Avalara : Will Nebraska broaden sales tax to services?

Two organizations seeking to encourage economic growth and opportunity in Nebraska are working together to modernize the state's tax policy. Expanding sales tax to services is a key part of their plan.

Nebraska's corporate income tax rate is on its way down; it's scheduled to drop from 7.81% to 7.5% on January 1, 2022, and to 7.25% on January 1, 2023. The legislature may further reduce corporate income tax in 2024 and 2025. According to Blueprint Nebraska and the Platte Institute, broadening sales tax to services would help offset the inevitable drop in tax revenue.

The Blueprint Nebraska plan wouldn't increase the sales tax rate, but it would eliminate the state and local sales tax exemption for many services. (Unprepared grocery items would remain exempt, and medicine as well as medical equipment and services would be partially exempt.) An economic and fiscal impact analysis commissioned by Blueprint Nebraska estimates local option sales tax revenue alone could increase by more than $2 billion between 2022 and 2031 as a result of the change.

The Platte Institute makes three arguments for expanding the sales tax base:

• Modernizing sales tax can level imbalances
• Sales tax should change with the times
• Tax and economic policy experts support sales tax modernization

Modernizing sales tax can level imbalances

Currently, 'sales tax picks winners and losers in some arbitrary ways,' according to the Platte Institute. For example, a person with a pool doesn't pay tax on pool-cleaning services, but a person without a pool does pay tax on a sprinkler. A bag of chips is tax-free if purchased at a grocery store but subject to tax if purchased at a restaurant. And in a nod to wacky tax policy, the Platte Institute points out that breakfast sandwiches sold at the drive-thru window of a restaurant are taxable, while doughnuts sold at a drive-thru are exempt.

Why, they ask, should the person buying breakfast sandwiches have to pay tax when the person buying doughnuts does not? Why does one Nebraskan have to pay tax on a fast-food burger while another can buy a dozen lobster tails at the grocery store tax-free?

Sales tax should change with the times

Consumer habits change over time, as new technologies replace old, and the Platte Institute notes that many new technologies aren't subject to tax. Videos and DVDs (remember those?) are taxed in Nebraska, but streaming services aren't. You'll pay tax on a new car but not on ride-sharing services. And so on.

Online shopping offers another example. A few years ago, no state could require an out-of-state seller to collect tax on its online sales, and today, just about every state with a sales tax does.

Nebraska began taxing remote sales on April 1, 2019: Remote businesses are required to register with the state and comply with sales and use tax laws if their annual sales into the state exceed 200 transactions or more than $100,000 in total retail sales. Many sales of exempt services are included in that threshold, so businesses making exempt sales into the state can establish registration and reporting requirements, too.

Taking a free sales tax risk assessment can help you determine whether you have an obligation to collect.

Tax policy experts support sales tax modernization

Finally, the Platte Institute argues that sales tax is both too narrow and too broad. Although sales tax should apply to consumer goods and services alike, business inputs (i.e., business-to-business transactions) should be exempt.

The Platte Institute is not alone in this. The Tax Foundation has long called for taxing 'all final personal consumption.' Carving out exemptions on clothing or groceries, it says, is an ineffective way to 'lessen the regressive nature of sales taxes.' Like the Platte Institute, it believes sales tax should apply to more services but not B2B transactions.

Changing sales tax won't be easy

Nebraska has tried and failed to broaden sales tax in the past: A 2020 bill seeking to reduce the state sales tax rate and expand sales tax to services hit a dead end.

The current plan is already being criticized as 'good for the rich and bad for the poor.' And although Governor Pete Ricketts helped found Blueprint Nebraska, he's no fan of a broader sales tax.

Still, businesses that sell exempt services in Nebraska should keep an ear to the ground. If the Cornhusker State does decide to expand its sales tax, we'll report on it in the Avalara blog.