but I don't see any real explanations as to why beyond the fact that they don't like business taxes. They got VAT taxes in Europe, that seems to work just fine.

It's a Simple Justice Issue

If I have to pay sales tax on the services provided to me by my lawyer as an individual,...

then Honeywell, Best Buy, Medtronic, Boston Scientific, TCF, etc, can blessedly well do the same.

Furthermore, those large corporations can write off those taxes as part of their business expenses,...

something which an individual seeking help with filing routine legal documents, setting up a will, a trust, etc., CAN'T do.

I'd suggest our big business friends and our corporate lawyer friends STOP their WHINING, 'cause they're all just making themselves look like a bunch of 2-year-old crying because mommy and daddy wouldn't let them have that THIRD cookie,...

and protesting loudly that once upon a time, somebody else (auntie, uncle, baby sitter, big brother, grandma, grandpa, Tim Pawlenty, whoever) DID let them have a third cookie and it's NOT FAIR that they aren't getting one now.

Taxing a conundrum

While I DO have a dog in this fight, as does every other Minnesotan, Steve obviously thinks Dayton’s plan is way off base, and there doesn’t seem to be much of an attempt to present the Governor’s purported side of the argument. Dayton’s plan may, in fact, be more regressive, may squash the state’s economic recovery, &c., ad nauseum, but why and how? I don’t see anything in this piece that explains that.

Assuming (I don’t make that assumption, but for the sake of argument) Dayton’s plan is put into place by the legislature relatively unaltered, would that make Minnesota the only state in the nation applying a sales tax for business-to-business transactions for goods and services? I suspect not, but I’m not an economist, and offhand, don’t know how to get at the answer to that and related questions. If other states already tax business-to-business transactions, which states, and which services and business-to-business transactions? What have been the results in those states? Since no tax system is perfect, do the benefits of business and service-related taxes outweigh the negatives – not necessarily for the businesses and services paying the tax directly, but for the affected state and its population as a whole?

It’s hard to argue with “…Generally speaking, the broader the tax base and the lower the rate, the better off you are,” and I wouldn’t attempt it, but the Minnesota Taxpayers Association is rather far removed from being in any sense a reasonable and objective source for information on taxes. As Ross Willits succinctly phrased it, “Conservative groups don’t like taxes.” There may be occasions, and this might be one of them, where that antipathy to taxes in general makes economic and social sense, but there’s no reason for the reading audience to take their opposition at face value. It’s a rare exception when business interests DON’T oppose a tax, whether it’s new, old, graduated, lump sum, or on any other basis.

And, as several others have said in the context of Dayton’s proposal, if you’ve been operating for… decades, even generations… without having to pay those kinds of taxes, no one should be surprised that people and businesses in that situation are very unhappy with the prospect of now having to pay a sales tax that in prior years, decades, generations, didn’t apply to them. The fact that they’re opposed, however, doesn’t automatically confer on their arguments some sort of moral weight. The new tax may, in fact, make the system as a whole more fair than it used to be. Or not. We're only getting one side of the argument here.

Further, in making their arguments against the Dayton budget proposal, I’m not seeing any credible alternatives being offered. We have a $1 billion+ hole to fill in the budget. How do Dayton’s opponents propose to fill it (besides cutting every social program by ‘x’ percent and further starving public schools)? I like literate neighbors, paved roads, infrastructure that works reliably, and other signs and measures of civilization. None of those things are free, and we’ve had ample evidence here and abroad that “cut, cut, cut” is not a path to prosperity.

A more accurate headline would be “Some Tax Experts and Economists Think Dayton’s Business Sales Tax is a Bad Idea.” That might be followed by another piece in which other tax experts and economists could explain why they think it’s NOT a bad idea.

Cut, cut, cut?

2010-2011 spending just under $30 billion
2012-2013 spending of about $34.5 billion
Governor's 2014-2015 proposal just under $38 billion

Someday I hope to see the figures showing which state departments are actually spending less money from one biennium to the next. 2010-2011 spending drop of almost $4 billion doesn't count, that was the evil Pawlenty.

