Repealing Tax Changes Before They Take Effect -- Is There a Better Way?

In the past year, we have seen both Michigan and Maryland enact new taxes, only to repeal them soon thereafter and before they became effective, due to complaints. That's a lot of work for no effect. What could have been done differently?

On 12/1/07, the day a use tax on specified services was to go into effect, Michigan repealed the law (see prior blog post). More recently, Maryland repealed its expansion of the sales tax to computer services. In November 2007, the legislature added computer services to a measure designed to address a budget shortfall (see Washington Post article of 12/9/07). The tax was to become effective on July 1, 2008. Fierce opposition by the business community led to its repeal in April 2008. The tax would have mostly applied to businesses since they purchase more computer services than do individual consumers.

Back in 1987, we saw Florida expand its sales tax to include specified services, only to repeal that tax 6 months later. In 1990, Massachusetts expanded its sales tax to services, but repealed it before the effective date.

This seems like a lot of wasted effort. In Maryland, the Comptroller's Office was struggling to write regulations to help businesses be ready to comply - a project now pulled.

What night have helped lead to more productive legislative efforts and more lasting tax changes? Here are a few suggestions:

1. Transition: In creating a new tax or expanding an existing tax to include new taxpayers, provide sufficient time for the tax agency to provide guidance and assistance and for taxpayers to get their computer and business systems ready to handle any new collection, reporting and payment procedures. In Michigan, the expanded sales tax was enacted in October to be effective on December 1. That's not enough time for businesses to get ready to collect the tax.
2. Use Prior Research: Many states have had commissions to study tax reform in their states. Typically, there are hearings and months of thought and discussion. Commission final reports tend to sit on shelves. Legislators should look for such reports to see what was suggestion as typically a lot of thought and research goes into these reports. NCSL keeps a list.
3. Avoid Sales Tax Pyramiding: Plans to expand sales tax to more types of services should stay away from services that are primarily purchased by businesses. This will avoid pyramiding in the sales tax.
4. Accompany Any Base Expansion with a Rate Reduction: If a tax base is to be expanded, the rate should be lowered. Typically, a tax with a broader base and lower rate is simpler (fewer rules needed to define what is not taxed or is treated specially), can have higher compliance rates (less interest in tax planning due to lower rate), and is more neutral (fewer special rules causing the tax law to influence decisions). Base expansion accompanied with a rate reduction is more likely to be accepted as tax system improvement by taxpayers than just a base expansion.
5. Educate Taxpayers: Use advertising to help taxpayers understand the current flaws in the tax system and why they need to be fixed.
6. Fix Tax Systems in Good Times: Tax law changes made during times of budget crisis are likely to be focused more on what raises the requisite revenue rather than what makes best sense for modernizing a tax system within the principles of good tax policy.