Year of Publication
Martin School of Public Policy and Administration
Currently Kentucky is facing a budget deficit of $108 million dollars for the fiscal year 2010. As some lawmakers search for revenue options, one possibility is to consider a sales tax on professional services.
Professional services are considered any kind of service that requires skill, knowledge, reputation, ethics, and creativity. For the purpose of this study, medical services are not included in this category. Many of the services are infrequent, such as the services of an attorney or an accountant. A professional services tax could be used for both businesses and individuals, or could make businesses tax exempt. As of 2010, three other states tax professional services: New Mexico, Hawaii, and South Dakota.
According to tax professionals, one model of analyzing a possible new tax is to examine the potential revenue, incidence, and competitiveness of the tax. The potential revenue can be estimated by finding the approximate amount of revenue spent on professional services and performing a Moving Average Forecast. This would assume 0% elasticity. A sensitivity analysis provides a range of the expected tax revenue for several assumptions of elasticity. The incidence can be analyzed by determining who will pay the tax, and then examining the equity of the tax, such as who the burden of the tax will fall on by examining the demographics of Kentucky. The competitiveness can be analyzed by analyzing the effect of a professional tax in Kentucky when the surrounding states do not.
Potential revenue was estimated to be about $322,000,000 for the fiscal year 2010. Analysis of the incidence of the tax estimates that the burden of the tax would unfairly fall on those in the lower income bracket, and could also have a negative effect on small businesses. While the structure of the tax code could be written to exempt the professional services consumed by businesses, then the amount of revenue generated would not be as much since businesses make up at least a portion of professional service clientele. However, broadening the tax base helps keep tax rates lower. It is also important to consider that most professional services are generally considered an inelastic service, since many professional services are necessary, such as hiring an attorney or an accountant. The fact that surrounding states do not tax professional services could also drive business to neighboring states, especially in circumstances like Northern Kentucky and Cincinnati, when many professional services are located right across the river. The surrounding states have a comparable sales tax to Kentucky.
After considering all possible outcomes of the tax, it is recommended that Kentucky not institute a tax on professional services, and continue to study revenue options. Even though taxing professional services could cover a significant portion of the budget deficit, there are still too many unknowns in regards to the incidence of the tax.
Mando, Meghan, "Should Kentucky Tax Professional Services As a Way to Raise Revenue? An Economic Analysis of Possible Revenue Options" (2010). MPA/MPP/MPFM Capstone Projects. 134.