EVERYBODY loves to hate South Carolina’s mile-long list of sales tax exemptions. That’s not to say that — outside of a couple of particularly egregious loopholes — we have a clue what’s on it.
This column was first published on Oct. 30, 2011
So I was intrigued recently by a reader’s suggestion: “If you want to do the citizens of the state a service, why don’t you list all of the exemptions in your newspaper. We had a speaker a couple of months ago at a meeting, and he spoke on this issue. I was shocked at all of the special interests groups that have tax exemptions, ie. pet grooming!!!!”
Actually, pet grooming isn’t on the list of items exempted from the sales tax, but only because of a quirk in the way the tax code is written: We exempt all the things that are listed in the statute, but we exempt all the services that are not listed. And pet grooming — along with 133 of the other 167 categories of services that the Federation of Tax Administrators has identified as taxable — is not listed.
Still, it was a good idea — and preparing the list for publication proved quite educational. Although I’ve gone through the list of exempted products many times over the years, I usually was searching for absurdities. You know: Eyeglasses are taxed; hearing aids aren’t. Elephant ears you buy at a “public or charitable” festival are exempt, but the ones at the State Fair and county fairs aren’t.
In trying to figure out a useful way to arrange the list, I was struck by three things. First, how recent the proliferation of special exemptions is. Second, the way the Legislature moved over the years from the sort of exemptions that economists consider reasonable to those that had more to do with politics, or with attracting a specific company to the state, or granting a special favor to a specially favored lobby. And finally, how much of the value of the exemptions is tied up in a handful of items.
The tax code lists 78 numbered items that are exempt from the sales and use tax, but several of them have multiple parts; by my count, there are about 110. In 2008, the Board of Economic Advisors projected that they were worth $2.8 billion. That’s on top of the $1 billion in services that are considered “feasible” to tax and that are exempted by exclusion rather than inclusion, and the $100 million in Internet sales that the Congress won’t let us tax. By comparison, we collected about $3.3 billion in sales taxes that year. Add it all up, and we have a tax code that exempts far more products and services than it taxes, and as a result we have to have one of the highest tax rates in the nation in order to generate the revenue needed — the exact opposite of the wide and thin tax that economists say makes for a smart, sustainable tax code.
The first 25 to 30 exemptions were written into the 1951 law that established the sales tax, at 3 percent. The Legislature raised the tax to 4 percent in 1969 without adding any more exemptions. In fact, lawmakers went a quarter century after the first batch, until 1976, before they granted any additional exemptions. (The rate was raised two more times: to 5 percent in 1984, to pay for the Education Improvement Act, and to 6 percent in 2006, to pay for eliminating homeowner property taxes for school operations.)
Once lawmakers started granting exceptions, they couldn’t seem to stop themselves. They added more exemptions in 1979, and more still in all but nine of the next 32 years. (There might have been fewer no-exemption years; I couldn’t determine when three exemptions were passed.)
The first exemptions were mostly of the sort that economists smile upon: exempting the raw materials used in the manufacture of products that will be taxed, in order to avoid double-taxation. Many of the later exemptions fall into that category, as well.
The goal of most of the biggest exemptions also can be justified from an economic perspective — they make the tax code less regressive, by excusing people from paying taxes on necessities — even if the method used to achieve this caused serious problems.
The biggest exemption in the 1951 batch was for gasoline; in 2009 it was worth $557 million — a fifth of the cost of all the exemptions. Lawmakers followed this in 1976 with an exemption for prescription drugs and medical devices, worth $585 million in 2008; in 1979 with residential electricity and home-heating fuel, worth $188 million in 2008; and in 2007 with a $354 million grocery exemption that one tax expert believes has grown to at least $400 million since the last time the state did an official estimate.
The problem with exempting necessities is that the untaxed necessities are what we keep buying during a recession, while we cut back on the taxed non-essentials. That’s why sales tax revenue drops precipitously during a recession. We wouldn’t have that problem if instead of adding to the list of exempt products, we added to the list of taxed services.
Lawmakers passed the other two big exemptions in 1984. They were backed into a constitutional corner and had to grant a $253 million exemption on goods sold to the federal government, and they passed the $300 cap on the tax on vehicles — a $173 million gift to auto dealers, to buy their support for the EIA penny.
If there is a poster child for the abuse of sales tax exemptions, this is it. The cap makes the inherently regressive sales tax even more regressive, by forcing someone who buys a $5,000 clunker to pay a 6 percent tax rate, while someone who buys a $300,000 Lamborghini pays a tax rate of 0.1 percent. Yachts and planes, also subject to the cap, are taxed at an even lower effective rate. And the justification for the cap — to prevent South Carolinians buying cars in Georgia or North Carolina at what was then a lower tax rate — long ago evaporated, when those states raised their sales taxes.
The lawsuit challenging the ever-growing list of tax exemptions argues that the sheer number and value render them unconstitutionally arbitrary and capricious. Perhaps; perhaps not. But the fact is that the Legislature could abolish 100 of the 110 exemptions, tax all the taxable services and still be left with more than $2 billion in exemptions.
Do we need to get rid of a lot of those piddling little tax exemptions? Certainly. But while that’s a useful good-government move to eliminate special treatment, it’s not enough to constitute smart tax policy. To get that, we’re also going to have to go after the big four exemptions that benefit us all - and the car tax cap that benefits some of us more than others.
Editor’s note: Since this column was originally published, the plaintiffs lost their lawsuit challenging the constitutionality of the ever-growing list of tax exemptions. And the Legislature has added four more exemptions.
Ms. Scoppe writes editorials and columns for The State. Reach her at email@example.com or (803) 771-8571 or follow her on Twitter or like her on Facebook @CindiScoppe.