Proposed Tax on Services Would Be Costly for Consumers and Employers

By CalTax Director of State Fiscal Policy Therese Twomey

The sunny state of California is enjoying a record period of economic recovery, but our business climate forecast is cloudy with a chance of layoffs from a barrage of proposed tax increases.

A tax increase traditionally is one of several tools used to balance budgets, but one has to wonder about the need for tax increases when revenue is at an all-time high, and surplus reserves in the state’s Rainy Day Fund (yes, that really is the name of the fund) are expected to hit the full-funding mark. The budget/policy advisors to the Legislature (formally known as the Legislative Analyst’s Office) anticipate that even more money will flow into the state’s coffers this spring, based on current tax collection trends and possible economic stimulus from recent federal tax law changes.

It seems like the sky is the limit for this year’s tax increase suggestions, which include proposals that would, in effect, double the tax on some of California’s largest employers; another that would tax large employers based on compensation for their management team; and an oldie but not-so-goodie, a proposal to tax services.

For four years running, California legislators have proposed to expand the sales tax currently imposed on purchases of goods and products, so that purchases of services (like haircuts, movie tickets, pet grooming) also would be subject to tax. The proposals of previous years have been unsuccessful, and this year’s version adds a twist in an unsuccessful attempt to mollify the taxpayers, consumer groups, trade associations and employers who solidly oppose the tax hike.

Essentially, SB 993 would exempt services used by individuals, but tax all services purchased by businesses in the state, with the exception of a handful of services and an exemption for very small businesses. The bill includes a complicated mechanism to slightly reduce the sales tax on actual products that are subject to tax now, but in the end, the bill represents a massive net tax increase. It represents the largest expansion of the sales tax in the state’s history, and it bodes ill for our economy in so many ways.

The measure purports to mitigate some of the adverse impacts of a tax increase, but it would raise the price on consumer goods. By taxing the many services that are integral to preparing and bringing a product to market – including research and development, quality testing and control, marketing, transportation, etc. – this bill would increase overall production costs, which ultimately are passed on to consumers. This far-reaching cost increase would affect everything from everyday essentials like milk and bread, to housing affordability and cars.

Keep in mind, California already is a high-cost state because of our high base sales tax rate, expensive housing costs, high gas tax and our highest-in-the-nation marginal income tax rates.

Higher business taxes mean fewer jobs. When the cost of doing business increases, employers look for ways to counteract those effects. For some, it could mean cutting employee hours or wages, or downsizing operations. For others – like Aerojet Rocketdyne, formerly in Sacramento; Toyota, formerly in Torrance; and Nestle, formerly in Glendale – it means closing California operations and moving to another state.

When it comes to promoting revenue growth, lawmakers should take to heart what our iconic President John F. Kennedy said many decades ago: “It is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise the revenues in the long run is to cut the tax rates.”

A tax on services would accelerate the exodus of jobs. How does chasing away well-paying jobs and driving up consumer prices help working families? It doesn’t.

Because of the tremendous competitive disadvantages and the threat to jobs and economic growth, Florida, Maryland, Michigan and Massachusetts all abandoned services taxes shortly after they were implemented. California should learn from the mistakes of those states, rather than making a mistake of its own that would put many Californians in the unemployment line.

For more information about the challenge of taxing services, read this report from the California Tax Foundation.


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