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Service taxes go stateside: associations face a new threat.

Associations face a new threat.

The pros and cons of service taxes have sparked much debate in state legislatures, and while only a few states have taken the fiscal plunge and imposed new taxes, many are keeping the option open. Considerable budget pressures resulting from the recession, coupled with the shift from a manufacturing to a service-based economy, have left service organizations vulnerable to taxation as states search for alternative ways to balance their budgets.

Consider the following:

* A poll of state fiscal officers by the National Conference of State Legislatures, Denver, reverals that general revenue collections are more than 1 percent below the level on which fiscal 1991 appropriations were based in half the states, and are more than 5 percent below that level in 11 states. Most state fiscal officers expect the situation to continue to deteriorate in 1992.

* The costs of state programs such as medicaid, aid to families with dependent children, education, and costs associated with public safety (such as maintenance of prisons) have escalated.

* The economic downturn means reduced consumer spending and increased unemployment, which lead to a reduction in the amount of revenue produced by existing taxes and opposition to raising such other assessments as income taxes.

Within such an environment exists a service sector that has expanded significantly during the past several years. A report by the Federation of Tax Administrators notes that in October 1986, for the first time, services constituted a greater proportion of U.S. gross national product than the tangible goods sector. The report also notes that during the 1980s purchases of services grew from 47 percent of total personal-consumption expenditures to more than 53 percent. The expanding service sector is viewed by some as a ready source of substantial tax revenue.

Service tax rationale

A tax on services is like a sales tax, because it is a tax on consumption. And the idea of a sales tax, a fixture of tax policy in most states for decades, is hardly new. In addition, although only a few states currently have a broad tax on nearly all services (namely South Dakota, New Mexico, and West Virginia, which tax more than 100 services), most states levy a tax on at least some services, such as rental of public accommodations.

Proponents cite a number of reasons for taxing services. Citizens demand spending for programs, and the revenue must be found somewhere. Proponents view a broad-based service tax as good public policy, because it would require a healthy and growing sector to pay part of the cost, thus bringing greater "fairness" to the tax system.

In addition, a service tax may help keep other tax rates lower. When faced with budget pressure, legislatures that want to maintain existing services must either broaden the tax base or increase rates for other taxes such as income tax or the sales tax on tangible goods. Often, these are politically unacceptable.

Taxing impact

Service taxes affect associations as well as the individuals and firms that comprise their memberships. Taxes placed on items paid to the association (such as dues) or services provided by the association (such as educational programs) directly affect the cost of doing business. Even if the cost is not directly passed on to the member, the association may suffer an increase in overhead by hiring additional staff to ensure compliance with the new tax, and it may not be possible to absorb the additional expense without raising prices. Moreover, associations also purchase services, and expenses such as legal fees, data processing, and consulting services may increase with the implementation of a service tax.

The cost of doing business will be disproportionately increased for smaller associations. If associations can provide necessities such as legal services in-house, they will incur no extra costs. However, small associations often do not have the luxury or capability of hiring or using their own staff to provide needed services.

The increased costs could result in decreased membership. Dues could increase without any commensurate increase in benefits. Fees for services such as association-provided seminars or educational programs could increase, and new fees might be imposed on members for services, such as research, that previously were provided at no charge. The higher costs could make membership less attractive or prompt reduced use of association services.

Recent activity

Service taxes may be imposed piecemeal by enacting a broad service tax or through a gross receipts tax. A piecemeal tax proposal takes the form of a bill that applies to specific services (such as legal, accounting, or data processing), or eliminates certain sales tax exemptions. Similarly, broad-based service tax proposals might add the words or services to the state's sales tax on goods, or simply eliminate all of the exemptions in the state's existing sales tax law. Another form that in effect taxes service providers is a gross receipts tax on the income of all businesses-which could include service providers, goods providers, professionals, and associations.

One of the best examples of the pitfalls of a service tax occurred in 1987 when Florida's proposal to extend its tax on services was repealed six months after its enactment. A broad coalition of service providers, including associations, the media, advertisers, and licensed professionals opposed the tax, which was also unpopular with the public at large. Many people felt the state's department of revenue rules were too complex, and the tax placed Florida businesses at a competitive disadvantage. The Florida Institute of Certified Public Accountants, Tallahassee, launched a public education effort by adding a line to service providers' bills that reflected the projected additional cost of the service tax. The information successfully raised consumer interest and helped defeat the tax.

More recently, Massachusetts passed a broad service tax in 1990. A coalition including 20 groups-among them, the Boston-based Massachusetts Society of Certified Public Accountants, Associated Industries of Massachusetts, and Greater Boston Chamber of Commerce-opposed the tax. Efforts included grass-roots activities, meetings with legislators, public education initiatives, and litigation challenging the constitutionality of the tax.

