BUDGET : Patient May Find His Doctor Taxing as States Seek Revenue

The states, desperate to ease their mounting fiscal crises, are once again eyeing a seemingly boundless source of additional revenues--imposing taxes not just on the sale of goods but also of services, which now are exempt from most state sales taxes.

And, despite powerful opposition, the move toward taxing services may become an unavoidable trend for a more basic reason: It permits state tax systems to adapt to the fundamental shift in the U.S. economy from manufacturing to services.

Levies on services could affect everything from plumbing repairs to haircuts, from physicians’ fees to advertising and interior decorators’ bills. They could also net the states hundreds of billions in revenues, depending on which items were taxed.

In the near term, states are likely to move cautiously. Any new tax imposes pain on voters and makes unwelcome changes in the shape of the economic playing field.

All-out lobbying efforts--especially by small businesses and advocates of rapid growth--already have defeated or, in some cases, reversed state taxes on services.

In the longer term, however, many tax specialists believe taxing a wide range of services is inevitable.

“A substantially larger portion of the economic activity each year is taking the form of services,” said Hal Hovey, editor of State Budget and Tax News. “Without taxing those, you are hitching your economy to a falling star.”

The push toward taxing services already is under way. Although only three states--New Mexico, South Dakota and Hawaii--levy sales taxes on a broad array of services, almost all states have some form of service taxes, mostly on hotel and motel lodging.

And Corena Eckl, a tax policy specialist with the National Conference of State Legislatures, said that, in their current sessions, at least eight legislatures have considered bills to expand their states’ sales taxes to cover services. (California was among them, but for now has set the idea aside.)

The path so far has been bumpy.

In one classic turnabout, Florida imposed taxes on a broad array of services--including advertising--in 1987, but was forced to repeal the measure the very next year after the service industries began a massive lobbying campaign that wreaked havoc in the Legislature.

And a services tax on everything from architects to entertainment, adopted in Massachusetts last year, remained in effect for only 48 hours before being repealed. Opponents, including the governor, said the paperwork associated with the tax imposed too big a burden on business.

Opponents of the taxes argue that they make the cost of buying services so high that some firms might begin to turn to in-house staff instead of contracting for services outside--or they might even leave for a state that does not tax services.

They contend also that the impact of any tax on services will fall harder on small businesses than large ones. Without support staffs of their own, smaller firms must rely more on buying services from other companies.

“Everyone who tries it is sorry because it either drives business away or down,” Daniel Jaffe, executive vice president of the Assn. of National Advertisers, said about imposing services taxes.

But some states are experiencing success by extending the tax to only a few services at a time.

New York, for example, last year began taxing cleaning and security services, adding to previously existing taxes on auto repairs and appliance installation. But lawmakers scrapped proposals to tax public relations and management consulting services--in the face of heavy lobbying.

Laird Graeser, a New Mexico state tax revenue expert, believes that the gradual approach offers the best hope for success. “When you get too many groups screaming at the Legislature and governor . . . they lose their will to do it,” Graeser says.

But Marcia Howard, deputy director of the National Assn. of State Budget Officers, contends that, no matter what the setbacks in the short-run, a tax on services is inevitable. “The states are in such deep trouble,” Howard said.