From accounting firms to law firms to ad agencies, opposition to Gov. Mark Dayton's proposal to expand the state sales tax to services is overwhelming and portends a bruising legislative battle.

The prospect of a sales tax on the dollars companies spend on services -- such as consulting and legal work -- is variously described as anti-competitive, job-killing and discriminatory.

"It would really handicap the Twin Cities advertising and public relations community," said Doug Spong, president of the Carmichael Lynch advertising agency and founder of Carmichael Lynch Spong Public Relations. "It's absolutely a business killer. Ninety-nine percent of our clients are based somewhere else. When you add sales tax to a fee proposal, procurement officers will make the decision not to go with a Minnesota-based agency."

Dayton outlined his sales tax plan in a two-year budget proposal released Tuesday. His proposal would tax clothing for the first time, albeit only items that cost $100 or more. Minnesotans also would start paying a sales tax on consumer services like haircuts and auto repairs. As part of the sales tax expansion, the current sales tax rate on other goods would drop from 6.875 percent to 5.5 percent.

The effects of taxing business-to-business services is difficult to quantify. Only about six states tax business-to-business services, according to the Tax Foundation. Three states -- South Dakota, New Mexico and Hawaii -- tax nearly all services, although in South Dakota, for instance, the tax is offset by the lack of a personal and corporate income tax. Another three states -- Texas, Connecticut and Iowa -- tax services in a more limited fashion, but do tax business-to-business professional services.

St. Paul accountant Larry Mahoney, of Mahoney, Ulbrich, Christiansen & Russ, said his firm could lose business if a sales tax were imposed on accounting services.

"It's discriminatory against small business and most of our clients are closely held small businesses," Mahoney said. "It could reduce demand for services and competitively damage us when accounting services can be performed anywhere in this electronic world. And don't think they [accounting firms in other states] won't be marketing that."

Dayton's proposal to tax services would raise $1.5 billion in 2015, its first full year of implementation, said Revenue Commissioner Myron Frans in an interview Wednesday. Frans said the sales tax expansion for businesses would be offset by corporate income tax and property tax breaks.

Frans noted that Minnesota's economy was two-thirds goods and one-third services in the 1950s and 1960s and is just the opposite today. Minnesota's sales tax began in 1967.

"We understand businesses are not used to collecting sales taxes on services but we have to make the tax code reflect the economy we have," Frans said. "People don't like being in the system for the first time, but they've been out of the system for 40-some years. It's time for everyone to pay their fair share."

But it still is going to be a tough sell at the Legislature, where special interest groups can impose formidable roadblocks to unpopular proposals.

'Bad tax policy'

Charlie Weaver, executive director of the Minnesota Business Partnership, said his organization has been getting the message "loud and clear" from members that an expanded sales tax would be a job-killer.

"Economists say it's bad tax policy. It's regressive, it pyramids into the cost of a product and it's horrendously complex to administer," Weaver said. "Hopefully we can tell our story and convince the governor this is not good policy."

Beth Kadoun, director of tax and fiscal policy for the Minnesota Chamber of Commerce, said: "Good tax policy should be based on consumption, not services."

Scott Drenkard, an economist with the nonpartisan Tax Foundation in Washington, D.C., said he and many other economists and public finance professionals support expanding state sales taxes across the board to all consumer services, but say business-to-business services should be exempt to avoid double taxation -- first at the wholesale level and again at the consumer level.

"You should go for the gusto with sales tax expansion," Drenkard said. "To me, good policy is expanding to all [consumer] services and making them all pay the same rate."

Yet as a practical matter, Drenkard pointed out, it's difficult to expand sales taxes to professional services because they tend to be powerful groups.

"They're very well organized, they have lobbyists," he said. "It's hard to expand the sales tax to lawyers, because they've got a lot of lawyers."  

Robert Enger, president of the Minnesota Bar Association, has a potential lobbying force of 16,000 lawyers in Minnesota to rally against the proposal.

"A tax on lawyers really impedes access to justice," said Enger, supervising attorney for Legal Services of Northwestern Minnesota. "It's a misery tax. It's not a good time if you need services from an attorney."

There are 9,400 members of the Minnesota Society of Certified Public Accountants. Ad executive Spong said 5,500 people in the Twin Cities are directly involved in advertising and public relations with a total workforce of 44,000 when support services such as printing, animation and design are included.

Drenkard noted Maryland's failure in 2008 to expand its sales tax to "luxury services" such as landscaping. As Drenkard tells it, the various groups formed lobbies and, in the end, only one such service wound up taxed: information technology.

In short fashion the techies lobbied and got themselves carved out too, he said.

David Phelps • 612-673-7269 Jennifer Bjorhus • 612-673-4683