Although the tax eventually passed, the final bill included exemptions for professional services below a certain monetary threshold. After passage, the effective date was delayed, giving the newly elected governor several months to carry out his campaign promise to eliminate the service tax. Two days after the tax went into effect, it was repealed.

In 1990 service tax proposals surfaced in New York and Washington, D.C. The New York State Society of Certified Public Accountants, New York City, and the District of Columbia Institute of Certified Public Accountants actively opposed those efforts. The D.C. CPAs formed an antitax coalition including the District of Columbia Bar, law and accounting firms, and the Greater Washington Society of Association Executives.

During the 1991 legislative session, more than 15 states considered proposals that would impose or increase a gross receipts tax or place a sales tax on services. In some states, the proposals passed and are being implemented. In addition to the imposition of service taxes in other states, Nevada passed a business privilege tax based on the average number of employees.

Final budget bills in Connecticut and Pennsylvania contained sections that imposed sales taxes on varied services, but several professional services were exempt. Connecticut lowered its sales tax from 8 percent to 6 percent but extended it to a broader range of services.

During the current legislative session, states in every region are expected to propose legislation that will contain service, gross receipts, or business privilege taxes. For example, at press time the District of Columbia was considering two professional licensing fee proposals. Service tax legislation is also pending in several states, including Maryland and Florida. Tennessee recently passed legislation that will impose an annual $200 fee on the licensees of professionals registered in the state in lieu of a general service tax, and a service tax proposal passed in Iowa.

Attacking a service tax

Associations can use a number of arguments to oppose service tax proposals. Service taxes are frequently criticized as regressive, because they are imposed at the same rate on all consumers regardless of income, thus having a greater impact on low-income people. For example, a state may impose a tax on coin laundries. Wealthy or middle-income people may be more likely to own washers and dryers, but less wealthy people may be more likely to use laundromats. And just as less wealthy individuals may purchase rather than own certain services, associations-particularly small ones-must sometimes contract out for services.

Another problem is the administrative work that service taxes entail. New taxes require thousands of associations and businesses to register with a state's department of revenue. In addition, service taxes may raise difficulties as to valuation and taxable location for services, particularly professional services. For example, what value and apportionment should be placed on an audit of a branch office in one state of an organization headquartered in another state? What is the location of a service provided by an association for a member in another state, particularly if the member calls an association office in one state and is telerred to an office in another

Answering these questions is likely to require larger staffs for revenue departments, thus increasing the cost of government.

Another argument against service taxes that works well is the threat of competition from neighboring states. If one state taxes services, consumers may travel to a nearby state that does not have a service tax and purchase the same services at a reduced cost. Associations and businesses in the taxing state may relocate or shift operations to another state in order to reduce operating costs. Both results would benefit neighboring states and be counterproductive for the taxing state. In addition, associations, businesses, and entrepreneurs might be less likely to relocate to the taxing state.

Collection and compliance also pose problems. The state department of revenue would most likely be flooded with inquiries about registration and compliance issues. The costs of answering such inquiries must be balanced against the revenue the tax might produce.

Associations and businesses that want to successfully oppose a service tax proposal need to educate legislators and the public about the adverse consequences of service tax proposals.

The American Institute of Certified Public Accountants, Washington, D.C., assists state CPA societies in opposing proposals to tax services. In 1991 AICPA sponsored a seminar that provided background on service tax issues for state society executive directors. Participants learned about the experiences of states that had recently faced service tax proposals, compared notes on successful strategies, and discussed coalition building, grass-roots efforts, and arguments opposing service taxes.

AICPA has also helped draft testimony and public-information brochures, and disseminated information among state societies. Tactics that have proved successful for state CPA societies include press releases, publications, and media exposure through interviews of state society leadership.

Coalitions are another means of achieving success. For example, a coalition formed in Kansas-Kansans For Tax Free Services-included the state society of CPAs, independent insurance agents, auctioneers, the bar association, consulting engineers, architects, advertisers, and broadcasters. Legislators find it difficult, if not impossible, to ignore such broad and influential coalitions.

Similarly, grass-roots opposition can be very effective. Legislators are more likely to respond favorably if approached by constituents who are neighbors, members of the legislators' congregations, small-business people from the community, or others with whom legislators have long-term relationships of trust.

A broad-based campaign that includes all these elements can achieve success. It is significant that Florida and Massachusetcs, the two states that recently imposed taxes on professional services, found it necessary to repeal those taxes soon after they were enacted, in large part because of the reasonable and persuasive policy argumencs opposing the taxes.

Because numerous groups across the association and business spectrum, as well as consumers, are adversely affected by service taxes, there is ready-made coalition and grass-roots support available. With early action, service tax proposals can be defeated.
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Author:Webb, Virgil W.
Publication:Association Management
Date:May 1, 1992
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