State may consider taxing services

May 22, 2012

By Dave Roberts

Hold on to your wallet — Sacramento may be hatching yet another way to reach into your pocket: a state sales tax on services. Assemblywoman Alyson Huber, D-El Dorado Hills, has authored AB 1963, which calls for a study of the revenue impacts of a service tax.

Huber said she’s looking for a way to reduce state tax revenue volatility. Boom and bust economic cycles have had state revenues skyrocketing and diving for several decades. But some fear that placing a new taxing tool in the hands of Democrats will lead to increased taxation in this already highly taxed state.

“The bill started out as raising the issue of extending sales taxes to services as a way of diversifying the pot,” Huber told the Assembly Revenue and Taxation Committee on May 7. “AB 1963 seeks to at least get the Legislative Analyst’s Office (LAO) involved in doing an analysis of California’s revenue system to help come up with a solution on volatility. It is an issue I talk about in my district a lot, about how in California we have these huge peaks and then deep recession on our revenue side. If I were your investment advisor and your investment portfolio looked like California’s revenue stream and was going like this [waves her arm up and down] on a cyclical basis, I would tell you to diversify, that you are too susceptible to risk.”

Fluctuating State Revenue

About half of the state’s general fund revenue comes from income taxes, which disproportionately fall on upper incomes. During good economic times, like the dot-com bubble in the late 1990s, income tax revenue flowed like a tsunami into state coffers, accounting for 57 percent of total revenues in 2000-01. But when the bubble popped, income taxes fell to 48 percent in 2003-04 when the bubble popped. During the recession in 1979-80, income taxes accounted for just 37 percent of total revenues.

The other two main sources of revenue are corporate taxes, which also can swing wildly with the boom-and-bust cycle, and sales taxes, which are also affected — people buy fewer cars during recessions — but are generally less volatile than the other two revenue sources, according to the LAO.

Friday’s LAO report on Gov. Brown’s budget revision describes the uncertainty in tax collection: “Economic and revenue forecasting is very difficult now due to a variety of issues, including uncertain federal fiscal policies, difficulties in forecasting recent corporation tax policy changes, the usual issues of stock market volatility, and Facebook. Given these forecasting challenges, state leaders should not be surprised if 2012-13 state revenues end up several billion dollars lower (or higher) than current projections.”

Increasing Revenue by Increasing Taxes

Huber said she’s attempting to find a bipartisan solution to the tax revenue problem.

“The problem we have is a political one,” she said. “And that is generally when the folks on the left talk about our revenue side, it’s to talk about getting more revenue. And the folks on the right, when we talk about our tax system, promise no new taxes ever. And if we can’t get past that political problem, then we can never achieve a solution on our revenue volatility in California.

“So my suggestion is that the LAO look for a way that would be revenue neutral, wouldn’t actually try to increase the pot, but would diversify the existing tax structure so that we could make California’s revenue stream look more like California’s economy. In California right now, our economy is growing to a $2.1 trillion economy and our revenue line has gone down. And that kind of disconnect between our economy and our revenue causes a lot of the huge deficits that you see right now.

“The good years are not so good either. Because when we have those huge peaks in revenue … people tend to spend a lot more, and they build spending in as if that money is going to continue. And then we have to turn around and cut to make up for that. At this point we all generally agree what the problem is. What we don’t agree on is how to get the solutions. So let’s have an in-depth analysis from the LAO and see if we can do something to fix this revenue volatility in California.”

The Argument Against Raising Taxes

Speaking in opposition to a tax on services was Therese Twomey, fiscal policy director for the California Taxpayers Association, who said, “It puts California businesses at a competitive disadvantage. It hurts lower income businesses, families and communities. It also moves jobs out of state.”

Parke Terry, legislative advocate for the California Landscape Contractors Association, is not opposed to the bill, but he is concerned that taxing services will cost the government money.

“Probably the biggest purchaser of construction services in California is state and local government,” he said. “It’s not well known that state and local government currently pay sales tax on materials that go into construction projects, but they do not currently pay sales taxes on the labor component of that construction. So we think the bill, in that context, significantly increases the cost to state and local government.

“When the Board of Equalization looked at this issue about three years ago, they determined that the largest single economic segment in California that would be subject to a sales tax on services is actually advertising and marketing. Just like attorney services, those are jobs that could easily be exported to other states. We are certainly not opposed to looking at it. But we think there are a lot of issues here that you need to consider before you seriously think about expanding the sales tax to services.”

Differing Republican Opinions

There may be some bipartisan support for AB 1963 if Committee Member Brian Nestande, R-Palm Desert, is any indication. He believes taxing services will help California if overall revenue remains neutral and if exemptions are carved out for business-to-business services and for low-income residents.

“I don’t think Ms. Huber is suggesting just a tax on services in a vacuum, not having lowered the rate to income taxes, to the current sales tax, so you have a lower rate overall,” said Nestande. “This is what all the economists say: we should move to a different taxing system. It’s almost unanimous, at least from the ones I’ve talked to.”

But not every Republican Assembly member is confident that the addition of a new tax in California won’t lead to an increase in overall taxes and more businesses leaving the state.

“The problem that I have since I’ve been here since 2008, the only bills that I’ve ever seen with any kind of change in tax policy, the goal has been to increase revenue,” said Diane Harkey, R-Dana Point. “Businesses are not sure right now if they are going to survive. Studies are all good. But I really do believe that there is going to be leakage just on the mere mention of the possibly of a change in our tax code. Because there’s so much uncertainty. I have a feeling that, when the study comes, we will pick and choose those items that will conceivably generate revenue rather than increasing employment.”

Democrat Legislators Hungry for More Revenue

Harkey’s fears were immediately confirmed by Gilbert Cedillo, D-L.A., who is salivating at the prospect of bringing in and spending more tax revenue.

“I have been here a little bit longer,” he said. “When I got here we had an economy of $1.4 trillion. We were spending about $100 billion on services. That was our budget. Today we are at $2.1 trillion and we spend $85 billion. So, while it may seem that we were going in one direction, the fact of the matter is we have cut 15 percent in taxes. They had gone up above $100 billion, but we are down to $85 billion in services for a state that’s growing. And for a state whose infrastructure that business relies upon is in tremendous need of reinforcement, our waterways, our highways. The entirety of the services that we provide for businesses need upgrades. It needs an educated and stable workforce. So the question for me would be also what is revenue sufficiency.”

Huber agreed that, in addition to leveling out the revenue peaks and valleys, state government needs to bring in more money.

“In revenue neutrality I’m not talking about a spending cap,” she said. “Generally, when people talk about those it’s only enforceable when you have a constitutional amendment. As a budget item, it probably would be gone the very next year. But I’m talking about something that is a rational relationship between the size of our economy and the size of our spending.

“We are not trying to starve the very economy that we would like to see grow. But we are the government and the people who try to make sure there are resources to educate the population, to do the roads and bridges, to have the infrastructure. If we have those additional resources as our economy grows, that makes sense. But having them go down the way they are now with our economy growing, that doesn’t make sense. And that’s the problem we are trying to fix by having this study bill.”

The committee passed the bill 6-0, with Harkey and two others not voting. It will next be reviewed by the Assembly Appropriations Committee.