Legislators pursue new tax on business services in Nevada

With Nevada educators and some lawmakers seeking new revenue to fund public education, Democratic legislators have proposed a new 1 percent tax on a wide range of services, from hair salons to plumbing repairs, landscaping and diaper services.

And, possibly, even brothels.

The idea of a tax on services, economists and tax advocates say, was born as three-plus years of recession have battered Nevada's traditional revenue sources -- taxes on gaming, sales and property.

Some Las Vegas business owners say they're nervous about the unknown effects any new tax would have on their firms and on a still struggling economy.

While Michael Mazerov, senior fellow with the Center on Budget and Policy Priorities in Washington, D.C., understands their hesitation, he says taxing services helps stabilize and neutralize a state's tax system.

He contends that Nevada, with its dominant and growing service economy, would be better off because it would be better able to maintain financial support for education, health care and state and local governments during a recession when other state revenues decline.

Still, his insistence that broadening the tax base would actually benefit the local economy doesn't reassure everyone.

"It's a sluggish economy as we all know. It's definitely going to put added strain and stress on smaller businesses," says Nikki Musegades, owner the New York Hair Co. in Las Vegas.

With average visits ranging between $40 and $80, Musegades is concerned that regular clients, who come in twice a month, would be put off by a new tax. She says it's too early to know whether the proposed tax would force her to raise her prices or simply pay the tax -- from 40 to 80 cents for that average customer -- out of her own pocket.

"We've seen a 15 percent to 20 percent decline in business over the last three years. It's our existing clientele that is keeping us in business," says Musegades, who moved to Las Vegas from El Segundo, Calif., in 2004 to open her salon.

Musegades also thinks service workers who depend on tips to supplement a minimum wage will also be affected: "Every little piece that is taken out by the tax is going to dip into what they are making."

pros and cons

If Democratic legislators have their way -- Gov. Brian Sandoval has promised to veto any new taxes -- they say the new service tax would raise about half of the $1.2 billion they are hoping to generate for education through new levies.

Some services would be exempt, including health care, day care and funerals. The tax would raise a projected $566 million in the next two years.

Sandoval and other anti-tax opponents argue that a transaction tax on services would threaten Nevada's economic recovery and those businesses clinging to life after the recession.

But Christopher Thornberg, a founding partner and an economist with Beacon Economics in Los Angeles, says "Republican cries on taxes and prosperity are based more on faith than economic logic. Mind you at some point taxes can be bad for the economy. But the argument that the tax structure is crushing economic incentives doesn't work."

He says the general rule when it comes to taxes is that small taxes over a large base spread "the pain out over a large group."

Thornberg has been advocating for a service tax in California, and maintains that a 3.5 percent tax on both goods and services would be more effective in generating revenue than a 10 percent tax on goods alone.

Regardless of the math, Democrats in the Nevada Legislature will need some Republican support to reach the two-thirds majority needed to pass tax bills and override the expected Sandoval veto.

Mike Larkin, whose Larkin Plumbing and Heating has been based in Las Vegas since 1936, says that while he understands the need for additional tax revenues, the state should first look at spending priorities.

Under the proposed legislation, he would have to charge customers the 1 percent service tax for labor in addition to the current sales tax on products associated with a repair or construction, from fixing a leaky sink to installing a new water heater. Instead of a bill for, say, $70 in labor, the charge would be $70.70.

Larkin is also concerned whether the state will be able to collect from what he says are his biggest competitors -- unlicensed contractors who, by their very work, are violating state statutes.

Tax experts have urged states for decades to include more services in their tax base, but say its public support and passage depends on which services are taxed.

"Politically, taxes on services are a very tough thing to get through," Mazerov says. "There have been more proposals than enactment of service taxes."

But failing to recognize that consumption has been shifting from goods to services for decades, and not adjusting the tax structure, means states are "going to have serious erosion of (their) tax base," he says.

To compensate for this trend, many states, including Nevada, have increased sales taxes. In 2009, the state's minimum sales tax rate was temporarily increased from 6.5 percent to 6.85 percent to help close a previous budget deficit. The change was expected to raise $280 million in revenue by the end of the 2010-2011 fiscal year on June 30. Without legislative action and Sandoval's signature, that 6.85 percent rate will sunset June 30, reverting back to 6.5 percent.

Sandoval has said he will not approve an extension of the expiring sales tax increase. Dale Erquiaga, a senior adviser to the governor, has argued that the $1.2 billion tax proposal, which includes a tax on services, was introduced too late in the session.

The ability of states to continue raising sales tax rates is constrained, however, by several factors, including the ease with which Nevada residents can shift their purchases to the Internet, where sales taxes often are not charged.

"If consumption continues to shift toward services, including services in the tax base will be essential to maintaining sales tax revenues over the long term," Mazerov says.

