The Clinton administration's talk of a value-added tax - essentially a national sales tax - has thrown a spotlight on the troubles the states are having in broadening their own sales taxes.
Still the number one revenue producer for the states, the sales tax has been eroded by the shift to a service economy and the difficulties the state are having in taxing intangibles.
Now the talk of a value-added tax suggests that the states could face a major competitor at the retail counter.
"You may call it a value-added tax, but it's actually a sales tax, and it's going to compete with the states' revenue base, " said Douglas Lindholm, head of the state tax policy division at Price Waterhouse. "If the states were being offered some of the revenues themselves, that might be different. But if the federal government appropriates the money for health care, it's definitely going to hurt the states' finances."
Stephen Moore, staff economist for the Joint Congressional Economic Committee, said he was "a little surprised that there hasn't been more outcry from the states on this one. Traditionally, the states have been very jealous about the federal government invading some of their preserves, such as the gasoline tax.
"I don't think the states recognize how much a VAT, as it is now being proposed, would compete with them for sales tax revenues," Moore said.
Moore said the value-added tax, as floated in April by deputy budget director Alice M. Rivlin and Health and Human Services Secretary Donna Shalala, would run about 6% to 8% and raise $60 billion to $90 billion a year for health-care reform.
"There's no sense in doing a value-added tax on a small scale." said Moore. "Once you've got the administrative apparatus in place, you might as well go ahead and tax a significant amount. It's a huge pool of revenue.
"But you have to consider," he said. "Once you take an 8% value-added tax and pile it on top of a 6% to 8% state sales tax, you're talking about putting a very large tax burden on consumers."
Hyman Grossman, managing director of municipal finance at Standard & Poor's Corp., warned that the tax "would put a lid" on future sales tax increases by the states. "On the other hand, the federal income tax hasn't stopped the states from raising their own income taxes," he said.
Claire Cohen, executive vice president of governmental finance at Fitch Investors Service, echoed both points, while also saying that the tax "would be an instance of the federal government moving into an area that has been the province of state and local governments."
At Moody's Investors Service, George Leung, vice president and managing director of state ratings, agreed that a value-added tax would be a federal "incursion" into the states' territory. "Hypothetically, would it affect the states' credits? It's certainly something we would need to examine."
Canada and Europe
The value-added tax, now collected in Canada and almost every European country, seeks to tax the "value added" to a commodity at each stage of the production process.
When trees are cut for timber, for example, the logger would be taxed for the difference in value between raw wood and standing trees. Then the sawmill would be taxed when the wood become boards, and the builder when the boards are used for a house. At each stage, the tax paid at all previous stages would be subtracted in order to avoid duplicate taxation. The ultimate taxpayer, of course, is the consumer, who finds all these taxes wrapped into the price of a new home.
"The advantage of the tax is that it is supposed to promote national savings by taxing consumption instead of income," said Rob Shapiro, of the Progressive Policy institute. "It encourages savings in a way the income tax does not."
On the other hand, a consumption tax is often considered to be extremely regressive, particularly when it applies to essentials such as food and clothing. The states do not levy such taxes on clothes, but 17 do apply them to food.
"An income tax is a much fairer tax," said Steven Gold, director of the Center for the Study of the States. "The sales tax, and a value-added tax, are far more regressive. "
The fairness or unfairness to taxpayers of a value added tax has often been discussed. But Washington has not yet spent much time looking at how states and localities may be affected.
One of the most forceful cases for a value-added tax, made in 1992 by economist and Clinton official Alice M. Rivlin, called for letting the states get most of the revenues.
In her book, "Reviving the American Dream," Rivlin, now deputy director of the Office of Management and Budget, proposed a "revived federalism" in which numerous social programs would be "devolved" from the federal government to the state government, with the value-added tax serving as the revenue base for these enhanced efforts.
In Rivlin's vision, rivalry among the states would be replaced by uniform taxation. Instead of competing for businesses by lowering taxes, neighboring states would set the same value-added tax, then share the revenues.
"Once clearly in charge, the states would compete vigorously with each other to improve services and attract business by offering high-quality education, infrastructure, and other services," Rivlin wrote.
At the time, Rivlin was not contemplating the huge health-care reform effort that the Clinton administration has undertaken. Now that this projected $60 to $120 billion item is on the table, the idea of redistributing the value-added tax among the states has faded from view.
"It's ironic that a tax that only a short time ago was supposed to be strengthening the states is now being used to invade their revenue base," said Moore.