Current Tangible Tax Expenditures and the Problems in B2B Taxes

Ray:

I always like reading your comments.

Here is the starting point where we agree:

"We have a $1 billion+ hole to fill in the budget. …. None of those things are free, and we’ve had ample evidence here and abroad that “cut, cut, cut” is not a path to prosperity."

First, let me address two issues on the sales tax side for "business-to-business service" taxes:

(1) What the governor's Sales & Use Tax Booklet completely ignores (in saying that a consumer sill save money from a reduced rate) is that a $2.6B increase in business services will undoubtedly find it's way as a general increase in consumer price increases. That in addition to "consumer services

(2) Compliance costs: For each dollar ($1) added to the Sales & Use tax base, there is a marginal increase in compliance costs to business: software systems, design and maintenance; legal consultation; accountancy fees; additional staffing and more. I have talked to approximately 25K businesses in the past four years and I know the challenges they face, what works, what doesn't work. Minnesota should strive to be an entrepreneurial hot-spot within a laggin US economy and these type of compliance hurdles are some of the biggest impedances to that happening. What I propose is a 21st century "economy" and that requires a 21st century "tax system". Do you agree with that assessment and ambition?

Now, we need to start talking about tax expenditures. I have raised two very big one's just on the Sales & Use Tax side: Capital Equipment and Farm Machinery. These are two that go right at business that as others say, "write-off" the expenses on the income side for those same equipment. I through out 2% to start the discussion, but what would we gain by fully taxing that equipment, those purchases?

According to the Revenue Department Tax Expenditure report in a 2013-2014 biennium (fiscal years) that would be:

Capital Equipment: $233,900,000 + $251,600,000 = $485,500,000.00
Farm Machinery: $48,600,000 + $49,000,000 = $97,600,000.00
Total: $485,500,000.00 + $97,600,000.00 = $583,100,000.00

On these major equipment purchases alone we are over halfway to the $1.1 Billion and these hit major businesses the way many would like to see

Here are two big targets on the Income Tax side: Charitable Contributions and Home Mortgage Interest Deduction

Charitable Contributions: $178,400,000 + $183,600,000 = $362,000,000.00
Home Mortgage Interest Deduction: $335,400,000 + $329,700,000 = $665,100,000.00
Total: $362,000,000.00 + $665,100,000.00 = $1,027,100,000.00

To cap each of those at 50% of their current levels, we've got another

As a 28 year old "dog in this tax fight", not sure if you use that word also or if you've heard me say it, but I know few of my peers claiming this deduction and I don't understand incentivizing home purchases if people can't outright afford them nor personal contributions to charity: those are personal choices and if you have the income to do it, good for you, but I simply do not.

Also, back to Sales & Use Tax: Clothing along can make up half the difference we seek, and a modest low-income credit of $50-100 (which would cover a family clothing purchases of $750-$1500 on clothes) much, much, much more efficiently than ridiculous $100 price threshold.

Clothing: $322,800,000 + $331,100,000 = $653,900,000.00

There are a lot of untaxed services out there but the problem with those are the nexus requirements and ease of substitution that would send money outside of Minnesota. You cannot substitute clothes, for example, or capital equipment. If you use those in Minnesota you owe tax.

I believe all these service tax projections are a bunch of junk because it is far too easy in the 21st century to "outsource" intangibles and where tangibles. No one knows the effect on (a) consumer prices or (b) business decisions including the cost of compliance, use tax compliance rates (or, efficiency of enforcement) and "outsourcing" of services (c) and so no one can get a realistic target on the revenue effect. We should stick with what we know and those are the numbers I have jut provided.

I think I am proposing the most radical (in terms of different) as well as the most realist reforms. So, have I augmented or reduced our common ground?

Regards,

~Bob Helland

MN Center for Fiscal Excellence

MN Center for Fiscal Excellence is a non-partisan tax think tank. They are research, not ideology, driven. Agree or disagree with them, but they do rely on facts for their analysis and are in that sense both reasonable and objective.

