Recipe for Sales Tax on Food in Minnesota - Too Complex!

 

Our tax laws are generally more complex than necessary. Most of this complexity is due to special rules where we try to give some types of taxpayer or activities special treatment. While there might be good reasons for the tax exception, there usually are simpler alternatives.

A recent news update from the Department of Minnesota included a Prepared Food Flow Chart. The first question is whether the seller heated the food or mixed or combined two or more food ingredients into a single item. That alone doesn't sound too complex but likely results in "yes" to most prepared food including cooking an egg in a pan that has butter in it. But there is more. Despite combining food, if the item is a bakery item but no utensils rae provided or needed (and if needed not made available), then the bakery item is not subject to sales tax. Also see the DOR's Fact Sheet 102D on prepared food.

I encourage you to look at the chart. Nice job by the DOR in trying to simplify the law created by the legislators.

What would be simpler? Tax all food purchased by a consumer. Provide relief to low income individuals through an income tax credit such as a larger EITC. If the federal government continues sending the advance child tax credit monthly, states should look into how they can provide funds to increase these amounts to advance the food sales tax credit.

Or, the entire sales tax system can be changed from being assessed at point of consumption to being computing using a formula approach of Income less Savings = Consumption. This could be a schedule attached to your state income tax return. Individuals below a specified income tax level would be exempt.  And there could be a graduated rate structure. And there would no longer be any sales tax compliance by sellers and businesses would no longer pay sales tax. There could still be sales tax applied to vehicles to help buyers who want to finance that (and the registration process can handle the sales tax collection). Also, if needed to help with revenue, perhaps businesses pay sales tax when they purchase vehicles. For more on this idea, see a 2017 paper on it I wrote with two of my econ fellow faculty. 

What do you think?

#Letsfixthis

Shifting tax base to consumption tax is bad idea

In January 2020, a Nebraska legislator introduced LR300CA, to amend the state constitution to prohibit all forms of taxation other than a consumption tax. The proposal states that the tax is to be at a single-digit rate. Presumably, both the state and local governments could have a single-rate tax. It would apply to all new goods and services, but does not define this term. It sounds like it means tangible personal property and services, possibly also travel and entertainment, but not clear.

It is unlikely that such as tax can raise as much revenue as an income tax, even with no exemptions to the sales tax. High income taxpayers don't spend all of their income, they save it and invest it. So that drops the tax base compared to an income tax.  Consider these two formulas and you'll see the base for an income tax is broader.

   Income = consumption + savings

   Consumption = Income less savings

And, with an income tax it is easier to have a progressive rate structure to increase vertical equity in the system.

One new category that would become taxable and affect higher income individuals more than lower-income is to tax food. Currently, Nebraska doesn't impose sales tax on food.  According to data from the Bureau of Labor Statistics, the top 20% of income earners buy 1/3 of total food purchases. They also buy 41% of all entertainment spending. Hopefully the Nebraska proposal  intends to apply sales tax to entertainment.

The proposal is likely to be a tax increase for low-income individuals as there is no exemption for low-income as there easily can be for an income tax.  With removal of income and property taxes and only a single-digit sales tax, it is likely that government would have to cut services which would also disadvantage lower income individuals.

What about alternatives?  Here are a few ideas:

• Repeal income tax preferences such as the mortgage interest deduction.

• Impose sales tax on food but provide an income tax credit to low-income individuals to reduce the impact to them of the tax.

• Expand the sales tax base to include high-end consumption such as entertainment, travel, and household help.

Also in 2020, a California legislator introduced AB 2712. This calls for a universal basic income amount of $1000 per month to be paid to individuals age 18 or older with income below 200% of the median per capita income for the person's county of residence (measured by the BLS). This amount would not be subject to tax in California or affect income based tax and other benefits. AB 2712 defines "universal basic income to mean unconditional cash payments of equal amounts issued monthly to individual residents of California with the intention of ensuring the economic security of recipients." The payments would be handled by the FTB.

To pay for this, the bill calls for that "on or before July 1, 2024, the California Department of Tax and Fee Administration shall submit a report to the Legislature on the feasibility of establishing a new state tax to finance the California Universal Basic Income (CalUBI) Program. The report shall consider the feasibility of establishing a value-added tax on goods and services in the state, an analysis of the feasibility of taxing the sale of services offered in the state, and an analysis of the feasibility of raising the corporate tax. The report shall also include projections of expected tax revenue."

Adding a VAT on goods and services to fund the UBI would impose a burden on those receiving the UBI. Aside from rent, much of what is left over each month is spend on goods and services with most of the goods (other than food) subject to sales tax. Adding a VAT on top of the sales tax would also add complexity. Consideration should instead go to replacing the sales/use tax with a VAT with a broad base and low rate.

A higher corporate rate will be borne by employees, owners and customers and so can also hurt low-income individuals.

Why not remove tax breaks that primarily benefit high income individuals such as the mortgage interest deduction, sales tax exemptions for household utilities, personal service, entertainment and food? And consider if the EITC should be increased in place of a UBI although the EITC is only for workers.

