Minnesota eyes long-ignored sales tax on services

Nearly 46 years ago, Virginia City Council member Edwin Hoff warned the News Tribune readership about what he called a “nuisance tax” being debated in the state Legislature in 1967.

“A sales tax is next to impossible to repeal once it is in effect,” Hoff implored in a letter to the editor. “I know of no state that has lowered the percentage rate of a sales tax. Most states have raised the percentage rate, some as high as 5 percent.”

Hoff, who would later be elected to the Legislature, was right. The state Legislature, after a historic debate, passed a 3 percent sales tax that spring, overriding Gov. Harold LaVander’s veto. It made Minnesota the 44th and one of the final states to enact such a tax. Today the rate is 6.875 percent.

Hoff, who died in 2007, also deplored the regressive nature of the tax because it applied to everyone, no matter their income. The poor would end up spending a greater portion of their income on the sales tax than the rich, he said.

Rising rates and diminishing returns, along with the regressive nature of the tax, are part of what is driving the current debate surrounding Gov. Mark Dayton’s proposal to drop the sales tax rate to 5.5 percent while broadening the base of what is taxed.

Back in 1967, the new sales tax exempted food prepared at home, fuel, drugs and clothing, considered basic necessities. But it also exempted most services because many people felt that taxing services was like taxing work.

At the time, tangible goods accounted for 60 percent of personal consumption for Minnesotans. But over the years, services have taken over, pushing goods to under 40 percent, meaning there is less of a base to gather taxes from.

It all means that today’s sales tax does not collect as much as it could, and the tax rate has been raised over the years to help it hold up its corner of the so-called three-legged stool of Minnesota taxes on sales, income and property.

Dayton’s proposal, much like the reasoning in 1967, is to use some of the new sales tax revenue to give property owners a break — in this case, a $500 property tax rebate. The 1967 bill dropped property taxes by 35 percent. The package also came with sweeping local and school funding measures. It set the stage for the further tax distribution reform in the early 1970s known as the “Minnesota Miracle.”

Resigned reaction

In introducing his budget last month, Dayton said he wanted to be bold in fixing the volatility of state taxing and spending. The sales tax proposal has been criticized in St. Paul as a $2 billion tax increase, but on the streets of Duluth some business owners say they are OK with the reform.

“I’m kind of pro-tax,” said Adeline Wright from the hair salon she owns on Ninth Street in Duluth. “We’ve been stuck for such a long time.”

Wright’s business of hair care and other personal services, called Adeline’s, is one of those targeted in Dayton’s budget, along with auto repair, veterinarian, legal, accounting and taxi service. Clothing items costing more than $100 were also on the list for new taxes.

Wright said she’s known her service would get on the sales tax list one time or another. She chose to look at one bright side. “It’ll bring more money into the city.”

Duluth stands to make nearly $8 million more in taxes a year if its 1 percent tax is applied to a broader range of sales.

“My contribution would be significant,” Wright said, and she’s OK with that. “I feel good about it.”

Greg Hansen, owner of Hansen House Company in Duluth, said accountants across the state have known a tax on their services would be coming up. He said accounting and business consulting advocacy groups will fight any proposed tax.

He said it’s too early in the budget process to fret too much. He’s banking on much of Dayton’s proposal to die on the Legislative vine.

“Tell me what’s going to pass, and then I’ll have an opinion,” Hansen said.

“We’re just the bank for it,” Gary Lofald said of potential new taxes on labor services at his Fourth Street Auto Repair in Duluth. “The poor consumer will feel it.”

Lofald has seen many of the products he sells come under a sales tax — trailer hitches and bug shields — to little customer complaint.

“With taxes it kind of creeps in everywhere,” he said.

“It doesn’t shock me that it’s on the table,” said veterinarian Paul Fitzgerald at the Airport Animal Hospital in Hermantown.

Any new tax will pinch his customers and also his own costs. Fitzgerald worries about taxes on business-to-business services he uses, like accounting and legal work, eroding his bottom line.

“It’s a balancing act in staying profitable,” he said.

Like others, Fitzgerald will look for further scrutiny of Dayton’s plan and more details and alternatives to emerge.

Bob Maclean, owner of Northern Business Solutions in western Duluth, said he wouldn’t see a big retail effect with the tax on the sale of business forms to other businesses. Most of his items are already taxed.

Maclean, a former president of the Lincoln Park Business Group, said “I feel bad for my brothers in the clothing business or auto repair.”

But he did call the lowering of the rate to correspond with spreading the base a “fair and equitable” bargain.

Unbalanced approach

In 1967, there were a handful of exempt categories, based mostly on the agreement to not tax items deemed as necessities. Today those breaks number in the hundreds, neutralizing any additions to the tax base in the past 46 years.

It’s a problem economists have been warning governments about for more than 20 years.

“There’s a reason we have such a high (sales tax) rate,” state Revenue Commissioner Myron Frans told the News Tribune last week. Minnesota sits behind just six states that have higher rates, none of them in the Midwest. “We have too many exceptions.”

The Citizen League was an influential force in 1967. It marshaled tax studies and gave reports to the Legislature to consider. The League’s stance today remains the same as then, and economists agree.

“Those who receive an exemption or deduction think of that particular tax expenditure as a tax cut, but the real impact of certain items and activities receiving exemptions from taxes is to raise taxes on everyone who does not benefit from the exemption,” a League statement from January reads.

In its 1967 proposal, the League asked the Legislature to create a broad base, wider than any other state, to support the sales tax. It recommended exemptions only on housing payments, rent, educational costs and medical services. It recommended a break on the first $600 spent by those with qualifying low incomes as a way to get around a tax on food and non-luxury clothing.

Dayton’s proposal seems to satisfy the League’s recommendations and those of economists across the country.

“It’s the way that states need to go,” said Michael Mazerov is a senior fellow with the Washington D.C.-based Center on Budget and Policy Priorities and an expert on state fiscal policies. “The governor should be commended.”

It’s possible to get the change done, he said, citing recent examples in New Jersey, Iowa, Texas and Connecticut.

“You want to right what’s wrong,” Mazerov said. “Expand as broadly as you can.”

He said changes in other states were “not terrible controversies.” The key is to stress the lower rate and everyone paying a fair share.

Mazerov asked why a treadmill purchase is taxed but a person choosing to pay to go to a health club isn’t.

“It’s possible to go out and sell this in terms of fairness,” he said.

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