A couple points

Paul - by it's very definition, a VAT (Value Added Tax) can not pyramid because the tax is only applied to the difference between the inputs used and the sale price of the output created. So it is not the same analogy. Unless you believe that business will simply absorb the proposed Business to Business tax into their overhead, it will pyramid as prices are raised accordingly as the tax is passed along.

Ray - 2 professors NOT associated with the Mn Taxpayers Association are quoted in the article. The U of St. Thomas professor was quoted as not being able to find any economist that support it. The U of MN professor talks extensively of the pyramid effect. I think the reason that you are finding very few academics in support is - because they don't support it.

And it is correct - this tax will disproportionately fall on small business who can't afford to have these services provided "in house".

I think the biggest issue is that this tax provides the overwhelming part of the new revenue Dayton seeks. And it's not just a hole that needs to be filled - the budget is actually increasing expenditures rather substantially. The General Fund Budget is proposed at 37.9 Billion Dollars. Our population estimate is 5.4 M people. That's $7000 of spending for every man, women and child in the state. (Not including all the local government spending that comes from local taxes)

Why can't we provide the necessary services in MN for that amount of money? Or, is it that we are spending a lot of money on non essential services that are diverting money from those in need of additional funding? That is the question I want answered before I sign up for more taxes.

Solid points, Tim. Right on.

Just wanted to pitch in and affirm, from my perspective, that you certainly know what you are talking about: on the VAT, the Minnesota Center for Fiscal Excellence (FKA Minnesota Taxpayers Association) and what experts are actually saying and the dearth of those in support, the enormous spending increase (which more and more seems like another Governor Dayton political tactic and "room for compromise" rather than a serious plan), small business decision-making and most importantly, the resultant consumer price increase/pyramid.

On the consumer price increase: Not only does the Governor's administration appear to falter on basic economic understandings (I do have a Bachelor's in Economics if that counts for anything) but they appear also to struggle with Basic Math! See page 14 in the Governor's Sales & Use Tax Booklet from his website's "toolkit" section.

http://www.mn.gov/governor/images/sales_tax_booklet.pdf

Receipt before plan: Total $166.89 with $9.12
Receipt after plan: Total $165.52 with $7.75
Sticker: "You save $1.52"

Actual saving are $1.37 which is less than 1.0% (0.82% to be exact) of the receipt example they came up with and provide to illustrate a point.

That means, that if tax policy experts, economists, the MCFE, Tim Milner and myself are all correct about this and the increased tax burden and compliance costs lead to something near a 0.8% general price increase for Minnesota taxable tangible items representative of basic household purchases: All those savings they "offer" are wiped away. (This is just on the cost of the items they provide, ladies and gents, that does not include your increased costs in other "consumer services".)

(I've been telling them for days now, so it is likely the image will be corrected tomorrow (I would hope!), but that can be a gauge of how responsive and efficient this administration is I suppose.)

~Bob

yep !

Interesting headline to an interesting effort at what might be characterized has someone having their own set of facts. The above piece from Mr Sohoch's entery ..."A more accurate headline would be “Some Tax Experts and Economists Think Dayton’s Business Sales Tax is a Bad Idea.” That might be followed by another piece in which other tax experts and economists could explain why they think it’s NOT a bad idea." In light of the introduction to the article..."Most tax policy experts would endorse — at least in concept — DFL Gov. Mark Dayton’s proposal to expand Minnesota’s sales tax to clothing and consumer services, and lower the tax rate from 6.875 percent to 5.5 percent,"in the author's own words one has to wonder where he is going with his point.
If anything what the Dayton plan has doen is to show just how good business has had it here in Minnesota. The next step is for the Chamber and associates is to pony up.

