Illinois continues to generally limit its sales tax to transfers of tangible personal property. This limitation has created a disconnect between sales taxes and the Illinois economy, because while the sale of in-state services accounted for 51 percent of the total Illinois economy in 1965, one study reports that by 2012, the sale of services had increased to 72 percent of the state’s economy.

Despite the growth in the service industry, Illinois—unlike other states—has not extended its sales tax to include sales of many services. Indeed, Illinois ranks 45th (out of 45 states imposing sales tax) in the number of service industries identified as subject to its general sales tax.

First-term Governor Bruce Rauner proposed in his gubernatorial campaign last year that Illinois expand its sales tax base to include 32 select services, notably air charter, advertising agency, attorney, marketing, consulting, and public relations services. This expansion was projected to raise approximately $600 million in new tax revenues, with an estimated $167 million projected to come from imposing a tax on attorney services alone.

Governor Rauner again referred to this expansion of the sales tax base in a speech shortly after taking office; however, the expansion was omitted from the Governor’s 2016 fiscal year-end budget, released in February. Instead, the budget opted to close Illinois’ multi-billion dollar budget deficit, with deep cuts to state expenditures. Naturally, the legislative leaders responded by arguing that the budget deficit could not be eliminated by expense cuts alone, and that new tax revenues also must be found. Thus, there is significant speculation that expansion of the Illinois sales tax base to encompass services will resurface in budget negotiations this year in the General Assembly.

On May 20, 2015, the Center for Tax and Budget Accountability and the Taxpayer’s Federation of Illinois released a joint report, which predicted that if the Illinois sales tax was extended to encompass a broad array of consumer services, an additional $2.01 billion in new tax revenue would be raised. According to the report, such consumer services would include a broad array of services such as hair grooming, country club memberships, health club memberships, lawn care, etc. Yet, the study recommends that business-to-business services and professional services (e.g., attorney services) be excluded from the tax base, and its revenue projections do not extend to taxes on these services. Indeed, the study eschews taxing business-to-business transactions because this typically results in “tax pyramiding,” which occurs when essentially one economic transaction is taxed multiple times during production and distribution, rather than just once upon final sale to the end-user.

Comment

With Illinois facing projected multi-billion-dollar budget deficits, worsened by the Illinois Supreme Court’s recent ruling invalidating the state employee pension reform legislation, the General Assembly may be compelled to extend Illinois’ sales tax to services.  Nevertheless, it is worth noting that in 1968, the Illinois Supreme Court struck down a previous attempt by the General Assembly to extend Illinois sales tax to a select number of services. The Court ruled then that such an extension violated federal and state constitutional due process, as well as tax uniformity guarantees, because there were no real and substantial differences between services taxed and services not taxed under the legislation. Thus, if the General Assembly does enact a sales tax on services, it will undoubtedly face a constitutional challenge in the courts, like the ill-fated pension reform legislation before it.