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The ‘pyramid’ problem with Gov. Dayton’s sales-tax hike

St. Paul Pioneer Press (MN) – Sunday, January 27, 2013

Gov. Mark Dayton wants to tax the sale of food, clothing, and just about everything else you buy in the worst possible way.

His budget proposes a $2.1 billion, or 20.7 percent, sales tax increase.

Since everyone pays sales tax, everyone will pay Dayton’s sales tax increase.

But it’s worse than that.

Dayton’s tax plan violates the basic principles of tax reform.

It intensifies the pain of taxation by imposing hidden taxes on intermediate business purchases. This causes “tax pyramiding,” which is a big mistake.

According to non-partisan legislative researchers, “Standard tax policy principles argue that intermediate business purchases should not be subject to consumption taxation. This follows from the purpose of the tax, to tax consumption, and the principle of horizontal equity — i.e., to tax taxable consumption on an equal basis or only once.”

Dayton’s proposal to tax business services would hurt all Minnesota households by causing the sales tax to apply at several levels of a supply chain.

The same non-partisan researchers explain: “The result of this typically would be to pass the tax along in higher prices at the next level of production (e.g., a manufacturer who sells to a wholesaler). The tax burden ‘pyramids’ or cascades at each level, so that the total burden on the consumer is higher than the statutory or nominal rate.”

For example, a 5.5 percent sales tax on auto repair that pyramids twice would result in an 11 percent effective sales tax rate, but the consumer would only see a 5.5 percent sales tax rate on the receipt. The other part of the sales tax is hidden as higher consumer prices.

Dayton’s tax plan is harmful for small business and the people who will lose their jobs at Minnesota’s small businesses.

Large, vertically integrated businesses will not have to pay sales tax on legal, accounting and other in-house services. Small businesses using independent law firms or CPAs will have to pay sales tax on the same business functions. This inequity violates basic fairness.

It also makes Minnesota’s employers less competitive in a competitive, global economy.

Minnesotans will also lose their jobs to competitors in other states that don’t levy sales taxes on business-to-business services.

Dayton’s sales tax proposal would add more complexity to the tax code. It also would create new administrative and compliance costs. Yet, Gov. Dayton has not addressed how much it would cost to enforce his new business-to-business sales taxes.

Economist Alan Viard also warns, “The tax on inputs pyramids into the price of the final goods in an uneven manner, causing effective tax rates to vary across goods subject to the same statutory tax rate, which can distort consumers’ choices between different goods.”

Dayton’s sales tax proposal would add new sales taxes to the price of food in the grocery. The hidden taxes paid by all of the businesses from the farm to the store will be baked into price of every loaf of bread that you buy, even though food would be nominally exempt from sales tax.

Dayton’s budget creates new hidden taxes throughout the Minnesota economy.

Visible taxes make the tax burden clear so that citizens can compare the costs of taxation to the benefits of government services funded by taxation. Hidden taxes allow elected officials to camouflage the true cost of taxes.

Increases in hidden taxes are an implicit admission that greater spending might not pass a cost/benefit test unless the costs of the higher taxes are camouflaged.

As the Legislature considers the budget, they should ask whether each dollar of spending is worth imposing higher, visible taxes on all of their constituents.