The collection of taxes is a

The collection of taxes is a means of gathering revenue. Value added and other flat taxes are very good for collecting revenue because they aren't easy to escape (broad base, low rates). They do not, however, punish the wealthy for being wealthy. To do that you need income and property taxes which in turn are worth evading, and less efficient. Inefficient in this case means that as you raise the rates, the amount of money you collect per rate increase goes down as it becomes increasingly worthwhile to pay to avoid those taxes.
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To make a system with flat taxes more 'fair', the benefits derived from those taxes must be spent disproportionately on those most in need, rather than equally on the citizenry. So, for instance, a government provides healthcare free for the poor but charges progressively more for richer people. All of the high tax countries in the world use flat taxes extensively, and strongly direct their benefits to the poor. Lower tax countries such as the United States have some of the most 'progressive' taxes in the world (i.e. the proportion of taxes that come from the wealthy), but dole out benefits universally, which often means that the rich receive the greatest benefits (higher mortgage deductions, more Medicare because they live longer, etc.). So in practice, the US system, with highly progressive tax rates (half the population pays no income tax) and universal benefits, ends up taking money from the rich and the middle class and handing it right back to them, with the poor paying nothing and receiving close to the same. Systems that rely on flat taxes and highly directed benefits, typical of northern Europe, collect more revenue and spend much more on those who most need it, yet the citizenry objects less to the taxes they pay, because the tax base is so broad.
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High rates of taxation of income and profits are far more deleterious to economic output than taxation of consumption, because they discourage innovation and investment, and encourage the hiring of clever tax accountants and lawyers. Crucifying fat cats on a cross of high marginal income tax rates may be terribly satisfying to your overdeveloped sense of moral indignation, but it doesn't raise enough revenue, and it doesn't provide benefits for the poor.
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People like to quote the high marginal income tax rates in the Eisenhower era, but leave out some key facts. Those high rates brought in less in taxes than we bring in now as a fraction of the economy, and paid for far less benefits (no Medicaid, no Medicare) than we do now. What allowed those benefits were flat taxes on income and lower rates on a broader base of income. Move from flat taxes on income to flat taxes on consumption, and direct the benefits to the poor rather than everyone, and you might actually see some social justice in this country. Will that make the rich any richer or poorer? No, but it might put a few tax accountants out of a job. Spend a little more time worrying about how to help the poor, rather than how to punish the rich.

I have asked in several venues

and even written to Dayton's office, and I still have no answer: Would the proposed tax on business services apply to services performed for out-of-state clients?

Somebody must know.

I'm pretty sure this is your answer

From the article:

"Late last week, top aides to the governor attempted to “clarify” the proposal, saying it never was intended to apply to services performed by Minnesota firms that are “delivered to another state.”

Thank you.

I guess I missed that part. Having to add sales tax to services sold out of state would have been extremely awkward, since some of my clients have automated invoicing systems that make no provision for it.

I still don't get it

Greg says:

"If I have to pay sales tax on the services provided to me by my lawyer as an individual,...

then Honeywell, Best Buy, Medtronic, Boston Scientific, TCF, etc, can blessedly well do the same."

Well, that looks like an argument to eliminate the tax deduction for business. Besides, Honeywell has in-house lawyers. I just don't see how or way this is so regressive or unfair? You're lowering the rate for consumers by sharing it with business.

Tim says: "Paul - by it's very definition, a VAT (Value Added Tax) can not pyramid because the tax is only applied to the difference between the inputs used and the sale price of the output created. So it is not the same analogy. Unless you believe that business will simply absorb the proposed Business to Business tax into their overhead, it will pyramid as prices are raised accordingly as the tax is passed along."

Tim, they have the VAT because businesses in Europe PAY sales and service taxes. the VAT is added upon sale or resale AFTER those taxes are paid. VAT is simply a way of compensating for the "double tax" instead of eliminating it. And it works just fine as far as I can tell.

I don't see how you can predict inflation here. Look at my previous example, it all depends what the mark-up is. Nor can you even predict that business will pass the cost along, some will some won't. You know we don't run our businesses based on our taxes, there are a lot other factors. Even if some businesses do pass it along the effect will be nominal in most cases. It looks like over-all consumers will see a 2% decrease in sales taxes (I'm rounding the numbers for the sake of simplicity), so unless businesses raise their prices by more than 2% the effect is nil. Look, if I buy a product for $50.00 my 5% sales tax would $2.50. If re-sell that product for $100 the sales tax would be $5.00. If I pass my $2.50 on to the customer the price would be $107.50, or more precisely $107.62. Well right now with a 7% sales tax the customer's paying $107.00 anyways. You're telling me 62 cents is going to ruin the economy? And if the markup is more than 100% the price to the consumer will actually go down. And if I don't pass the entire cost on to the consumer the price actually goes down.

