Studies by independent think tanks argue that while increasing service taxes is a good idea, extending that tax to professional services isn't.

One year ago, LawPulse featured Governor Rauner's 2014 campaign proposal to implement a service tax to shore up Illinois' budget deficit. ("A service tax on lawyers?" February 2015 Journal.) Attorneys were the only professional service included in his proposed tax; medical services, architects, accountants, and engineers were not included.

Given that the General Assembly hasn't yet addressed the revenue side of the budget equation, a tax on legal services remains on the table. According to a joint study by the Center for Tax and Budget Accountability (CTBA) and the Taxpayers' Federation of Illinois (TFI) (online at http://bit.ly/1N3CJSB), Illinois' sales tax base needs to be modernized to reflect the importance of services.

The study recommends that Illinois expand its tax base to include the sale of services, particularly consumer services - such things as pet grooming, haircuts, lawn care, and health clubs. But the study specifically warns against taxing professional services. It notes only six states do so of the 45 that have a general sales tax. (None of Illinois' neighboring states do so.) The study says that "Illinois simply should not go from being a national tax outlier by having too narrow of a base, to being an outlier for having too broad of a base. There are other, administrative issues unique to taxing professional services that make doing so more complicated than other services."

'No panacea'

Brian Hamer, former director of the Illinois Department of Revenue, recently wrote an article for State Tax Notes entitled "Taxing Services Is No Panacea," available at http://bit.ly/1mRNYJ6. In the article, Hamer identifies the failure of the sales tax to grow with the economy as a contributing factor to the state's financial challenges that include a more than $100 billion shortfall in unfunded pension obligations.

Hamer says that the "case for modernizing the sales tax in Illinois is compelling." However, he also believes that "taxing services in not a solution, or even a material part of the solution, to Illinois' budget woes." His analysis tracks that of the CTBA/TFI study, noting that taxing business-to-business services undermines the transparency of the tax because it is unclear who bears its ultimate burden. A tax on those types of services targets business inputs at several levels of the supply chain, meaning that each step is taxed. Economists refer to this as pyramiding.

Hamer agrees with the CTBP/TFI study that any service tax should be limited to consumer services and that professional services should be off-limits. Observing that most states do not tax professional services, he points out that medical, financial, and legal services are difficult to regulate. He notes that Governor Rauner's proposal would tax legal but not financial services.

The ISBA's position is that regardless of the taxation principles at play, a tax on legal services is regressive and unfair to consumers and small businesses, according to ISBA Director of Legislative Affairs Jim Covington. People seeking payment of delinquent child support, custody of a child, recovery for injuries in a worker's compensation or personal injury action, or guardianship of an older parent should not be taxed, Covington says. "We shouldn't tax individuals for exercising or defending their legal rights."