I had a great time yesterday listening to students debate major South Dakota issues and speaking with them afterward at the South Dakota Democratic Party’s Young Elected Legislative Leaders event at the Capitol. I also had the chance to talk with some adult Democrats who got me thinking about our tax system.
I advocate a moonshot plan to fund $10,000 raises for every teacher in South Dakota by cutting one eighth of our tax expenditures, mostly breaks we give on sales and use tax. An expert on the subject tells me that even with those breaks, 60% of our sales tax revenue comes from businesses.
Suppose you run a business. Whether you make a profit or not, you buy raw materials, tools, services from other contractors, electricity, and other inputs all the time. Would you be better off paying sales tax up front on the costs of your inputs, or would you be better off paying income tax at the end of the year (or the quarter) on your profit, if you have any?
My expert friend suggests that businesses watching the bottom line would prefer the income tax. South Dakota’s sales and use tax actually hits less profitable businesses harder than would a well-designed income tax.
The Tax Foundation, which regularly ranks South Dakota’s tax system as one of the best for business, dings our sales and use tax for exactly that reason:
The negative impact of sales taxes is well documented in the economic literature and through anecdotal evidence. For example, Bartik (1989) found that high sales taxes, especially sales taxes levied on equipment, had a negative effect on small business start-ups. Moreover, companies have been known to avoid locating factories or facilities in certain states because the factory’s machinery would be subject to the state’s sales tax.
States that create the most tax pyramiding and economic distortion, and therefore score the worst, are states that levy a sales tax that generally allows no exclusions for business inputs.27 Hawaii, New Mexico, Washington, and South Dakota are examples of states that tax many business inputs. The ideal base for sales taxation is all goods and services at the point of sale to the end user [Scott Drenkard and Joseph Henchman, “2015 State Business Tax Climate Index,” Tax Foundation, 2014].
The Tax Foundation weighs individual income tax most heavily in its ranking methodology, counting it as 32.1% of the score. Their methodology weighs sales tax at 21.6%, one percentage point higher than corporate income tax. In other words, the Tax Foundation says sales tax is a slightly worse burden than corporate income tax.
Senator Brock Greenfield is trying to legislate himself and his fellow VFW/American Legion baseball coaches out of paying sales and use tax on their services. Governor Dennis Daugaard vetoed that exemption Friday. Our friend Nick Nemec points out that South Dakota is really taxing Coach Greenfield’s income. Maybe Coach Greenfield is trying to cut the wrong tax. He only pays the tax on his coaching income if he gets a job coaching. He’s got to pay sales tax on his food and baseball shoes and his workouts at the gym (gotta stay fit year rounds to keep up with those kids in case yo land a coaching job, right?) whether he’s working or not. Coach Greenfield, maybe instead of repealing your particular state income tax, you need to work on replacing the sales tax with a fairer business income tax.