Lee Schafer: Dayton made the right call on services tax

The business community appears to have won an easy one in convincing Gov. Mark Dayton to back down from a proposed sales tax on business-to-business services. After all, it’s all but impossible to find a policy wonk who thinks it is good tax policy.

But those from business who jumped into the debate say they didn’t think it was easy, didn’t win by quoting wonks or writing white papers and are holding their breath on the idea staging some sort of comeback.

That’s because bad policy is not necessarily bad politics, and filling a hole in the state’s budget never seems to get any easier.

The business-to-business services tax created an uproar when it was proposed in late January as part of Dayton’s broader budget and tax reform package. His goal was a more stable source of funding than other taxes and one that would let the overall sales tax rate decline from 6.875 percent to 5.5 percent.

“We never considered doing this without that big rate reduction,” said Myron Frans, commissioner of the Minnesota Department of Revenue. “And the only way to do a really big rate reduction was with business-to-business services.”

He also said complaints about pyramiding, the effect of taxing goods or services at multiple steps of a value chain, were at times “overstated.” He acknowledges pyramiding occurs, and observed that it occurs under present law with sales taxes on office equipment and other products used by businesses. But his goal was to devise an implementation of the tax that would “control” those effects.

The problem is, no workaround readily comes to mind on the problem of pyramiding.

The reason consumers pay sales taxes and businesses mostly don’t is not due to some fundamental policy unfairness, as the governor suggested, or that consumers are politically less powerful. It’s that the consumer is, by definition, the last link in any value chain. They are the ones who “consume” a product or service.

In the household, no purchase gets put in inventory for resale, nor is paying for a service an operating expense incurred in making something else or providing a service.

This is why there is a policy consensus that a broader tax on consumer purchases including services can be a fine idea, eliminating distortion between consumer goods that may be taxed and services that may not.

In the world of business, a tax creates a layer of taxation at each stage of production, which is what economists mean by “tax pyramiding.” Given enough tax pain, business owners start thinking about bringing in-house functions they had previously bought from other companies.

The only fix for tax pyramiding is to not ask businesses to pay a sales tax. But that straightforward policy argument isn’t the only one the business community took to the Capitol.

The Minnesota Chamber of Commerce’s membership “truly saw that it was going to make them, frankly, uncompetitive in Minnesota,” said Beth Kadoun, the director of tax and fiscal policy for the Minnesota Chamber. “They were running the numbers, and it did not look good. And they were sharing this with the governor, and they were sharing this with their legislators.”

Dayton also heard from big company leaders, represented by the Minnesota Business Partnership.

“When [Dayton] came to our meeting, and stood eyeball to eyeball with 50 CEOs of global companies who specifically described the impact this tax would have on their businesses and their ability to grow jobs here, and sustain jobs, it was very helpful,” said Charlie Weaver, the group’s executive director.

Weaver attributed part of the effectiveness of the business community’s response to Dayton’s sales tax plan to its breadth, that stories came “not just from 3M but from Joe’s Engineering Shop and Joe’s Advertising Agency. In politics, individual impact is always more powerful than policy papers.”

When the state’s projected budget deficit of $1.1 billion was revised downward to $627 million, and given the opposition, the governor dropped the proposal altogether.

Some sort of expansion of sales tax remains under discussion in the Minnesota Senate, Frans said, but the administration considers the business-to-business services tax dead for this year.

“By placing it on the table, we have had a good discussion, and we have seen the pitfalls,” Frans said. “So this will be an opportunity now to study what’s going on in other states. If we were to bring it back, how would we do it? We would want to be engaged in a pretty intense dialogue with businesses and policy people about how best to do it.”

Weaver, who credits the governor for “a very mature reaction” to opposition from business, has not relaxed entirely on this issue so long as the Legislature remains in session. Like the character in the classic film “The Princess Bride,” he said, the business-to-business tax “is only mostly dead.”

This column originally appeared in March 13, 2013 edition of the Star Tribune.