Placing Sales Taxes on Services Creates Upward Mobility for Few

Justin Adams, Ph.D.

President and Chief Economist of Encina Advisors


Some have called Senate Bill (SB) 8, Senator Robert Hertzberg’s proposal to impose sales taxes on most services in California, needed tax reform. The basic argument made is that while California’s economy has shifted over the past 50 years from being based on agriculture and manufacturing to information and services, the state’s tax policy remains mired in the past. Consequently, a revamped tax system – one that focuses on services rather than personal income, as is the case today – would better reflect this new reality.

Californians can, and should, have an open and honest debate over tax reform. That’s because replacing our current tax system with one focused on services involves real tradeoffs for the state: It would help reduce the volatility of government revenue while at the same time placing a larger burden on low-income families and adding substantial new compliance costs for businesses and taxing agencies.

That said, we should be clear about one thing: SB 8 is not about reforming taxes. It’s about increasing spending.

The bill’s title, the Upward Mobility Act, suggests as much. And a quick read of the bill’s preamble confirms this. SB 8 “would help ensure California’s residents and businesses can thrive in the 21st century global economy by increasing funding by $10 billion dollars for the following programs….” (Emphasis added.)

Which programs would get increased funding? They include K-14 education ($3 billion), the University of California and the California State University ($2 billion), local governments ($3 billion), and a new earned income tax credit for low-income families ($2 billion). This spending is specifically targeted to combat income inequality and grow the number of middle class jobs.

In this light, Californians should not judge SB 8 by how well it would modernize California’s tax system. Instead the appropriate question is, with respect to facilitating upward mobility in the state, how do the benefits of SB 8 compare to the costs?

Senator Hertzberg is still fleshing out the details of SB 8, but we know enough today to start a preliminary analysis of benefits and costs. Let’s focus in particular on the spending for the University of California (UC) and the California State University (CSU).

First, what are the benefits from spending an additional $2 billion, split evenly, on UC and CSU? In other words, how many new graduates can we expect to see every year? These graduates presumably would be well positioned to obtain good paying jobs and contribute to the state’s economy.

The California Department of Finance shows that in 2014-15, the state spent $3.872 billion on General Fund university support and financial aid for the UC system. Across a total of roughly 249,000 UC undergraduate and graduate students, this implies an average of about $15,550 of state spending per student. For CSU the numbers were $3.563 billion in spending and 448,000 undergraduate and graduate students, resulting in an average of about $7,950 per student.

If these per student averages continue to hold, then the additional $2 billion from SB 8 could help support about another 64,300 UC undergraduates and 125,800 CSU undergraduates a year. Note that some of these students would be underclassmen, and some would leave school early. So assuming these additional students would be evenly distributed across all four class levels and then factoring in historical graduation rates – four-year graduation rates for freshman are 63 percent for UC and 19 percent for CSU – this means SB 8 would result in about 10,100 UC graduates and 6,000 CSU graduates each year.

Now what are the costs? IMPLAN, as well as similar economic modeling software based on U.S. Bureau of Economic Analysis statistics, captures the historical spending patterns of households by income level. Consequently, IMPLAN can be used to apportion SB 8’s $2 billion levy for higher education across the service sectors that would be taxed (i.e., all services excluding healthcare and education) and approximate the additional costs per household.

My quick analysis using IMPLAN is that the more than 13.6 million households in California would pay on average an additional $148 per year specifically for SB 8’s higher education provision. (This suggests that funding SB 8’s entire $10 billion requirement entails an average of closer to $740 per year.) For the nearly 6 million households making $50,000 or less a year, the average additional burden would be about $84 per year, which is less than $148 but still significant.

So that’s the tradeoff: Roughly 16,100 new UC and CSU graduates every year versus $148 taken from 13.6 million households every year.

In other words, in a state with a population approaching 39 million, SB 8 would provide upward mobility through higher education, but only for a few. And it would come at the expense of many who could use a little help on their own.

To be clear, having more graduates from UC and CSU certainly would be a good thing, primarily because of the job opportunities and earning potential that these institutions convey. But there are probably better ways to squeeze an additional 16,100 graduates out of the existing educational system than by imposing new burdens on 6 million low-income households. One need only look at UC and CSU’s current graduation rates to know there’s significant room for improvement.

There has been talk about Senator Hertzberg running SB 8 as a ballot proposition in next year’s November elections. It will be interesting to see if voters, once they fully appreciate the benefits and costs of the proposal (such as with higher education), can be convinced that they’ll truly be better off.

Dr. Justin L. Adams is the President and Chief Economist of Encina Advisors, LLC, a Davis-based research and analysis firm.

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