Into the Pumpkin Patch

Bloggers have had a field day ridiculing a year-old decision by the Iowa Department of Revenue that would subject certain pumpkins to state sales taxes. True, the decision was worthy of a Halloween chuckle, but the gigglers are missing the point.

This was one of those Solomon-like decisions that tax agencies have to make all the time. Is a pumpkin a tax-exempt "edible squash" or is it fated to be carved into a jack-o-lantern, which makes it a taxable decoration? Iowa's revenue department concluded that a retailer who markets the thing as a decoration has to collect tax on it. On Nov. 1, after this became a national story, the state reversed itself and decided to, um, squash the tax.

But at the same time Iowa first parsed its pumpkins, it tackled another question—one which is much less of an attention-grabber, but which has much bigger consequences. Should it collect sales tax on interior design plans? Is the buyer purchasing the plans themselves, which are taxable tangible personal property, or is he buying a designer’s work creating the plans, which is a tax-exempt service?

These questions keep coming up because even as states rely heavily on sales tax revenues, they bow to special-interest pressure to exclude many goods and services from the levy.

Politicians often say they must do this because the sales tax is regressive. But I don't know many poor people who are buying plans from a home designer. In reality, this is State House politics at its worst. And it prevents the states from making a much healthier trade-off. If they are willing to broaden the sales tax base, they could lower the rate.

In 2006, Americans spent $9 trillion. Nearly $5.5 trillion of that was spent on services—most of which are exempt from sales taxes. This doesn't make much sense on the state level. And if you think it is a problem now, just wait until the feds start talking more seriously about a value added tax or a retail sales tax. No one will be smiling over pumpkins then.