Maybe it's me but I just can't follow the logic on this. Yes, as a general rule sales taxes are more regressive, but the proposal is to LOWER the sales taxes, how can that make them MORE regressive? Why is it worse for the for the economy for me to pay 62 cents more for something at the cash register than to have a higher income rate or property tax rate?
We're extending the sales so it's more evenly distributed and not confined to consumers AND we're raising income tax on the wealthy. I'm not saying it's a revolution but I don't see how this makes the tax system more regressive when all is said and and done.

Look, we have to raise more revenue. Ventura and the Republicans dumped us into a cycle of never ending crises with ill advised tax cuts and we have to put an end to that. The crises was not created by "big" or inefficient government, it was created by dismantled revenue streams. OK so you don't want to turn the clock back to 1997 but we have to do something else then.

As for economists, remember these are the same guys that assured us that the Great Recession was impossible because a nationwide housing bubble couldn't exist and the markets were self correcting and self regulating. No one could find anyone who saw that coming either.

Richard says: "High rates of taxation of income and profits are far more deleterious to economic output than taxation of consumption, because they discourage innovation and investment, and encourage the hiring of clever tax accountants and lawyers. Crucifying fat cats on a cross of high marginal income tax rates may be terribly satisfying to your overdeveloped sense of moral indignation, but it doesn't raise enough revenue, and it doesn't provide benefits for the poor."

This is pure ideology masquerading as economic law. There is no data to support this assertion and history flat out refutes it. What is a "high" tax? I'd say a 94% or a even a 75% income tax rate is high. Those were the income tax rates for the wealthy until 1985. Gee, we hardly had any growth or innovation after WWII did we? We are now paying historically low taxes and NO ONE is talking about any taxes that could be considered "high". In fact a very strong argument can be made that US growth and innovation has declined along with the tax rates since 1985. Almost all of the technology we're using today was invented prior to 1985 and the so-called business innovations have merely been one bubble after another produced successive waves of corporate crimes sprees. The biggest single financial "innovation" in the last 30 years was the hedge fund- need I say more?

Listen it's called:"tax blindness". This idea that taxes are the only or even a major factor of economic growth or health. The fact is taxes have negligible effects on the over-all economy. Government spending on the other hand can have dramatic effects, and what we've seen in the last 15 years is that spending cuts are more harmful than higher taxes.

Your attitude comes from

Your attitude comes from regarding the collection of taxes as a crusade for righteousness and justice rather than a means of gathering revenue. So please stop with your simplistic ratios and learn something about the realities of taxation and what works in practice.

Tired of the "NO TAXES" Club

Ray and Paul come closest to points I'd make but beyond that for the last 30+ years the no tax, lax regulation, "freedom" coalition have been pushing and we have tried their way. As a result it's been boom or bust. You can actually take a graph of the 30 year period before '29 and overlay it starting about '79 and the results are errily similar.

Unfortunately we did not look at what got us out of that mess and have done the exact opposite and gotten even deeper in the mess for the majority of Americans and we're by continuing the policies that got us here. The resulting inequality is a fast track to third world nation status. We used to occupy the number one spot in all quality of life issues. We now are no better than middle of the pack and frequently at the bottom. I believe the definition of insanity is to keep doing the same thing over and over and expect different results.

So for the no tax, flat tax, some other gimmick tax folks find a place to store it for a while. Let's try something where we have evidence that it has worked. There'll always be another election if it doesn't this time.

We are devolving into the type of country our ancestors escaped from, with all the wealth concentrated at the top, the rights of inheritance keeping it that way, taxes controlled by the corporations and the ruling class, and only levied on the poor..

