In D.C., a bill that would expand the sales tax to include services like health-club memberships has drawn the ire of gym and yoga-studio owners. Here's why it's good for cities—and for consumers.
Yoga practitioners in the District of Columbia are tying themselves in knots over a budget proposal that would introduce a sales tax on yoga classes and gym memberships. D.C.'s so-called "yoga tax" even has politicians stretching: D.C. Council member and mayoral candidate David Catania has pledged to introduce an amendment nixing the tax before the final vote on the budget on June 24. Muriel Bowser, another Council member who is running for mayor, is also against it.
If the Council wimps out, it will be a shame—for the entire District, gym rats included. The gym tax represents an expansion of the sales tax that fits today's economy, which has long been shifting from a products footing to a services one. More cities need to take the lead in that regard. And cities should emulate this specific category of services tax: Higher prices for gyms and yoga studios could help to clear residents' thinking about what they get out of the bargain.
In Washington, D.C. Council Chairman Phil Mendelson is defending the gym tax as a plan to pay for an income tax cut. Although the 5.75 percent sales tax expansion has been dubbed a fitness tax, it in fact covers a variety of services, including health clubs, car washes, and bowling alleys. Meanwhile, the proposed income tax restructuring would (among other things) carve out a new bracket for single residents making between $40,000 and $60,000.
These residents would pay a 6.5 percent D.C. income tax rate as opposed to the current rate of 8.5 percent. As the D.C. Fiscal Policy Institute notes (based on tables provided by the D.C. Office of Revenue Analysis), the proposed income tax cut would save D.C. residents making between $50,000 and $75,000 about $400 per year. That'd be welcome news for most taxpayers in D.C., where mean per capita income in 2012 was about $45,000 and median household income was about $64,000.
The sales-tax expansion applies to a suite of services, including billiard parlors, upholstery cleaning, at-home water delivery, and tanning studios. Not all of these are membership services. The price for a one-hour game of billiards at one D.C. pool hall would go up about 50 cents, by my math—the same way you'd pay a 5.75 percent sales tax on a pool table, cue, and neat-looking visor, if you were simply buying the products instead of paying for the service. Only the health-club tax has spurred any significant outcry; to this point, the sales tax would add about $4 to your garden-variety $70 monthly gym membership.
No sales tax on abs! pic.twitter.com/yHOgUtQyki— Josh Barro (@jbarro) June 12, 2014
Both Matthew Yglesias and Josh Barro have explained why expanding sales taxes to include services is a good, even critical deal for cities. A sales tax on gym memberships is no more a tax on fitness than a sales tax on books is a tax on knowledge. Yglesias notes how a "distortionary" sales tax that doesn't include services creates "a tax subsidy to convert more things to services rather than goods than would otherwise be the case." Barro explains that sales tax expansions aren't as popular as they are reasonable: Between 2008 and 2011, seven states that tried to expand the sales tax to services saw those measures struck down.
A fitness tax, if we're going to call it that, is a good deal for cities and gym owners alike. That's because there is almost nothing a gym or a city council or anybody else can do to convince someone to cancel a gym membership. This has been true since 2005—if not for centuries or millennia longer—when economists Stefano Dellavigna and Ulrike Malmendier described the irrational preferences that seize consumers when they're buying gym memberships. That study established that people will choose a monthly contract for $70 over paying $10 per visit, even if they only consistently go just four times a month. Or not at all.
The theory of "hyperbolic discounting" also helps to explain why you put off going to the gym. As Derek Thompson explains:
This is the theory that we pay more attention to our short-term well-being and "discount" rewards that might come further down the road. Think of a small reward in the distant future, like taking a nap three weeks from now. Doesn't hold much appeal, does it? But when the small reward is imminent—Take a nap right now? Woo hoo!—it's considerably more attractive. Given the choice between small/soon rewards versus larger/later benefits, we'll take the former. Hyperbolic discounting helps to explain why Congress can't pass deficit reduction, why drug addicts stay addicts, why debtors don't pay off their bills, and why you keep telling yourself that the right day for exercise is always "tomorrow."
Dellavigna and Malmendier offer several explanations for why we keep paying for gym memberships even as we're putting off ever making any use of them. Or, in economics terms, why consumers so consistently deviate from making the optimal contractual choice. The researchers offer several explanations: memberships make members feel "virtuous" whether they use them or not; sometimes it's a giant hassle to cancel a membership; people plum forget about it.
"In our view, the most parsimonious explanations are those allowing for overconfidence (naivité)," the study reads. "Consumers overestimate, for example, their future self-control or their future efficiency in pursuing costly activities." In other words, the right day for exercise is always tomorrow—and every other day after that going forward plus twice on weekends.
What this means for fitness club owners is that raising monthly fees is unlikely to lead droves of members to cancel their memberships, since nothing will. Failure is built into the traditional gym model: According to Men's Journal, commercial gyms need 10 times as many members as they can accommodate in order to thrive. "The entire gym, from soup to nuts, has been designed around getting suckers to sign up, and then getting them mildly, vaguely exercised every once in a long while, and then getting them out the door," writes Daniel Duane.
So if your city council did convince you to quit your gym, they might be doing you a favor. Opponents of the sales-tax expansion strenuously disagree: Debra Perlson-Mishalove, the creative director of D.C.'s Flow Yoga Center, told me via email that the bill would negatively affect everyone in D.C., "from youth who take dance classes, yoga, and meditation, to elder people whose doc prescribe yoga and movement."
That could be the case when it comes to yoga: Studios tend to provide services by the class (though often with discounts for packages of classes), not by subscription, meaning that yoga enthusiasts are not always subject to the same fraught consumer psychology as gym members. Rational consumers looking to maximize their utility might cut back on those services when the price of a class rises from, say, $11 to $11.60. But another aspect of the proposed budget—a gradual decrease in the District's business franchise tax rate from 9.975 percent to 8.25 percent—could offset any losses for yoga studio owners. Maybe yoga studios should offer more memberships as opposed to classes (and many already do).
When more and more Americans belong to gyms and more and more Americans aren't fit, it's hard to follow how taxing fitness services necessarily results in taxing fitness. But the prominent criticism that says that lower-income gym-goers will be adversely affected by higher costs for gym memberships is provably false, at least in this case. Lower-income D.C. residents would have more money to spend on services, including those gym memberships they'll never use.
Expanding the sales tax to cover services is a good idea for cities even absent the income-tax cut that D.C. is proposing. As Yglesias notes, "If you exempt a large and growing share of economic activity from taxation, then you need to tax the rest at a very high rate to make up the lost revenue."
It makes sense that gym and yoga studio owners would rather not see their services taxed. But it's not necessarily worse for city residents or for consumers to move in this direction. Taxing gyms may not affect fitness one way or another: In D.C., the sales-tax expansion is revenue smart, fitness neutral.