Sales tax base expansion proposals target broader services

Take a wild guess at which state has proposed a contentious bill that would enlarge its sales tax base by greatly expanding its definition of “taxable services.” Hint: this state, whose Latin motto translates to “strong deeds, gentle words,” is no stranger to controversial sales tax legislation in the digital era, along with others such as California and New York , for instance.   That’s right – Maryland is at it again.  

While several states already include some narrow categories of services in their sales taxes, others are disproportionately expanding the tax base through broader, ill-timed consumption taxes.  During the last two years, many states have reduced taxes, including income, property, and yes, even some sales tax rates. In attempting to provide some economic relief for its taxpayers, some are now undergoing budget shortfalls or deficits as pandemic-era funds diminish and persistent systemic inflation remains “sticky,” – especially in the services sector.   

Some states continue to reduce sales tax rates (vertically), while broadening and over–burdening the base (horizontally) with more digital and services taxes at a time when this is an overwhelming contributing factor to rising inflation. Consequently, through this type of revenue reallocation, these states are creating a sort of “fiscal illusion.” One example of this is Nebraska’s controversial attempts to pass property tax relief measures to be funded through a sizeable increase in sales tax, having first cut taxes a year ago.

However, Maryland House Bill 1515, which awaits a second reading in the state’s House of Delegates, aims to increase sales and use tax revenues via a unique two-step approach. 

First, the proposed legislation would reduce the state’s sales tax rate from 6% to 5%. Second, HB 1515 would expand the state’s current definition of “taxable service” to apply to many more categories of professional services. The bill would implement other smaller changes, such as adjusting how sales tax is calculated on sales under $2; changing tax rates on vending machine sales, alcohol beverages and dyed diesel fuel; and eliminating some current sales tax exemptions.

Today, Maryland applies sales tax to about a dozen services, including commercial cleaning, special-order printing and fabrication, security services, a range of telecommunications services and transmission and distribution services related to the delivery of electricity and natural gas. HB 1515 would expand taxable services to cover “any activity engaged in for a buyer for consideration.” Certain services would remain exempt from sales tax, including education and healthcare, as well as services provided by business, professional, labor and political associations.

This is a big deal. The bill shows that Maryland legislators are well-aware of the fiscal risks posed by a shrinking sales tax rate base. According to an analysis conducted by the state’s Department of Legislative Services, the state’s proposed expansion of the base – even with the 1% sales tax rate reduction – would have a net result of increasing Maryland’s funding by $868.3  million to $2.9 billion annually from 2025 to 2028 (see the tabular breakdown on the first page of this report).

As for who will bear the brunt of the tax increases – well, that’s where the story gets heated. 

State revenue agencies favor the proposal as it provides them with a more lucrative, and stable, funding mechanism. Some smaller (non-service) businesses might appreciate the reduction of the state sales tax rate, given that it could stimulate consumer spending. Critics of the sales tax exemptions that would be repealed likely favor the proposal as well.

Strong opposition to the bill, and its application of indirect tax on professional services in particular, also exists. 

The Maryland Chamber of Commerce, the Maryland Retailers Association, and the NFIB issued a joint statement assailing HB 1515: “This draconian tax expansion is being considered as a way to cover funding gaps created by numerous unfunded policy mandates and costly legislation passed in recent years. However, placing such an enormous burden on Marylanders and small businesses is not the answer. While the policies driving these funding needs may be well-intended, the proposed solution of a $2.9 billion tax increase through HB 1515 fails to fully consider the severe economic impacts it would have on Marylanders, businesses, and our state's competitiveness.”  

To be sure, the proposed bill has a ways to go: numerous additional readings and reviews in Maryland’s House and Senate await. We’ll keep you posted as (or if) the bill advances. If it does, the state may want to consider reforming its moto to “strong deeds, controversial indirect tax legislation.”