Tax policy in a service economy

Services now account for over three-fourths of GDP, and the percentage keeps rising. This has dire consequences for states that depend on sales taxes for revenue. The North Carolina General Assembly struggled with this issue last year and was not able to come up with a resolution. States face a simple choice: broaden the tax base to include services and charge a lower, less distortionary rate or continue to raise the tax rate on an ever shrinking base. Yesterday's WSJ reports how various states are addressing this issue. Of course all taxes have some distortionary effects, but lower rates and broader bases are generally regarded as pluses.

NC to start taxing services?

The General Assembly is seriously considering expanding the sales tax to include services, according to the Raleigh News and Observer. From a purely conceptual point of view, this idea makes a certain amount of economic sense. By levying the tax solely on goods, consumers have a government-created incentive to substitute services for goods. Also, services represent a large and growing share of GDP, making it harder and harder for the state to generate a given revenue target from taxes on goods alone.

Some legislators are concerned that the new tax will cover some, but not all, services. Apparently the drafters of the legislation think movie tickets and hair cuts are fair game, but not legal and accounting services. I am having a hard time in seeing the logic here:

Sen. Dan Clodfelter, co-chairman of the Senate committee that deals with taxes, said white-collar professional services were excluded because most of their costs are tied up in health care and real estate, and the higher taxes would raise those industries' costs substantially.

I presume Sen. Clodfelter checked out deadweight loss calculations before he made that statement!