Schafer: Professional firms won't stick around for new tax

  • Article by: LEE SCHAFER , Star Tribune
  • Updated: February 2, 2013 - 4:07 PM
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Governor Mark Dayton unveiled his budget proposal Tuesday, January 22, 2013.

Photo: Glen Stubbe, Star Tribune

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Mark Dayton certainly doesn't want to drive the law firm Fish & Richardson out of the state.

No reason why the governor should. It's a top-shelf firm whose Minnesota jobs range from great -- law partners -- to just good, like mid-five-figure salaries plus benefits for administrative staff.

But if the governor's proposal to expand the state sales tax to legal services becomes law, the Fish & Richardson office in Minnesota almost certainly will not be around much longer.

Nothing special about the taxes of Fish & Richardson; it's one of many professional services firms running a national practice with people in Minnesota. This proposed tax changes the game for firms with that kind of profile.

Fish & Richardson is based in Boston with 369 lawyers, about 45 of whom are here. It's a go-to firm for patent and other intellectual property law for the likes of Google, Microsoft and Allergan.

None of its 12 offices is in South Dakota, New Mexico or Hawaii, the three states that tax nearly all services. Of course, none of those states is a major commercial center with a broad array of big services firms.

Dayton's rationale for extending the tax to services is that our economy has flipped from goods producing to services, so a tax on services reflects the economy we have. It's fairer to everybody.

A broader tax base is not completely crazy economics, either, as it can reduce one of the distortion effects of taxes.

Simply put, wherever tax rates vary a lot between products and services that do roughly the same job for consumers, known as close substitutes, consumers lean toward spending money on the option with the lower tax.

Now that means repairing a dishwasher rather than buying a new one -- avoiding the tax, tipping the decision in favor of repair. That's distortion.

But the problem of the governor's broader sales tax is that it's not nearly broad enough. For Minnesota firms in a national market, there's nothing broad about a sales tax if Illinois or Wisconsin do not have it.

Consumers of legal services purchased to defend a patent, like an associate general counsel of a company like Google, oh boy, do they ever have untaxed substitutes available to them. Untaxed perfect substitutes.

They can hire lawyers from another top intellectual property firm to represent them. Or they can pick an absolutely perfect untaxed substitute to Fish & Richardson in Minneapolis: Fish & Richardson in California.

Owners of local firms that sell mainly in a local market may be griping, but a 5.5 percent tax on consumer services like automotive repairs will not present different tax rates to services with readily available substitutes, except perhaps in border towns. Al's Auto Service will be treated the same as Jim's Auto Repair.

The biggest effect on Al and Jim is just a higher price to their customer, so at worst they maybe sell fewer hours of their services. Still painful for companies that built a cost structure assuming no such tax, but not a change in the competitive landscape.

The financial effect here on firms like Fish & Richardson, on the other hand, is significant.

We know that national clients with lots of options aren't inclined to pay higher bills for no more value, so the sales tax comes right out of profits.

In Minneapolis the proposed 5.5 percent state tax is also likely to extend local sales taxes onto services, a less discussed feature of this proposed tax policy change. That would take the tax rate in Minneapolis from what Dayton proposed, 5.5 percent, to 6.4 percent. It's enough to shrink the profitability of Minneapolis legal work by more than 20 percent.

"[My partners] wanted to know why on earth our state would do this," said Ann Cathcart Chaplin, managing partner of Fish & Richardson in Minneapolis. "No matter how we looked at this, it makes it unattractive to grow this office."

The sales tax is in a conceptual stage, and there eventually will be rules on precisely what would be subject to any new Minnesota tax. A spokeswoman for the Minnesota Department of Revenue said the bill was in the drafting stage and specifics would be forthcoming.

Cathcart Chaplin said it's her understanding that the work of a Minneapolis lawyer would be taxed, even if billed out of Boston.

This is not just a big firm problem, as firms that would be considered regional or even local may have expertise that clients from out of state really value.

A few blocks away from Fish & Richardson in Minneapolis is the intellectual property law firm Schwegman, Lundberg & Woessner, with about 45 lawyers in Minneapolis and smaller offices in other states.

Firm co-founder Micheal Schwegman said "maybe half" of his firm's clients are out of state. "We are in a national market," he said, "We like our local clients, but technology is a national and international market, and we are very much in competition with firms around the country."

It has to be much the same story for other law firms, and advertising firms, accounting firms and other kinds of service providers.

Cathcart Chaplin grew up in Marine on St. Croix and graduated from the University of Minnesota before going off to law school in the East. She has a top-of-the-profession job without having to leave her home state.

Would she really move?

"At some point, there is a limit for everyone," she said. "If your profession that you've dedicated all this time and effort to is so disadvantaged by your state, you would have to think hard. I would hate it, I confess."

lee.schafer@startribune.com • 612-673-4302

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