In reaction to a budget crisis that threatened to close down the state government, the Michigan legislature passed an amendment to the Use Tax Act, which would extend the tax to several categories of services on 12/1/07.
The 6% "service tax" encountered immediate opposition. In fact, two Senate bills were introduced that would delay and/or repeal the amendment to the Use Tax Act that created the service tax. It was a House bill (H.B.5408) that was eventually enacted, however, because it included a means of alternative funding. It was passed by both the Senate and House on December 1st, 2007, just a few short hours after the service tax amendment became effective. Governor Granholm signed the bill into law on Tuesday, December 4th, and it was assigned Public Act 145 of 2007.
P.A. 145'07 retroactively repealed the service tax amendment in favor of amendments to the Business Tax Act, not the least of which is the imposition of a business surcharge that will become effective on January 1st, 2008.
S.B. 845 was passed by both houses on December 4th and provides for refunds to anyone charged service tax on Saturday, December 1st, 2007.
Why a service tax? Mainly because extending the sales tax to services provides a new and expandable source of revenue. It also better reflects the economy in Michigan, which is changing from a car-based to a service/information-based economy.
Approaches in Other States
All states arguably have a tax that impacts a "service," including Michigan (See 1996 Sales Taxation of Services Update, pg. 12), but not many have a comprehensive service-tax scheme.
Of those states that do, most couch it in different terms and apply it by different method. According to Wikipedia's list of Sales Taxes in the United States, the most notorious is New Mexico with a 7% statewide gross receipts tax on businesses. Ohio calls theirs a commercial activity tax. Several other states, including Hawaii, Maine, Washington State and Texas, also relate the service tax to business receipts.
Of the states that apply the service tax like an extension of the sales tax, it has been an unpopular move. In fact, Florida repealed its 1987 service tax within the year. Of course, the opposition to a service tax is often dependent on how gradually it is applied, whether the services are taxed fairly across the board and the ease of reporting.
Note: For the most part, all states steer clear of taxing professional services.
History in Michigan
Michigan enacted the Use Tax Act in 1937 to close a loop hole regarding products bought from other states. According to a 2003 Michigan Sales and Use Tax Report, the use tax was extended through amendments over the years. Like most states, the effort to capture more-and-more revenue eventually blurred the line between products and services. For instance, telephone services, hotel rental and construction-related services have been subject to Michigan's use tax for years.
The idea of enacting a bona fide service tax has been a recurring one in our state in recent years. In 2003, the Red Cedar Coalition, of which the Michigan Educational Association is a member, considered a much more modest 1% service tax in exchange for a 1% reduction in sales tax.
The issue was officially addressed earlier this year after several Standard & Poor reports reduced Michigan’s credit rating and warned of dire financial consequences stemming from the repeal of Michigan’s Single Business Tax and the state’s chronic budget crisis. In an effort to balance the budget, the Governor proposed a 2% service tax on virtually every service except those falling within the categories of education and medicine. (Note: Link no longer available). The proposal was met with fierce opposition by various service industries.
Services Hastily Targeted
Given the urgency within which the legislature had to act in September of 2007 -- the state government would close down without a resolution to the budget deficit -- the 6% sales tax was simply extended to several service categories. Given the speed in which the services were selected, the natural concern is whether the services were picked arbitrarily or at the sway of service-industry lobbies.
Categories of Services Taxed
The services subject to taxation under the act fall into several categories. The first category is indirect business services. These services are generally contracted arrangements between one business to another, such as copy/printing services, consulting, transcription and the like.
The other categories of services subject to taxation fall under the broader category of “personal services” and include high-end discretionary or luxury services, as well as “other personal services” as defined in the North American Industry Classification System. In other words, the personal services subject to taxation were selected because they are considered non-essential. For instance, astrology, bail bonding, party planning, nail care and facials are included, but hair care and permanent make up are specifically excluded.
Stand Outs on List of Taxed Services:
- Weight-Reduction and Dating -- Given that deductions and credits for federal income tax liability are carefully selected to promote certain values, the specific selection of services related to weight-reduction and dating for taxation by the state arguably impedes/discourages values related to good health and marriage.
- Travel/Tourism -- In a state plagued with budget woes, taxing tourism-related services seems counter productive.
- Skiing -- One of the only recreational activities taxed under the amendment is skiing. Either skiing stands out on the list, or golf is notably absent. Perhaps the senators and representatives consider golf an essential activity.
- Real Estate -- After a campaign by the real estate industry earlier this year opposing Governor Granholm's 2% service tax proposal, real-estate related services are not included in the amendment.
- Lobbyist influence may have unfairly affected which services are taxed.
- Revenue projections are too speculative.
- The tax may prove to be the legislature’s own ATM when a budget crisis looms.
- Services do not fall neatly into the manufacturing and retail scheme of sales/use tax. The tax applicable to indirect business services could result in a tax on a tax for small businesses.
- Small businesses may be inordinately affected because they are more likely to outsource the services subject to taxation.
- The service tax as passed may prove a reporting headache. The long-term effect of which may be that people shift from independent contractor status back to traditional employment.
- The tax could affect the demand for services and/or tips given for service practitioners.