An
old friend is back in town, at least according
to George Skelton. He shows up every so often trying to settle in, but
after making an initial good impression, the neighbors usually politely ask him
to keep moving on.
I’m
talking about the proposal to extend the state sales tax to services, which is
apparently a tax reform being considered by the Governor’s Office.
We’ve
been through this before, most recently when the Commission on the 21st Century
Economy ("Tax Commission") began to consider reforming the tax
code to make it more stable and "fit with the state’s 21st century
economy."
Ultimately,
the Tax Commission threw the idea overboard, finding:
Among the ways to improve the (state tax) system
competitively, expanding the sales tax to include services has serious
shortcomings. Picking and choosing how to expand sales tax to services has been
difficult for most states in a situation similar to California’s. An
expanded sales tax would still leave the state with its current system of
requiring businesses to pay sales tax on inputs, such as supplies and capital
equipment. In addition, imposing the sales tax at the existing high rate would
cause a significant economic jolt for newly affected businesses.
The
Commission instead opted for a "new broad-based consumption tax,"
called the business net receipts tax, which for now is languishing in policy
purgatory.
Why
should this new tax be rejected? For a detailed explanation, I refer you to a paper
I provided to the Tax Commission last year. The key conclusions are:
1.
A
services tax is not needed to change the responsiveness of the sales tax to the
economy. The current taxable sales base is already very sensitive to the
economy, and adding services would not materially change that.
2.
Taxing
services that would most likely be added to the sales tax base would only
provide minimal opportunity to reduce sales tax rates in a revenue-neutral
manner. Increasing the price of a haircut by 9% in return for a quarter-percent
or half-percent reduction in the price of a shirt seems to be an odd trade
without much economic gain.
3.
Increasing
taxes on selected (and likely the most politically vulnerable) services would
be unfair, discriminatory and economically harmful.
4.
Imposing
a services tax would increase the cost of labor, which is just the wrong signal
when the economy needs to produce jobs.
5.
Elsewhere
in the country, enacting broad-based sales taxes on services has consistently met
with defeat at the hands of targeted industries.
Services
differ from tangible goods chiefly in that they are provided immediately,
on-site, and by a worker. Whether the activity is lawn care, veterinary,
repair, nursing, law, accounting or tattoo, they all involve the labor of an
individual to provide the service in real time at the site of consumption. A
tangible good that is subject to the sales tax may have been made next door, or
half-way around the world.
I’ve
written
earlier about how the sales tax base has not eroded to the extent that
services tax proponents claim. Drilling down on the nature of the
"services economy," the State Board of Equalization in
2008 made the following observations:
-
Americans
are spending substantially more of their incomes on services than did their
grandparents. Since the 1940s, the share of national disposable personal income
devoted to services has increased from about 30% to about 55%. -
The
largest components of services purchased are housing and medical care, which
together amount to 54% of all purchases. Add transportation and 60 percent of
services that Americans purchase would never be considered taxable in
California. -
The
fastest growing components of the services economy (medical care, education,
utility services, and legal, bank and brokerage services) tend to be those that
would not be taxed; it is the slow-growing services that are the targets
for taxation: personal services and spectator amusements.
But
can’t we increase the sales tax base and reduce the rate? Yes, but here arithmetic
trumps rhetoric: the more exemptions from taxation, the less the rate could be
reduced.
The
widest swath of services ever suggested for taxation in California, by Board of
Equalization chair Judy Chu in 2008, was $183 billion worth of services
transactions covering construction, repair, business services, warehousing,
entertainment and recreation and personal services. This ambitious approach
would enable the overall tax rate to be reduced by about one-and-a-half percentage
points.
Recognizing
this recipe may be a bridge too far, Ms. Chu also presented a mix of services
that "are most frequently taxed by other states." That list of
services comprised automobile repair and service, entertainment and recreation,
repair and maintenance, and dry cleaning and laundry. Amounting to about $56
billion in transactions, broadening the base would enable a tax reduction of one-half
percentage point.
Imposition
of a new tax on services would be unfair, harmful to jobs and the economy, and
ultimately ineffective. Since a service is by definition intangible, in
can be provided in a variety of ways that can defeat the tax:
-
Companies
that previously had contracted out for a service may decide to provide the
service in-house. -
Out-of-state
(or out-of-country) providers would have an advantage over in-state businesses.
Many companies have overcome the existing high cost of labor in California by
outsourcing jobs to other states or countries. And while these services may be
subject to a use tax, enforcement of that tax is notoriously lax. -
In-house
vs. out-of-house and in-state vs. out-of-state will provide some companies with
significant competitive advantages over other companies. Large businesses will
be much better able to avoid this tax than will small businesses.
Finally,
the experience of other states that attempted to impose a comprehensive
services tax should not be encouraging to those who may wish to take this
step. Over the past two decades, three large
states have adopted broad 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 purchases from
out-of-state providers. 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 in 2007, Michigan adopted a sales tax on a wide range of
mostly personal services. It was repealed before it even went into
effect.
Most recently, Maryland repealed its expansion of the sales tax to
computer services. Passed in November 2007, and set to become law the following
July, the Legislature repealed it before it could take effect.