The Once and Future Tax

Kelly at Talking Taxes has some interesting observations about the extension of sales taxes to services. She (he?) points out:

• Taxes on services can have a "layering" effect, with several layers of tax being added to the cost of goods or services by the time they are acquired by the end consumer.

• Some types of businesses (e.g., newer or smaller companies) could be put at a competitive disadvantage because they have to rely on outsourced service providers, while older and larger companies can rely on in-house (and, thus, sales tax exempt) staff to provide the same services.

• There may be a movement of service providers to states that do not tax their services.

To me, this last factor deals a fatal blow to any attempt to tax any services other than those that, by the nature of the service, always have a physical nexus to state where the consumer of the service is located.

Currently, with respect to sales taxes applicable to goods sold to businesses, attempts to make a jurisdictional end-run around the tax are blunted by the application of use taxes. Thus, the business consumer, if it does not pay sales tax, becomes potentially liable to pay a use tax. As a consequence, state tax collectors can usually collect the tax from the seller or the purchaser. (Use taxes are, theoretically at least, also applicable to individual consumer purchases. As a practical matter, however, there is little or no enforcement in this area.)

More importantly, however, the jurisdictional issue throws into question the possible theoretical utility of a national sales tax, the value added tax. One of the allures of value added taxes is that they offer the promise of tamping down domestic consumption, while simultaneously increasing the ability of American businesses to sell abroad. (As in Europe, the VAT would only be applicable to goods that are ultimately sold in the U.S. Thus, it operates as a sort of tariff, with U.S. residents paying more than foreign consumers for goods subject to the VAT.)

Any attempt to impose a VAT-like tax on services turns this policy goal on its head, since service providers in the U.S. would be at a relative disadvantage to foreign service providers when attempting to sell services to U.S. customers. By way of example, neither a VAT nor its state cousin, the sales tax, could be imposed on accounting services provided from Bangalore. The policy hurdles are especially tricky here, since any VAT on services would hobble precisely those sorts of high value services that nations want in order for their economies to remain on the cutting edge.