The General Assembly’s Joint Finance Committee on Tax Reform has focused almost exclusively on reforming North Carolina’s sales tax. Primarily this has meant extending the current sales tax, which applies only to goods, to services including haircuts and lawn and automotive care.
To reduce the burden on taxpayers and, more likely, to make the change politically palatable, the base broadening may be coupled with a rate cut. It is easier to raise revenues on a broader base than on a smaller one. When the purchases of both goods and services, as opposed to only goods, are taxed, a much smaller rate increase would be required to bring in the same added revenue.
As Michael Mazerov from the Washington, D.C.-based Center for Budget and Policy Priorities testified before the committee: “There is enormous revenue-raising potential in the sales taxation of services.” Mazerov claimed that North Carolina could raise an additional $1.5 billion a year by extending the current sales tax to services purchased by households. For those who are concerned that the size and scope of state government is already too large, this approach to tax reform should be alarming. It is a recipe for increasing taxes in the long run and expanding an already bloated state government.
This does not mean that sales tax reform should be abandoned. Indeed, sales tax changes that eliminate double taxation and that are neutral with respect to consumer choices — appropriate goals of tax reform — would include the taxation of services. But they must go well beyond this.
The tax treatment of goods and services is riddled with unfairness and special penalties. For example, most people are actually double-taxed on the products they purchase. This is because both business-to-consumer and business-to-business sales are taxed.
For example, if someone goes into a drug store and buys a bottle of shampoo, that person pays state and local sales tax on the price of the purchase. But the drug store has also paid a sales tax on all of the products and equipment that went into providing the shampoo to the customer, i.e., the cash register, the shelving in the store, the credit-card equipment, etc. The cost of these items, including the sales tax, is embedded in the price of the shampoo. Therefore the customer, in paying sales tax on the shampoo, is being taxed on taxes already paid. Hence, the shampoo to the customer is double-taxed.
Furthermore, there are many goods and even services that are taxed at extraordinary rates. While the sales tax rate in North Carolina is 5.75 percent (plus another 2 percent in most localities), movies and other entertainment, alcoholic beverages, tobacco products, hotel rooms, and rental cars are all taxed at higher rates.
In a free society the purpose of a tax system is simply to raise money for the operations of government. It should not be used to punish activities that are disfavored by politicians or to reward activities that politicians consider virtuous. Indeed, principles of both justice and economic efficiency would suggest that the tax system should be neutral with respect to people’s freely made choices.
Yes, both goods and services should be taxed. But they should all be taxed only once and at the same rate. This means that sales taxes on all business-to-business sales should be abolished along with all differential excise taxes on tobacco, alcohol, entertainment, etc.
Considerations of tax reform should start with first principles. And in a free society those first principles are individual liberty and the right of each person to dispose of his or her income as he or she sees fit.
Dr. Roy Cordato is vice president for research and resident scholar at the John Locke Foundation.