Sales/Use Tax Worse for South Dakota Business than Corporate Income Tax?

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.

8 Responses to Sales/Use Tax Worse for South Dakota Business than Corporate Income Tax?

  1. am i picking up that brock self-fosters his personal fears/desires to be heat packing in the legislature to protect himself and save the rest of us chickens too unpatriotic to hide guns in our pants, while creating tax loop holes for himself. his mom do this too?

  2. mitch mcconnell is alot like brock and his mom. in his own letter, mitch is asking all 50 governors to resist epa/obama’s call to cut green house emmissions from power plants by 2030 by 30%. the leader of the senate is worried about jobs for his constituents (yeah, like KXL jobs are vital, thats just the handle to take care of billionaires and corporations). huffpost, today

  3. Nick Nemec

    Under the current South Dakota tax system American Legion baseball coaches owe “sales” tax on the salary they earn for coaching. Did my daughter who was a girl’s softball coach for a couple summers owe “sales” tax on the money the City of Highmore paid her to fill that position as part of the city summer recreation program? Who qualifies as a coach owing “sales” tax and who is a coach not owing “sales” tax?

    Do private music teachers, arguably a group that is actually selling a service, charge and remit sales tax on the piano lessons they sell to children, or more correctly their hopeful parents? Does the music teacher at the school owe sales tax on the money she gets from the school district for providing music lessons in that venue? What’s the difference?

    In South Dakota we are so adverse to an income tax that we are willing to bend over backwards and call a cow a horse if it reaffirms irrational beliefs.

  4. Good question about all those other services, Nick. It would be a lot simpler if we just taxed income, taking a percentage straight from the line on the 1040, wouldn’t it?

  5. I’m aware of music teachers who collect sales tax in Brookings.

  6. Piano teachers

  7. Nick Nemec

    But do the music teachers at the school have to remit sales tax to the state on the money the local school pays them to teach music lessons to school kids? The only difference is the venue. Both should be reported, treated and taxed as income, not sales?

    I sell grain to the local elevators. When I get there I drive on a scale to be weighed and samples of the grain are taken for grading. The person who runs the scale and grades the grain is an employee of the elevator they are paid a wage and issued a W-2, what is to prevent the state of South Dakota from saying, that’s not a regular job you are selling your service as a scale operator and grain grader and as such owe sales tax.

    The baseball coach is an employee of the baseball team or at least an employee of whatever entity is sponsoring the team and as such should owe income tax on the wage paid. They are not selling a service subjected to the sales tax, at least not in the traditional sense of the words. They are captive to their employer, the sponsor of the team.

    Does the manager of the Sioux Falls Canaries owe sales tax on his pay? Using the logic of the State of SD why doesn’t he?

  8. Nick Nemec

    My greater point is in order to avoid an income tax the state has greatly expanded the definition of sales, and services subject to the sales tax. It would be so much simpler and less convoluted to have everyone pay income tax on the money they make.