Mark Robyn, staff economist at the Tax Foundation in Washington, attributes sales tax declines more to the recession than shifting trends in personal consumption: "People have been spending less and saving more, which translates into less retail spending."

sales taxes and rates vary

Nationally, the decline in sales tax revenues has leveled off, he says, but a modest growth rate had been expected as consumers cautiously begin spending again at the mall or on trips to Las Vegas.

In 2010, total sales taxes in the United States were $344 billion, compared with $345 billion in 2009 and $361 billion in 2008, according to the U.S. Census Bureau.

Some states have a single sales tax rate statewide though most permit local city and county additions to the base rate. In Clark County, for example, the sales tax rate is 8.10 percent. In Washoe County, which includes Reno, it's 7.75 percent.

The 1.35 percent in add-ons to the state's minimum sales tax in Clark County help fund infrastructure projects, road construction and public transportation, among other public services.

On the state level, sales tax collections are distributed between the state's general fund, school districts and cities and counties, according to the Nevada Department of Taxation.

How much revenue is generated by a sales tax depends on the percentage tax rate and the goods and services that are taxed. Many states exempt from taxation goods viewed as necessities of life, such as food and medicine.

In fiscal year 2010, Nevada generated $2.55 billion in sales taxes.

The figure places Nevada near the bottom when compared to other states with no personal income tax, including Texas at $19.66 billion, Florida's $18.53 billion, Washington's $9.6 billion and Tennessee's $6.13 billion.

Only South Dakota ($742.3 million) and Wyoming ($789.4 million) earned less than Nevada from sales taxes. Alaska and New Hampshire, two states with no personal income tax, also do not collect sales taxes.

Jeremy Aguero, principal analyst with Applied Analysis in Las Vegas, says the state's current sales tax was among the "narrowest" as to what it applies to and "wholly dependent on the sale of goods."

Aguero says that a progressive tax on services could include elective cosmetic surgery, accounting, architecture or even the lease of commercial buildings. He argues that sales taxes on items such as apparel or school items are regressive and a greater burden on lower-income residents.

Most states also apply selective sales taxes to particular foods and services separately from the general sales tax. The most common such taxes are on alcoholic beverages, motor fuels and tobacco.

Revenues from these taxes have been falling despite increases in rates.

Elliott Parker, professor and chairman of the Department of Economics at the University of Nevada, Reno, says the state's sales tax system makes little sense: "We pay taxes when we purchase a DVD, but not when you rent a DVD."

Mazerov takes it one step further, pointing out that most people don't pay a tax to "download a movie or stream it over Netflix."

delayed tax plus borrowing

A number of states, including Pennsylvania, Hawaii, New Mexico, Washington and South Dakota, already tax some services.

In Pennsylvania, for example, a 5 percent tax is applied to a wide-ranging list of services that include lobbying, credit reporting, collections, secretarial, building maintenance and cleaning services.

Elizabeth Brassell, acting press secretary for that state's Department of Revenue, says that Philadelphia (8 percent) and Allegheny County (7 percent) have approved local add-ons to the state's tax on services.

Earlier this month, Connecticut Gov. Dannel Malloy, a Democrat, signed a $40.1 billion budget that raises taxes on sales, income, cigarettes and corporations. The biennial plan also taxes more services, such as pet grooming, spa treatments and yoga.

UNR's Parker says Nevada has another option at its disposal regarding a tax on services. Lawmakers could pass a service tax during the current session but hold off implementing it until 2012.

By waiting, he says that the state could securitize future revenues and issue bonds to generate immediate revenue to offset cuts in funding to higher education and K-12 in Nevada.

"It's new revenue. We would be borrowing against future revenues," Parker says.

The state would likely issue Tax Anticipation Notes, also known as TANs, which are short-term debt securities issued in anticipation of future tax collections. Revenue Anticipation Notes, or RANs, are similar short-term debt instruments used to meet revenue demands of municipalities and states.

Parker admits the idea might be hard for lawmakers, especially those opposed to new taxes or borrowing, to understand or approve.

"We've got this instinct that it's bad to borrow," he says. "There is good borrowing. Borrowing on secure sources of revenue would give us more certain revenue to be able to handle (deeper) recessions."

He acknowledges that borrowing also means paying interest -- money that could otherwise fund other state priorities, including law enforcement programs or education.

Mark Mathers, Nevada's senior deputy treasurer, says there is no general authorization to issue short-term bonds backed by anticipated tax revenues or general fund revenues in Nevada.

"TANs or RANs are not authorized in state law," Mathers says. The Legislature would have to "specifically authorize it in state law."

Parker says some politicians, along with their constituents, need to understand the issuance of bonds can be an investment that results in long-term financial benefits.

"There is nothing bad with borrowing to build a factory or casinos," he says. "Borrowing for consumption is what got us into this mess."

Contact reporter Chris Sieroty at
csieroty@reviewjournal.com or 702-477-3893.