According to the Tennessee Department of Revenue, state and local governments in Tennessee lose over $3.5 billion per year as a result of sales tax exemptions. Just five years ago, that number was only $2.2 billion. Five years before that, only $1.1 billion was lost annually.
So why is this number so large? And why is it growing so quickly? The answer to the first question is especially interesting in light of the fact that Tennessee is one of a minority of states that continues to tax groceries. Exempting groceries is widely recognized as an easy way to reduce the disproportionate impact that sales taxes have on the poor, but Tennessee doesn't do this. So where is the money going? For one thing, less than 40 percent of potentially taxable services in the state are actually taxed. Despite the gains in revenue and in fairness to be had from taxing services, haircuts, taxidermy, limousines, dating services, and many others remain tax-free in the state.
This also helps explain why the losses to the state have grown more than three-fold in the last decade. It is no secret that the U.S. has steadily been moving towards a more service-based economy. As this has happened, consumption has been shifted into purchases that are tax free under Tennessee law. This shift in the economy has a lot to do with why one University of Tennessee professor believes that only 48% of Tennessee's sales are subject to the sales tax. In 1979, it is estimated that that number was 65%.
But services don't explain the entire loss. Under pressure from organized interest groups, year after year, Tennessee legislators continue to add more exemptions to the tax code. This year alone, football merchandize, solar panels, and flatbed farm trucks were proposed to be made exempt from the sales tax. Exemplifying the problem perfectly was one bill that proposed to exempt mulch from taxation. Upon being introduced, a long list of goods including fencing wire and machine oil were added to the bill, ballooning its cost from $88,000 to $1.3 million per year.
This problem is by no means unique to Tennessee. As one South Carolina newspaper recently pointed out, shrinking sales tax revenues are partially a result of "small, targeted tax cuts [that] get even less scrutiny -- and make even more of a mess of our Swiss-cheese tax code". But this problem is especially noteworthy in Tennessee because the state lacks a broad-based income tax. With Tennessee state and local governments relying almost exclusively on sales taxes for revenue, these kind of exemptions are cutting into the fiscal foundation of public services. Tennessee state and local sales tax rates have already been raised to levels that are among the highest in the nation in order to make up for this lost revenue.