Two of my colleagues and I wrote a paper in 2017 on a proposal for a different type of consumption tax that could be paid along with one's state income tax, but exempt low-income individuals. And businesses would not be subject to it (similar to how a VAT work and how a consumption tax should work to avoid pyramiding). Please check it out. I think it would be groundbreaking for the first state to adopt it in terms of removing regressivity of this consumption tax and making the state very attractive for businesses.

A UBI should be discussed as a way to help low-income individuals to know if it will help more than other programs such as greater education opportunities and medical care for all. 

And we have lessons learned from the pandemic and federal and state programs aimed at helping those with health and financial needs. This included funds for businesses of all sizes, unemployment benefits extended to self-employed individuals, economic impact payments and other provisions. Were these benefits equitably distributed? Did they help those most in need? How will the increased deficits and debt (and its interest expense) be paid?

How will these topics get attention in the public arena?

What do you think about such proposals?

More than one way to tax consumption

In the US, the consumption taxes we are most familiar with are the sales tax and some excise taxes, such as on gasoline, alcohol and tobacco. We typically think of these taxes as having to be imposed at the point of purchase.  There is an advantage to this because you'll know at that time if you can afford to pay the tax. Disadvantages to this approach include that the vendor has additional compliance to collect and remit the tax (and penalties if done wrong) and the rate can't be adjusted for the income level of the buyer (although I understand many might not view this as a disadvantage).

Another form of consumption tax that has been around in proposals and policy books and reports for a few decades is the formula approach or consumed income tax. If we consider that one's income is saved and spent, we have this formula:

     Income = savings + consumption

Simple algebra converts this formula to a consumption tax:

     Consumption = income - savings

We know how to measure income, but how do we measure savings? We can look at beginning bank balances and cash stored up (in case that's a lot; a few bucks in your wallet can be ignored). To that we add increases to savings and saving spending (such as purchase of stock). Debt must also be factored in. It might get a bit complicated, but can be managed with software and good records.

Two colleagues (Drs. Foldvary and Haight, economists) and I wrote a paper on how a sales tax might be converted to a formula approach consumption tax, how to do it and the advantages and disadvantages. One advantage is that it would remove the sales tax from businesses (they would not pay it or collect it). Another advantage is that low-income/low-wealth taxpayers can be exempt. Also, the calculation can be done as a form attached to an existing income tax return. And, as noted earlier, a progressive rate structure is possible. Disadvantages include that it won't get at the underground economy and visitors to the state won't pay the tax. Partial solutions to these problems is to retain the sales tax for vehicles (cars and boards) (which also allows the sales tax to be financed along with the purchase price of the vehicle). Also, the state could add a small tax to hotel stays, perhaps collected by cities that already impose such a tax.

Another challenges is that without a sales tax, local governments, at least in California, lose a significant tax source. So, a system of sharing state revenues with local governments would be needed. That won't be popular with local governments. It can be done to have the local governments share in the state income tax which would align both levels of government to want high paying jobs in the state (today, local governments benefit more from big box retailers in their cities because of the sales tax generated).

The paper is posted here. Yes, it is long, but 2/3 of it are appendices should you seek more background information.

What do you think?

Sales Tax Policy Outlook for 2017

I don't expect 2017 will look much different than activities of 2016.  With one change - Congress looking at a consumption tax at the federal level for business income. If that happens, there is relevance for state sales taxes.

For more, please see my policy post originally posted at SalesTaxSupport.com.

Sales tax law changes and discussions in 2017 are likely to look a lot like those of 2016, with one possible exception.

The repeating discussions and activities will include:

1) Expanding the sales tax base to include more services and digital goods.

2) Congressional hearings on the Marketplace Fairness Act without enactment of legislation.

3) Continued and expanded state efforts to get a case to the US Supreme Court to challenge the 1992 Quill decision. For more on this, see Sylvia Dion's 12/16/16 post.

The possible new item is the federal level tax reform discussions that include moving the business income tax to a consumption tax. The House Republican blueprint released in June 2016 calls for a cash-flow consumption tax where assets (other than land and inventory) are expensed, interest expense in excess of interest income is not deductible (it carries forward), imports are taxed and exports are exempt, and the tax rate is lowered. They hope that this is considered a valid border-adjustable tax by the World Trade Organization (WTO), because of the desire to tax imports and exempt exports (this will help pay for lower rates). If this cash-flow tax is not found to be border adjustable, and Congress wants such a tax, perhaps we'll see the debate move to replacing the corporate income tax (and perhaps other business income taxes) with a credit invoice VAT used by over 130 countries, and known to be border-adjustable. If that happens, that will lead to a new sales tax policy discussion - should the states convert their sales taxes to a credit invoice VAT? One issue of course, is what to do with the state level business income tax? Should it be kept if the federal business income tax ends?

Congressman Jim Renacci (R-Ohio) has introduced a tax reform plan to replace the corporate income tax with a credit invoice VAT.

For more on consumption taxes and the operation of a VAT, see my explanation here.

Let's see what happens.

What do you think?