With increasing frequency, offering new taxing mechanisms to fund ever-growing governments is becoming in vogue.  Whether it’s tinkering with California’s Prop 13, marijuana taxes, or the newly proposed 5% “service” tax in California, such proposals labor under the false premise that there are untaxed pots of gold and that if only we would tap them our budget problems would go away.  Rather than solve our problems, however, new taxes would weigh down our economy even more and result in less revenue over time –not more.

Keep in mind, as we consider government funding, that there is not one government today that is smaller than it was 10 years ago or 40.  The sphere of governments – federal, state and local – and their corresponding budgets have grown at alarming rates and run up huge unfunded liabilities.  The prospect that any of them will be smaller tomorrow or 10 years from now is literally zero.

Despite that, discussions over funding government growth, however unsustainable, dominate over whether we should be growing government at all.  Those who would accept government growth rather than curtail it, constantly look for new ways to tax. It is a predilection that is sinking our cities, states and country.

Keep in mind that throughout history, in any given economy, there is only so much that a government can extract from the economy overall before the weight of taxes drags the economy down.  Whether that is extracted by 1 tax at 50% or 50 different taxes at 1% – the economic effect is nearly the same. I would argue, however, that 50 small taxes are worse because people don’t realize the aggregate effect as much as they would one, large, blunt tax.  Since we live under many different and hidden taxes, it’s easier to offer new, however small, taxes.

As an economy weakens, there are fewer business transactions and fewer sales.  Recessions brought on by high tax rates, like all recessions, produce less tax revenues not more.  That is why John Maynard Keynes said that “high tax rates defeat their own object,” i.e. to collect tax revenue.

Today we face double-digit, structural unemployment.  Since 2007, the Nation has lost nearly $7 trillion in homeowner equity and California homeowners have lost nearly $2 trillion of that – more than the size of its economy for a year. With those losses, dramatic decreases in net worth and dramatic losses in consumer purchasing power have followed. Simply stated, the great lot of Americans and Californians do not have the money or wealth they once did.

Those weakened homeowners, unemployed and consumers in general are not hiding pots of money going unused and waiting to be taxed.   People are buying fewer things overall because they have less money overall – and less consumer purchasing results in less jobs which means less consumer purchases by the unemployed, and the downward spiral continues.  Those pushing the proposed new service tax in California fail to grasp those basic concepts and Keynes’ warning.

The new tax would tax nearly everyone that provides services including business consultants, most independent contractors, financial advisors, insurance brokers, real estate brokers, travel agents, housekeepers, gardeners, piano teachers, hair dressers, pool servicemen and the accountants and lawyers that service them.

Because the economy and consumer purchasing is so weak, people are already cutting back on the use of those services – which means less tax revenues from a reduced number of transactions whether they be a home sale or a new will.  In response to such weak demand, businesses are forced to lower prices to attract consumers and in periods of weak demand, like today, manufactures and sellers cannot easily pass on price increases.  For instance, despite rising costs for commodities and parts, today’s businesses have not been able to raise prices at the same rate as those rising costs.

All combined, those dynamics are why Keynes wrote in full:
‘Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance, than an increase, of balancing the budget.
For to take the opposite view today is to resemble a manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more–and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss.”

California and the Nation are already making a loss.

Keynes well understood that business owners of today will not simply be able pass on the 5% service tax increase which, if they tried, would amount to a 5% price increase.  Instead, by in large, the new 5% tax increase will be an added 5% cost of doing business on those providers. Thus, despite the modest tax decreases offered elsewhere in their proposal, an overall tax increase would await a huge portion of California businesses – not mention future increases to that 5% rate which would inevitably be pushed.

We should also know that just because a portion of the transactions that Californians undertake is not being taxed or is taxed lower than in some other states, i.e. property taxes or services, does not mean that a higher or new tax will net more money from people – just as higher prices do not create more sales.

At the end of the day, consumers and businesses have only have so much money – the number and variance of taxes leaves them with only so much in their pockets.  Attempting to pick another of their pockets will not produce long-term, newfound gold.  It will only leave them weaker than before and so to our economy – all of which leads to prolonged budget deficits.

I am literally saddened to hear some think a massive new category of taxation is the answer to California’s economic or budget problems.   At some point, those who want to raise tax rates or create new taxes will come to understand that California is already uncompetitive because it is over taxed and over regulated – while they may not get that during an economy where California homeowners have lost nearly $2 trillion in homeowner equity, the over 10,000 people that leave this state every week and those facing foreclosure and under-water mortgages certainly do.