Summary of Joint Meeting of Senate and House Finance Committees

December 1, 2009

Opening Remarks by Finance Chairs-Senator Hoyle-Chaired the meeting.

Expanding Sales Taxation of Services: Options and Issues

Michael Mazerov, Center on Budget and Policy Priorities, Senior Fellow, Center’s State Fiscal Project noted that North Carolina is not alone in taxing few services. Twenty-four of 45 states enacted sales taxes during the 1930’s-1940’s, to offset plunging property taxes during the Depression. States did not include services because services were a much smaller share of the economy, and the tax on services was viewed as a tax on labor and jobs. Most states could improve their sales taxes and their tax systems in general with some expansion of the tax base to include services. Some of the reasons states should expand their taxation of services is to improve horizontal equity (equal tax treatment of similarly situated people), to raise additional revenue, to mitigate long-term erosion of sales tax, to reduce sales tax revenue volatility, to eliminate administrative problems and to improve economic efficiency. There are also drawbacks to expanding the sales tax on services, which may include bringing many new retailers into the system. These new retailers would have to be registered, educated and returns processed and audited. Also, this would increase the possibility of substantial noncompliance by individual sellers of some services (i.e., “off-the-books” by individuals, such as child care, house cleaning, home repair). However, the benefit of taxing services outweighs the drawbacks, since sales tax, primarily based on durable goods, will fall farther and farther behind the growing cost of providing public services. Taxing services will have a significant short-term revenue-raising potential. The services that could be taxed by states include business to business, services to households or both. The recommendation is that taxing services on businesses should be avoided as this often leads to pyramiding (multiple taxing of one item) with possible negative economic, political and distributional effects. A list of household services that could be taxed includes lawn and garden, financial and insurance, personal property rentals, medical and admissions, recreation and travel. North Carolina taxes 30 services out of a possible 168 and is well below the national average. The two approaches for expanding sales tax on services include Comprehensive (all services unless specifically exempt) and Incremental (enumeration of services) and examples of the pros and cons for each were presented. Members were interested in knowing if any comparisons had been done for those states that have used the comprehensive approach during this last recession and how these states were impacted financially.

Taxation of Services:  A Case Study of Other States

Presented by Cindy Avrette, Research Division, and Sandra Johnson, Fiscal Research Division, Prepared by the Finance Team began with a slide presentation that  included information requested by the members from previous meetings. The Federation of Tax Administrators (FTA) has listed over 100 services, divided into 16 categories, with business services, personal services and utilities ranking among the highest. In North Carolina 63 percent of the general revenue is acquired from taxation on utilities. Several slides were presented showing comparisons of selected states charting the state sales tax rate, the combined rate, number of FTA services taxed, and if there was any impact to the rate. Comparisons were also provided for those states that taxed over 100 services, states that taxed between 60-100 and states that have taken recent action such as Maryland, Michigan, and Maine regarding tax reform.  North Carolina and Virginia were among the states receiving a large portion of their revenues from Corporate and Individual taxes.  In conclusion, many states tax more services than North Carolina. Repairs, installation, warranties, amusements and automotive cleaning and maintenance were among those services currently not taxed in our state that are being taxed by other states. States that tax more services tend to have more sales tax stability. It was also noted that North Carolina’s combined tax rate was high for a state that also taxes income, since some of the states with comparable sales tax do not have an income tax or it is smaller in generating revenue than ours.

Senator Phil Berger and Representative Paul Stam requested an opportunity to present a document outlining work they (House and Senate Republican members) had been doing on the tax reform issue. They stated they supported the concept of broadening the tax base, while lowering the rate, but they wanted assurances that tax reform won’t be used to raise additional taxes and that it would create job growth. They suggested two possibilities to prevent tax reform from turning into tax hikes; an amendment to the state constitution limiting the state sales tax to 3 percent and local sales taxes at the same rate, or a requirement that tax hikes can only be passed separately from the budget or other legislation with a two-thirds vote. There were several other conditions outlined in the document provided by the Republican Leadership including proportional representation for the two parties on budget conference committees, zero-based budgeting and a requirement that “off-budget” agency revenue be appropriated by the legislature. Also included was the condition that the Governor’s proposed budget be based on previous year’s tax collections, rather than projected revenues. Also discussed by the members were the amount of lost revenue due to Internet sales ($7-$12 billion by 2011) and the hope for Congressional intervention/legislation to address this issue.

Sales Tax Administration

Eric Wayne, Director, Sales Tax Division, Department of Revenue reviewed the Department of Revenue’s processes and procedure related to sales tax collections. In considering a tax rate increase or taxable base expansion several issues were presented that would have significant impact on the Sales and Use Tax Division of the North Carolina Department of Revenue. The list included taxpayer education, employee education, technology system changes, form redesign, worksheet, affidavits, Streamline Sales Tax Project, budgetary concerns and departmental resources. Mr. Wayne provided information for each category and the affect any changes would have on the 180,000 taxpayers. He requested members consider the time element, cost implications, and personnel for the Department of Revenue, when adopting new legislation regarding tax reform.

Next Meeting: January 14, 2010

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