Overall tax reform in Wisconsin depends on the sales tax

Department of Revenue's guidelines on taxing ice cream cakes illustrate the absurd complexity of state's sales tax system

By JAY MILLER | April 25, 2019

The Badger Institute and Tax Foundation’s in-depth report, “Wisconsin Tax Options: A Guide to Simple, Fair, Pro-Growth Reform,” offers a roadmap for revamping Wisconsin’s noncompetitive and archaic tax structure. What the report makes clear is that the linchpin for implementing overall reform is the state’s sales tax.

While Wisconsin’s individual and corporate income tax rates rank among the highest in the country,1 the sales tax rate, averaging 5.44% on a state and local basis, is the fourth-lowest of any state with such a tax.

Moreover, Wisconsin exempts from the sales tax whole categories of products and most services, leaving on the table huge amounts of revenue that could be used to fuel reform (including sharp cuts in income tax rates) without busting the budget.

Importantly, as the report explains, not all taxes are created equal. Studies show that high corporate and individual income taxes are more harmful to capital investment and job creation than a consumption, or sales, tax.

To illustrate the point, albeit without regard to other factors, look at the contiguous states of Oregon and Washington. Oregon has a top income tax rate of 9.9% (higher than Wisconsin’s), but it has no sales tax. Conversely, Washington’s sales tax in some locales, including Seattle, goes above 10%, but it has no income tax. Which state fares better from a growth standpoint? Washington.

This is not to say that Washington’s model is optimal for Wisconsin. Nonetheless, it supports the report’s premise that bringing down the Badger State’s too-high income tax rates will spark the economy more than keeping its sales tax as low and constrained as it is.

With that in mind, the report lays out four alternatives, any one of which would put Wisconsin on a more pro-growth trajectory. Despite their differences, all of the options would lower and flatten individual tax rates and sharply reduce or even eliminate the corporate tax.2 To make that fiscally feasible, the sales tax base would be expanded, and the tax rate slightly increased under two of the options.

Broadening the sales tax base ought to be the main priority. This makes sense from a tax policy standpoint.

Maze of rules

Tax scholars and economists have stressed repeatedly that the government should not be in the business of picking winners and losers, as Wisconsin does now with its maze of rules governing what’s in and what’s out of the sales tax bucket.

Consider the case of ice cream cakes.

The law stipulates that such cakes categorized as “prepared food” — which entails its own intricate definition — are subject to a sales tax, whereas other types of ice cream cakes are not. To sort out this mess, the Wisconsin Department of Revenue has felt obliged to offer no fewer than 10 examples to educate sellers of these delectables just where the tax line gets drawn. All this bother for ice cream cakes alone!

Other hair-splitting distinctions abound. A cursory review of state statutes and Department of Revenue publications reveals a seemingly endless list of exempted items, and it begs the question of why they all are necessary.3 (Spoiler alert: They’re not.)

Not surprisingly, these exemptions add up to real money. Insofar as goods are concerned, the report documents that in 2016 Wisconsin passed up $1 billion or more in revenue by not taxing food, bottled water and motor fuels alone.

Similarly, not taxing certain services cost Wisconsin another $1.1 billion in 2016. As the report notes, it’s more of a historical accident than anything else that explains why the sales tax applies generally to goods and not to services.

In prior decades, goods predominated over services as a part of economy. Now that has changed; services reign. And the sales tax scheme should change accordingly to keep pace.

Keep in mind taxing goods need not be an all-or-nothing proposition. Far from it.

There are varying degrees to which the sales tax base could be expanded — or offset for people at the lower end of the income spectrum (as the report shows). Nonetheless, moving in that direction would represent a positive step from a revenue and tax policy perspective.4 And all of this would be without an increase in the sales tax rate.

Yet, that, too, is proposed in two of the report’s four options because of the latitude Wisconsin has with respect to its currently low rates. Using the Department of Revenue’s sales tax projection estimates, it could be expected that a one-tenth of one percentage point increase in the state sales tax would generate approximately $118 million annually in additional revenue, all other factors held constant.

In addition, even if the state sales tax rate was raised from 5% to 5.75%, as one of the options posits, Wisconsin still would have a very competitive rate nationwide. In contrast, our neighbor to the south imposes an average state and local sales tax rate of 8.43%, and Chicago’s is 10.25%.

In its Introduction, the report tells us: “Positioning Wisconsin for the future means creating a tax code that can grow with the state, not hold it back.” A pro-growth tax code, in turn, depends on expanded use of the sales tax to provide the wherewithal to make that happen — that, and political will from our governor and Legislature.

Jay Miller of Whitefish Bay is a visiting fellow at the Badger Institute. He is also a tax attorney and an adjunct professor at the University of Wisconsin-Milwaukee’s Lubar School of Business.

1 Although manufacturing and agricultural corporations enjoy a substantial credit to offset most of their income taxes, other types of corporations in the state are obliged to pick up the slack, creating a very unbalanced playing field.

2 The options also would make adjustments to the state’s standard deduction and, under three of the options, repeal the personal exemption.

3 Holding sales tax holidays on selected products, as Wisconsin did last year, is another example of government picking winners and losers that ultimately contributes nothing to the economy long term.

4 Indeed, courtesy of the U.S. Supreme Court’s recent ruling in South Dakota v. Wayfair Inc. that says states can collect a sales tax from a large swath of out-of-state (mostly online) retailers selling to in-state residents, Wisconsin’s sales tax base already has been broadened.