Will July CA Tax Cuts Spur Recovery?

APRIL 14, 2011

By JOHN SEILER

In the hullabaloo over extending tax increases, one thing is being overlooked: As things now stand, on July 1, just 10 weeks away, California gets some pretty hefty tax cuts. You’ll have more change jingling in your pocket.

That’s when most of Gov. Arnold Schwarzenegger’s record $13 billion tax increases of 2009 expire. (The 1 percent income tax increase of that year already expired on Jan. 1.)

Overall, combining the Jan. 1 and July 1 tax increases, the average California family will have about $1,000 more to spend on food, children’s clothing, mortgage or rent payments, car payments, gas, charity, etc. Some of the tax cuts also will go into investments to create new businesses and jobs.

The following tax increases will cease as of July 1:

* 1 percent sales tax increase;
* 0.5 percent Vehicle License Fee increase (the “car tax”).

Spurring Sales

At the end of a tax-increase period, people generally postpone some economic activities until the tax expires. For example, someone wanting to buy a $30,000 today can, by waiting until July 1, save 1 percent on sales ($300) and 0.5 percent on the car tax ($150). Total savings: $450.

That means sales will be suppressed in the next few weeks, but will take off on July 1.

We won’t know until a few months from now how many new sales will be generated by this savings, but it could be substantial.

Moreover, even if you aren’t in the market for a new car, you’ll see savings on the VLF. If you old flivver is worth $10,000, you’ll pay $50 less on the VLF. Maybe your spouse has another car worth $10,000, and one of your kids has another worth $10,000. Total family savings: $150.

Marginal Tax Rates

Another factor is marginal tax rates. At some point, tax rates become so high that people stop certain economic activities. That point differs with different people.

Conversely, at some point, tax rate cuts generate more activity. If the taxes on that $30,000 car are cut by $450, it well could make affordable something that previously was beyond your reach.

The additional economic activity, in turn, actually generates taxes — even at the lower rates. That’s because, unless the purchase is made, the car dealer doesn’t get the sale, so he doesn’t pay the business tax. The salesman doesn’t get a commission, and so doesn’t pay income tax on the commission. And the sale, not being paid, doesn’t pay any sales tax at all.

However, if the tax cut makes a product more affordable, and thus generates a new sale, then all those taxes listed above are paid.

“Of course it will increase sales,” Esmael Adibi told me of the expected July 1 tax cut; he’s director of the A. Gary Anderson Center for Economic Research at Chapman University. “A 1 percent sales tax cut makes big-ticket items, such as cars and boats, more affordable. It will stimulate durable goods purchases.”

He added, “Generally speaking, if you pay less in sales taxes and the VLF, you have more money in your pocket. A good amount will be spent.”

Budget Dilemmas

The tax cuts would mean that the state budget would have to be cut more than was planned in Gov. Jerry Brown’s January budget. State workers would have to be laid off. “Cutting spending would be negative” on the state economy, Adibi said. However, he added, the overall effect would be positive because “the reduction in taxes affects a larger group of the population than would the spending cuts.”

Another factor is the predictability of taxation. Business managers always insist that the predictability of the tax code is essential to smooth operations. If the Schwarzenegger tax increases expire on July 1, that would be a plus for businesses. But if different taxes later are increased, the uncertainty generated — as well as the new taxes — would be a negative. Among the uncertainties:

* The California Teachers Association now is pushing a tax increase without a direct vote of the people. The CTA is a close ally of Gov. Brown and the Democratic majority in the Legislature.

* Assembly Speaker John Perez, D-Los Angeles, is pushing a new tax on wealthy Californians.

* A $2 billion yearly severance tax on oil production is being advanced. It also would increase gas prices at a time when prices paid by drivers are approaching $5 a gallon.

So, the predictability of California tax rates remains volatile.

Other Economic Factors

It’s worth remembering that something similar happened in the past. After Republican Gov. Pete Wilson increased taxes a then-record $7 billion in 1991, during the height of a recession, California did not enjoy the national economic recovery that the rest of the country soon was enjoying. It stagnated until, in 1995, most of the tax cuts finally expired and the Golden State economy roared into the prosperity of the late 1990s.

Adibi pointed to some additional benefits of the pending July 1 tax cuts. “Clearly, the sales tax is a very regressive tax,” he said, hitting the poor more than the wealthy. A wealthy person might pay a high sales tax on a new Mercedes. But it’s the day-to-day purchases of a poor person — children’s clothing, a new muffler for an old car, over-the-counter medicine — on which a high sales tax can add up. Conversely, a sales-tax cut can mean a great deal to a poor person.

Adibi also warned that higher gasoline prices are washing out most of any benefit we might get from tax cuts. “So we’re getting it from every front,” he lamented.

Perhaps the gas increase is not felt by Gov. Brown and California Legislators, for whom cars and gasoline are supplied by taxpayers. But for most Californians, extending the Schwarzenegger tax increases would be a doubling of the heavy new burden of higher gas prices.

By contrast, any chance that California’s struggling economic recovery has to be sustained rests on maintaining the tax cuts beyond July 1.