Tax Decoded | Spring 2017
A Tax on Services?
Illinois budget woes set the bar for expanding the tax base.
Keith Staats, JD
Executive Director, Illinois Chamber Tax Institute
Deciphering Today's State & Federal Tax Law
AS I WRITE THIS COLUMN, THERE’S STILL NO SOLUTION TO THE BUDGET IMPASSE IN SPRINGFIELD.
All that seems clear among both Democrats and Republicans is that spending cuts alone will not be enough, and tax increases are therefore inevitable.
Which brings us to the real unanswered questions: Which taxes and how much?
One proposal being floated around is for a tax on services. To understand how this might be possible, we need to understand the current Illinois sales tax system.
Sales Tax in Illinois
What we know as sales tax is actually a complex combination of taxes, including the Retailers’ Occupation Tax (ROT), the Use Tax (UT), the Service Occupation Tax (SOT) and the Service Use Tax—none of which currently tax services. You then need to add to this the various locally imposed retailers’ occupation taxes authorized by state law, and administered and collected by the Illinois Department of Revenue.
The ROT is imposed on persons in the business of selling tangible personal property at retail or to end users, and is measured by the selling price. The UT is complementary to the ROT and was enacted in the early 1950s to end the practice of persons making out-of-state purchases of tangible personal property to avoid sales taxes. Although Illinois has an SOT in name, it doesn’t actually tax services. Instead, it taxes tangible personal property transferred as the result of a sale of service. In fact, the only services Illinois currently taxes (through other tax acts) are telecommunications, hotels and car rentals, among others.
The Source for a Tax on Services
In my estimation, absent of blowing up the current system and starting over, Illinois can’t just amend its existing sales tax (ROT and UT) to tax services. Instead, the State would need to adopt a new tax act or acts.
Similarly, if the General Assembly wishes to grant local units of government authority to tax additional services at the state level, it would have to adopt a whole series of locally imposed service taxes similar to the multiplicity of tax acts that currently grant various local government bodies the authority to impose local taxes.
What we’ve seen so far is the filing of Amendment 3 to Senate Bill 9 (SB 9), the tax component of the Senate’s “Grand Bargain,” which proposes amending the existing sales taxes to tax a number of services, including storage; repair and maintenance; landscaping; laundry and dry-cleaning; private detective, alarm and security; pest control; cable television, video and audio streaming; direct satellite broadcasts; and personal care services, such as manicuring, tattooing, tanning and massage. The bill also grants authority to certain units of local government to impose additional local taxes on taxable services.
I suspect that if the bill is enacted in its current form, it will be challenged under the Illinois Constitution’s “Uniformity Clause,” which provides that, “In any law classifying the subjects or objects of non-property taxes or fees, the classes shall be reasonable and the subjects and objects within each class shall be taxed uniformly. Exemptions, deductions, credits, refunds and other allowances shall be reasonable.” A challenge could be based on the broad issue of why certain services are taxed while others are not. For example, a challenge could address the taxation of storage services and why there’s an exemption for grain storage.
The service tax proposal in SB 9 appears to have its genesis in the results of the Illinois General Assembly’s bipartisan Commission on Government Forecasting and Accountability’s (COGFA) recent study comparing Illinois to surrounding states that do tax services.
The COGFA’s report indicates that Iowa taxes an additional 81 services compared to Illinois, while Indiana taxes eight, Kentucky six, Missouri 11 and Wisconsin 14. The COGFA then estimates the additional state revenues that could be generated by taxing services in Illinois, both at the business- to-business and end-user levels. Following Iowa’s example, for instance, Illinois could generate an additional $1.2B to $2.9B a year. Following Wisconsin’s example, the state could generate an additional $588M to $953M. The latest version of the service tax proposal appears to be a modified and expanded version of services Wisconsin taxes.
In contrast, I recently spoke with COGFA Director Dan Long, who advised that each quarter-percent increase in Illinois’ corporate and personal income tax rates would generate $98M and $925M, respectively, and each one-percent increase in the state sales tax rate would generate $370M.
The current proposal to tax additional services has generated a great deal of controversy and opposition. When you review the numbers, and the push back from the groups subject to expanded taxation, you can see why Illinois has tended to raise income tax rates over expanding the tax base to additional services.
Undoubtedly, adopting some or all of the proposals laid out in SB 9 would make Illinois’ current sales tax system even more complex. However, the only alternative to making the current byzantine system even more byzantine would be to blow it up and begin again. While that might sound appealing, it would be a massive undertaking for both the government and the taxpayer community.