Currently, the Illinois state government imposes a sales tax that applies almost exclusively to goods rather than services. Because Illinois is beset by chronic budget deficits, however, the state has been trying to float the idea of extending state sales tax to services, including legal services but for the moment excluding other professional services. The liabilities of this plan far exceed its benefits.
The Reasoning Behind the Illinois Proposal
The proffered justification for proposing a tax on services, in Illinois as well as other states, is that the revenue it would raise could help bring a spiraling budget deficit back under control. Supporters of the Illinois proposal claim that taxing services will raise over $600 million, and that exempting legal services from Illinois sales tax results in an unjust windfall for lawyers who are mostly wealthy enough to easily absorb any new tax.
The Constitutional Issue
The Illinois Supreme Court held in the 1982 case Commercial National Bank of Chicago v. City of Chicago that the state constitution forbids a local government from imposing an “occupational tax” (including a tax on professional services) without the permission of the Illinois General Assembly. The current proposal, however, would be submitted to the General Assembly and, if passed, would not be unconstitutional on this basis.
The Commercial National Bank case, however, held the proposed tax on legal services unconstitutional for a second reason — the law singled out legal services for taxation while exempting closely related professional services such as securities and exchange services. The current proposal strongly resembles the proposal struck down in Commercial National Bank in its discriminatory treatment of legal services.
The Economics Issue
The economic objection to taxing legal services is the same in every state — it amounts to a government-imposed tax on the enforcement of government-guaranteed rights. Inevitably, a sales tax on legal services will be passed on to consumers of legal services just the way the state sales tax on goods is passed on. Fathers trying to win visitation rights with their sons, mothers attempting to hold deadbeat dads accountable for impoverishing their own children, and patients injured by defective medical equipment will all end up paying the tax.
Although it may seem politically expedient to tax lawyers, ultimately, such a tax will be regressive in effect, because it would be a flat tax that applies to everyone equally, both rich and poor. The poor, with lower disposable income, would be less able to afford to pay the tax. Consequently, the tax would disproportionately hobble the ability of low-income people to enforce their rights, giving the rich yet another unearned advantage at the bar of justice.
In addition to disproportionately burdening the poor, a tax on legal services (as well as other professional services such as accounting) would make it more difficult for small businesses to survive — small businesses, especially during their start-up phase, have certain professional needs that simply cannot be ignored if they are to operate legally.
A Better Way
Illinois’ budget woes result largely from the expiration of the 2011 temporary tax increases that raised the state income tax from three percent to five percent. The proposed professional services tax would at best make up only a fraction of the shortfall. Instead of imposing a flat professional services tax using a politically expedient sales pitch about “taxing rich lawyers”, it would be fairer to taxpayers and consumers to raise revenues by simply reinstating a fraction of the expired increases (setting state income taxes at 3.5 or 3.75 percent, for example).
Since the state income tax is progressive (higher income taxpayers are subject to higher tax rate), the average professional would probably pay more, and low-income taxpayers would pay less without being burdened with additional taxes every time they have legal needs. Lowering state income taxes only to make up the shortfall by imposing a flat legal services tax that disproportionately impacts lower-income taxpayers is unwise and unfair.