That base is already shrinking as states struggle to draw the service economy into their sales tax net.
Despite the erosion, the sales tax is still the states' biggest source of revenue. According to the Center for the Study of the States, in Albany, state sales taxes raised $103.2 billion in 1991, while state income taxes raised $99.3 billion. Corporate income taxes raised $20.4 billion.
On a per capita basis, state and local sales taxes raised $2.68 per $100 of personal income, with $2.23 of that going to states and 45 cents to localities. Income taxes raised $2.36, with $2.14 of that for states, and 22 cents for localities.
But the proportion of revenues states get from income taxes has been increasing: 27.1% in 1980, it is now 33%. During that time, the share of sales taxes rose to 35.2% from 34.8%, a statistically insignificant gain. Property taxes account for most of the rest of the revenues.
"Sometime in the 1990s, the income tax is likely to surpass the sales tax as the leading source of state revenues," Gold said.
Of the states, Alaska, Delaware, Montana, New Hampshire, New Mexico, and Oregon have no official sales tax, although Delaware and New Mexico, levy gross-receipts taxes. The levies resemble sales taxes but are applied to businesses' sales income instead of being collected from customers.
Thus, while the Center for the Study of the States lists Delaware with no sales tax, the Federation of Tax Administrators points out that Delaware taxes the gross receipts of 141 different service industries, giving it one of the broadest levies in the country. More states do not use the tax to capture service dollars because businesses consider it cumbersome and resent the ill will generated by passing the cost along to the public.
Another significant trend is the degree to which the states are allowing local governments to impose their own sales taxes. "Basically, the states are getting tired of supporting local governments," said Gold. "They're cutting them loose and letting them fend for themselves."
At present, 31 states allow local sales taxes. In New York, Louisiana, and Colorado, the rates at the city and county level often match the state levy. But, across the country, recent years have seen more sales tax increases by localities than by states, according to the center.
Overall, however, the main trend has been a greater and greater tax effort with diminishing revenue improvement. "Between 1980 and 1991, the average sales tax rate went up 26%, but sales tax revenues only went up 4% faster than income," said Gold. "What this indicates is a tremendous erosion of the sales tax base."
According to most observers, the reason for this is the gradual shift of the economy from manufacturing to professional services, which now largely escape sales taxes.
"In 1950, only 33% of the economy consisted of services," said Laird Graeser, director of research in the New Mexico Department of Taxation and Revenue. "Today the service economy is more than 50%. Yet very few states have been able to adjust their sales taxes to compensate for this shifting revenue base."
Two notable attempts that fell short were made in Florida and Massachusetts.
In 1987, Florida imposed a blanket sales tax on all services, including lawyers, accountants, and companies that buy advertising. "The lawyers and accountants were particularly tough," said William Townsend, former general counsel of the state department of revenue. "They have a lot of clout in the Legislature." The political backlash forced a repeal of the law within six months and helped unseat former Gov. Bob Martinez.
Repeal happened faster in Massachusetts. In 1989, a broad extension of the sales tax to professional services provoked a furor that killed the measure after two days. Since that time, states have adopted an alternative strategy that might be called "picking them off one at a time." In 1992, for example, Florida moved quietly back into the service area by taxing burglar protection services, nonresidential building cleaners, and pest controllers. Iowa taxed swimming pool cleaners and taxidermists.
"They tend to start with the people who are able to complain the least - auto repair, hair stylists, janitorial services, detective services, people like that," said Lindholm of Price Waterhouse. "They prefer to avoid the big hitters, like advertisers, lawyers, and newspapers.
"There are also legitimate technical questions when a service is produced in one place and consumed in another," Lindholm said. "What happens when a local law firm does a legal brief for an out-of-state company? Is that taxable or not?"
Lindholm said that it was Florida's attempt to include out-of-state advertisers that doomed its effort to tax services in 1987. "The advertisers have tremendous access to the national media because they essentially pay their bills," he said. "They were able to turn the whole issue against the Legislature."
If nothing else, federal encroachment may at least galvanize the states to resolve the problem of their sales tax base. "A national value-added tax has some advantages and some disadvantages," said Gold of the Center for the Study of the States. "One disadvantage would be a reduction in the states' ability to rely on their sales taxes. That isn't reason enough for not having one. But if nothing else, the Clinton administration's dalliance with the VAT may goad the states into dealing more forcefully with their current problems."