Into the Pumpkin Patch
Bloggers have had a field day ridiculing a year-old decision by the Iowa Department of Revenue that would subject certain pumpkins to state sales taxes. True, the decision was worthy of a Halloween chuckle, but the gigglers are missing the point.
This was one of those Solomon-like decisions that tax agencies have to make all the time. Is a pumpkin a tax-exempt “edible squash” or is it fated to be carved into a jack-o-lantern, which makes it a taxable decoration? Iowa's revenue department concluded that a retailer who markets the thing as a decoration has to collect tax on it. On Nov. 1, after this became a national story, the state reversed itself and decided to, um, squash the tax.
But at the same time Iowa first parsed its pumpkins, it tackled another question—one which is much less of an attention-grabber, but which has much bigger consequences. Should it collect sales tax on interior design plans? Is the buyer purchasing the plans themselves, which are taxable tangible personal property, or is he buying a designer’s work creating the plans, which is a tax-exempt service?
These questions keep coming up because even as states rely heavily on sales tax revenues, they bow to special-interest pressure to exclude many goods and services from the levy.
Politicians often say they must do this because the sales tax is regressive. But I don't know many poor people who are buying plans from a home designer. In reality, this is State House politics at its worst. And it prevents the states from making a much healthier trade-off. If they are willing to broaden the sales tax base, they could lower the rate.
In 2006, Americans spent $9 trillion. Nearly $5.5 trillion of that was spent on services—most of which are exempt from sales taxes. This doesn't make much sense on the state level. And if you think it is a problem now, just wait until the feds start talking more seriously about a value added tax or a retail sales tax. No one will be smiling over pumpkins then.
Years ago, I was presented with a similar situation. My firm represented a company that manufactured styrofoam products. One of the products was a “six-pack cooler,” a little styrofoam cooler just the right size to keep a six-pack of (presumably) beer cold.
At some point, someone noticed that the six-pack cooler was being used by sports fishermen to keep live bait alive. Needless to say, they created a new label for the cooler, calling it a bait bucket, and began selling it to sporting goods stores. A large sale was in the works to a national chain to promo the bait buckets as “stocking stuffers” for the Christmas season.
Things were looking up until a statutory change in the federal excise tax extended it to bait buckets. The change (I think under the 86 Reform Act) was effective September 30, effectively putting it in the middle of the Christmas season for the manufacturer.
I was asked to determine whether the non-taxable “six-pack cooler” was converted into a taxable bait bucket merely because of the change in labeling.
The supervisor of the excise tax section in the IRS took a “Pigs is Pigs” approach and said, if you call it a bait bucket, it's a bait bucket, and it's taxable as a bait bucket.
The national chain canceled the order.
Some stylized facts that appear to characterize sales tax policy debates: (1) the sales tax outscores property and income taxes in polls about which taxes are least unpopular, (2) there is often relatively little political resistance to sales tax rate increases, and (3) there is often fierce resistance to proposals to broaden the sales tax base, even when those proposals involve goods or services that are taxed in many other states.