Proposed service tax is a dangerous prospect

Loren Kaye

President of the California Foundation for Commerce and Education


When politicians spend money as if the money was there, then they don’t have to raise taxes.  California leaders have practiced this sleight-of-hand for years, and now the bill has come due.

The California Legislature went on a spending spree that has nearly doubled outlays since 1998.  Now, faced with a $15 billion budget deficit, many elected officials and interest groups are advocating tax increases to pay for overspending.

With California sales and income tax rates among the nation’s highest, and its corporate tax rate in the top ten, the tax-and-spend lobby is reaching for more creative – and economically damaging – sources to feed the beast.

Topping the list is a new sales tax on services – an idea that has failed miserably when attempted in other states.  But the promise of a tax windfall is so alluring that the tax spenders cannot help themselves.

An elected leader of California’s top tax collection agency has prepared a list of services that when newly taxed would raise more than $8.7 billion, just for state purposes.  Another $5.8 billion would be raised for local government coffers.

Trouble is, these numbers don’t add up economically or politically.

Unlike gasoline, utilities and coffee, many services are elastic – demand for them is very responsive to price increases.  So raising the price of, say, a pair of movie tickets by $1.75 will decrease overall ticket purchases by about seven percent – almost entirely washing out the expected new tax revenues.  It would also encourage substitution, like making that DVD or on-demand movie rental much more appealing.  Bonus: the on-demand rental is sales tax free!

But the peril of raising services taxes is not just economic.  Over the past two decades, three large states have adopted sales taxes on services – and then repealed them within months.

In 1987, Florida enacted a broad sales tax on services, which covered all manner of personal and professional services, including a new tax on accountants, attorneys, architects and advertisers – and that was only the "A’s."  Within six months, the state legislature repealed the tax, replacing it with a penny increase in the sales tax on tangible goods. 

In 1990, Massachusetts expanded its sales tax to services, but repealed it before the effective date.  And just last year, Michigan adopted a sales tax on a wide range of mostly personal and business services.  It was repealed before it even went into effect.

Tax increases are not long-term solutions for budget deficits, especially if they worsen the fiscal ups and downs.  Any tax increase should be legislated as a temporary, last resort, broadly-based measure that would repeal after a short time.  And any discussion by the Legislature of new taxes must be tethered to consideration of spending reforms and tax equity that will demonstrate spending discipline.

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