For those who disagree it might also be a good idea to brush up on your history and the real reason behind the Boston Tea Party

Taxes are not class warfare

Richard says: "Your attitude comes from regarding the collection of taxes as a crusade for righteousness and justice rather than a means of gathering revenue."

Richard, you're the only one talking about class warfare here. The rest of us are talking about fixing the states revenue stream.

These class warfare accusations have become so tiresome. Every time we talk about raising taxes on the wealthy a few percentage points we get this Pavlovian accusation that taxes are a assault on wealth. As if the wealthy don't benefit from the government we're all paying for. As if the money in wealthy bank accounts just materializes there as a product of their superiority rather an extraction from the economy we all provide and participate in. As if a tax on my Photography profits are a violation of all that's decent and right in the world but a tax on my wife's wages are perfectly natural and just. Faith based economics pure and simple. A perverse distortion of economic principles and human nature. Do you really think I'm going to be less creative because I pay sales tax on my film processing? Simply absurd.

We're trying to repair a revenue stream that's been dismantled by faith based economic theories that have clearly failed. This isn't class warfare, it's democracy. I don't know anyone who's trying to "punish" the wealthy, I just want my government back and I'm sick of these never ending budget crises.

Look, history is very clear on this and I've already pointed this out. All the massive tax cuts for the wealthy have produced (and this WAS predicted) is an income disparity that rivals the Gilded Age. This has not produced unrivaled innovation and economic expansion. It produced the Great Recession just as the Gilded Age eventually produce the Great Depression. In fact when taxes were much higher back in the 50s and early 60s we had a contraction in wealth disparity, Kevin Phillips refers to it as the "Great Contraction". The disparity between the rich and the poor in the US reached historic lows. During this period the US saw it's most productive and innovative era in history. The wealthy were not stomped out of existence, they did not suffer untold misery and humiliation. No one was beheaded or served up for brunch. Many Americans including the wealthy look back on this as one of the most idyllic periods of US history.

Getting back to the issue at hand I really am trying to understand this criticism of Dayton's tax plan and it still doesn't make sense to me. The article makes several unsupported declarations and misrepresents a graph from the tax incidence study but there's no "there" there. That is NOT a graph of business taxes, it's a graph of over-all tax burden by decile. I've studied many of Minnesota's tax incidence studies and there is no graph of business taxes by decile, such a graph doesn't even make sense because businesses aren't distributed by decile. Nor is there a study in the 2011 TIS that examines the effect of Dayton's proposal or predicts any rate of inflation caused by Dayton's proposal.

A few years ago I wrote a lengthy blog entry about our tax system, just covering the basics. I invented a small city with only ten people in it and illustrated tax distributions and their effects. The interesting thing is that the numbers for my little city of ten people actually shake out very close to the actual numbers in the TIS for Minnesota. If anyone's interested you can look at Here: http://pudstrand.fatcow.com/blog/?p=8

What am I missing here besides ideology?

The answer to your query is:

The answer to your query is: Efficiency.

Eventually, we will have to enact measures to reduce the deficit. These measures will necessarily have to include higher revenues. Initially, they may be called user fees, offsetting receipts or other euphemisms, but they will raise revenues. Polls show that Americans are not averse to soaking the rich or taxing big businesses. Eventually, these will be enacted as well. After maybe ten years of doing this, Republicans will finally support a VAT as a tax reform, which will be used to undo many of the previously-enacted revenue increases. They will rationalize their support for a VAT on the grounds that they are not raising taxes, but only changing their composition. But in fact it will be a retroactive tax increase.

Personally, I think it would make more sense to avoid a decade of economic and financial pain and do what is necessary today. Conservatives and libertarians tend to oppose a vat on the grounds that it is a “money machine” for the government. I think it may take another ten years before reality finally seeps into the electorate and a conservative can talk realistically about what has to be done without being run out of the Republican Party on a rail.

A 10 percent VAT with a relatively broad base could raise $750 billion a year, enough to pay for about a fifth of the federal budget. This would make room for cuts in other taxes.

