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Tax on services could aid taxpayers, businesses

BY CHELYEN DAVIS

A Virginia group says it has come up with a way the state could reduce many taxes and improve the economy at the same time.

And it could even win support from business groups and local government groups alike, they say.

The Thomas Jefferson Institute for Public Policy—a Virginia-based government policy think tank—on Friday released a study on restructuring the state’s tax system.

It relies on applying the sales tax to many services, all of which are currently exempt from charging a sales tax.

In exchange, the plan would eliminate three taxes hated by the business community: the Business, Professional and Occupational License tax, the merchants’ capital tax and the machinery and tools tax.

Those three taxes are levied at the local level, and not all localities use all three.

The institute’s study says that eliminating those taxes and broadening the sales tax to include services would encourage businesses to expand, and could be done in a “revenue neutral” manner to appease anti-tax politicians.

“Revenue neutral” generally means that a tax reform plan is a wash, in terms of tax revenue generated, at the time it’s implemented—tax increases are offset by tax reductions. Such plans are generally expected to increase revenue in the future, however.

According to the institute’s study, if Virginia taxed most services and cut out those three business taxes, it could also reduce the sales tax overall, or eliminate income taxes for the lowest-income Virginians, and still see additional revenue in the future as well as economic benefits.

Part of the study, done by Richmond economist Christine Chmura of Chmura Economics and Analytics, showed that if all of Virginia’s sales tax exemptions were removed, the state could drop the sales tax to 1 percent and still collect about the same amount of revenue as it does under the current sales, BPOL, machinery and tools, and merchants’ capital taxes.

If the state taxed services but still exempted business-to-business transactions, the sales tax could be reduced to 1.6 percent to collect the same revenue.

The institute study proposes to leave some services, such as health care services, exempt from sales tax.

Chmura reported that the BPOL, machinery and tools, and merchants’ capital taxes bring in about $834 million, largely from the BPOL tax.

Those are local taxes, and localities would need to receive more sales tax from the state—assuming the elimination of those taxes went hand-in-hand with eliminating state tax preferences such as the exemption for services—to cover the loss.

Chmura’s report says that while the state currently splits sales tax with localities on an 80–20 basis, that 20 percent wouldn’t be enough to make up the loss for localities that had high rates for the three business taxes, and the state would probably have to develop a new formula for remitting more sales tax to make it fair. Some localities don’t levy any of the three business taxes.

Last year, the Joint Legislative Audit and Review Committee studied Virginia’s tax preferences. Its report said that Virginia exempts 150 of 168 typical services—including amusement parks, haircuts, legal services, advertising and consulting services, and more—from sales tax.

The decision not to tax most services was made in the 1960s. At that time most states did not tax services, and services were a small part of the overall economy.

Now services are two-thirds of the economy and growing, according to the study.

If Virginia taxed those services, it would bring in about $3.5 billion in additional sales-tax revenue, according to the JLARC report.

The institute’s report lays out a number of different scenarios—taxing all services, exempting some services, and so on—and found that all would be likely to improve the economy.

If the state eliminated the three business taxes, and applied the sales tax to all services except those in the health and medical field, the institute says the sales tax could be reduced to 3.9 percent, and it predicts private employment might create more than 12,000 additional jobs, with investment and real disposable income increases in the tens of millions of dollars.

The report predicts similarly large job growth, income growth and investment growth in scenarios where the business and sales tax changes occur and income-tax rates are cut.

When institute leaders saw the numbers, it was “absolutely fascinating,” said institute director Michael Thompson, who explained the report in a conference call on Friday.

“Every taxpayer can be substantially helped, the competitive business environment enhanced, and state and local governments will not lose a penny,” Thompson said.

The institute concedes that those industries not now paying sales tax are likely to object to a plan that requires them to do so.

But Thompson said his organization went to stakeholders—including Gov. Bob McDonnell’s office—to try to get them on board.

The state’s two largest groups representing local governments—the Virginia Association of Counties and the Virginia Municipal League—are at least open to the idea of working on such a restructuring plan, Thompson said, as long as local governments don’t lose revenue under any changes.

“I think we have crafted an idea that puts those groups comfortably at the table to say their ox isn’t being gored,” Thompson said. “Those important players politically are satisfied, or they seem to be satisfied.”

He also talked to business groups, such as the state Chamber of Commerce and the National Federation of Independent Business.

They were “very interested” in the study, Thompson said, in part because many jobs that could potentially be created would be in small businesses.

“We have talked to a number of business groups on this and everybody has been very interested in the positive economic impact that this idea can create for the state,” he said. “All of them are interested in a better economic situation in this state.”

The business groups also have long favored eliminating the BPOL and other taxes on businesses.

Of course, it’s all just a plan on paper unless state legislators propose bills to restructure the tax system.

Thompson said he has been keeping the governor’s office and key legislators informed, and plans to continue meetings with them in the future.

“I think there will be a fair hearing on this,” Thompson said.

Chelyen Davis: 540/368-5028

cdavis@freelancestar.com

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