A VAT is much less visible than an income tax—individuals don't have to file an annual return for it—so a tax that is paired with income-tax cuts might be surprisingly palatable, especially if it is phased in.

The VAT offers an opportunity to expand the tax base. Politically, it may not be feasible to abolish the most expensive and popular income-tax deductions, such as those for mortgage interest and health care. But the VAT starts fresh with a new base.

Exactly!

We need a money machine for the government. Where did all these people get the idea that they can have a government without paying for it? And how did all these people convince themselves that government is irrelevant?

Two final thoughts

First, Richard and I have agreed on a VAT, now was that so difficult? Someone call the Governor and make it so.

Second, you know that businesses don't simply pass these taxes on to customers because if they did they wouldn't opposing this so much. Obviously businesses are concerned that the tax will cut into their profits, and that wouldn't happen if everyone just passed costs along. Look, we're not concerned how much stuff costs our customers per se, what we worry about is how much we can charge and whether or not it's enough. Some business people just don't want to pay taxes, it's that simple. Any business that couldn't absorb or otherwise cope with this expense probably isn't a viable business anyways, 50% of new businesses fail with 5 years.

This isn't about innovation or motivation, greed doesn't evaporate when you pay taxes and I'm not going to be less creative as a photographer just because I suddenly have to pay sales tax on my processing. It comes back to fairness, we're talking about a huge chunk of commerce that's not being tapped for revenue. Again, why is it more fair for my wife to pay sales tax for her iPhone than it is for me to pay sales tax for the frames I resell to my customers? The VAT works for me.

Response to Paul

Paul,

In response to your comment:

"Any business that couldn't absorb or otherwise cope with this expense probably isn't a viable business anyways"

Passing the 5.5% tax on to your customer may work fine for your photography business, and thus you may not be impacted. However, not all companies will be able to pass this cost on to their customer. Companies who sell advertising services, for example, can't simply pass on the cost because 'advertising' in fundamentally an ROI-driven product. Thus some companies will pay the 5.5% sales tax on all revenue out of their own profits.

A company with 10% profit margins would thus be paying more than half of their profits in sales tax -- or increasing their overall tax burden to the state of MN by 500%. Whether you think this is 'fair' or not, surely you don't expect them to simply accept an increase of this magnitude without fighting for their own self interest.

Actually...

I don't pass my sales taxes on to my customers. No company will absorb the costs unless they can afford to so. This is business, we don't live in a static economic environment, we deal with expenses and fluctuations all the time. No business person is going to convert a 5.5% sales tax into a 50% loss in profits unless they're an idiot. Advertisers will just have to deal with it like everyone else. Advertising is no more of an ROI than any other business expense.

Facts

"Advertising is no more of an ROI than any other business expense."

Absolutely not true for performance-based advertising (lead generation). You cannot make this claim without understanding the industry.

"No business person is going to convert a 5.5% sales tax into a 50% loss in profits unless they're an idiot."

Labeling the business person an idiot doesn't change simple math. I have given you a real-world example in my numerous comments in this article: http://www.minnpost.com/braublog/2013/02/star-tribune-ceo-fights-daytons..., and summarized below.

1. Company sells performance-based advertising

2. Company cannot pass the 5.5% tax on to their customers; pay out of their profits instead

3. Company has 10% profit margins before the tax; thus 55% reduction in profits post-tax

4. Company has 20% profit margins before the tax; thus 27.5% reduction in profits post-tax

Assertions are not facts

And the name of that company is? None of these are 'Facts". Show me the company, I mean an actual company. We can invent models to support our arguments, but you show me the company that's actually going to convert a 5% sales tax into a 50% reduction in profits. You have NOT provided any real world examples using any actually businesses. You keep saying "cannot" as if there's some law of the universe in play here, there isn't. Show us, don't tell us.

My appoligies Daren

I hadn't read Daren's comment on the other thread prior to writing my response. He has in fact graciously offered his own company as an example. I appreciate that.

Governments would be wise to

Governments would be wise to tax retained earnings rather than profits to discourage cash piles. A healthy tax will make cash piles perishable, and encourage their movement