Episode 19: Service Sales Tax

Welcome to the Workplace, a podcast by Cal Chamber. I'm Alan Zarenberg, Cal Chamber President. Joining me today is Lauren Kay, president of the California foundation for Commerce and Education. Today we're talking about taxes, taxes, sales taxes on services in California and the changes it would create in the state budget and economy. Recently, Governor Newsom discussed the need for tax reform to help address budget volatility and he mentioned that he thought sales tax on services was a pretty good idea. We're going to discuss that today with Lauren. And while stabilizing the state budget is crucial to maintaining the booming economy, California state taxes are already some of the highest in the country. The new proposed sales tax on services was included in this discussion, which raises many questions for consumers and businesses alike. Loren, what's driving this issue?

Well, Alan, there's a couple of things driving the issue, an out loud explanation and an explanation that they really don't talk about. The one that they are talking about is what's known as budget volatility. And that's when the state budget goes from boom years to bust years. And there are many people, including the governor, who want to reduce that volatility. There's another reason though that's pretty much left unsaid and that is that there are a lot of interest groups in California that would like to see the state budget much, much bigger with much more money and that requires a tax increase.

So let's first talk about the taxes themselves. Sales taxes on services. As I understand this proposal, it's not on consumers except it's on businesses, business to business. And is that because consumers don't like sales taxes on services? Services?

Well, I don't think anybody likes sales taxes on services except for the people who get to spend the money.

Okay.

The latest proposal, although nothing's been written down yet I should emphasize, is to charge a services tax just on business to business services. But don't think that that doesn't mean that consumers won't pay. Consumers will pay because to the extent businesses pay higher sales taxes on services, the they'll pass it on to consumers.

Okay, so let's just give a practical example here. Let's say building a house, especially since housing costs are pretty high here in California. If you hire an architect and a plumber yourself, is that going to be covered as opposed to if you buy a house from a general contractor, a major company that builds houses and they hire the plumber, they hire the architect, is that going to add to the cost of the house?

It doesn't matter who's hiring the architect, that architectural service will be taxed. The design and engineering services will be taxed. The fees to pay for the mortgage will be taxed. Anything that doesn't involve the actual purchase of the supplies and the assembly of the supplies will be taxed. So we've estimated, in fact, that the sales tax on services at just a 5% level, which is pretty minimum for California, would increase the average house in California by $16,000.

And in Los Angeles, the current sales tax, Los Angeles county, is about 10%, isn't it? So if that was adopted, it would be even higher.

It would be much higher. That's right.

Okay, so as we talk about this sales tax on services, the proposal is just dealing with businesses. Who gets hit hardest here, small business or large business? I mean, large business can hire their own accountants. They can have plumbers on staff if need be. But a small business, they have to hire everything out, don't they?

That's exactly right. The front line of paying these taxes will be California small businesses. Can I give you an example of.

How that would work?

Let's say a small business wants to buy a whole bunch of new furniture for its offices, furniture and equipment. Well, the good news is that the furniture won't have a services tax on it because it already has a sales tax. But let's say the business owner orders it online while they're paying a services tax for that online service. Let's say that the furniture then gets delivered by truck. Well, the trucker is charging a services tax. Let's say it's installed and assembled by a contractor that does that sort of thing. That is a service that gets taxed. And let's say that the small business owner had to take out a loan to buy all the services and equipment. Well, the mortgage fees, that's a service. And that will be taxed. You can see how many individual taxes will be added to a small business's enterprise. And all of that will be passed on to consumers.

So let's talk about the need for this. You talked a little bit about boom and bust volatility with the state budget. Is that because most of our taxes are paid through income taxes in California and they fluctuate substantially with the economic success of California or if we have a downturn.

Well, remember, we have the highest income tax rates in the country. Half of the state's budget is. Is paid for by the top 1% of income taxpayers. So when those income taxpayers get the sniffles, then the whole state budget suffers.

So if we have a downturn and the Stock market goes down, then the state's revenues go down dramatically.

Absolutely.

Okay, so that's the volatility. So can we replace those income taxes with some of these sales taxes on services with. Would that reduce the volatility?

Well, the very short answer to that is no for a couple of reasons. First of all, it wouldn't make much difference in the volatility if you added a services tax because there's still so much income tax, it overwhelms the amount of new taxes that would come in. So that wouldn't make any difference in the volatility. But perhaps more important is that these really, really high income taxes which are responsible for the volatility, they're in the state constitution. So in order for that to change, you'd have to go out and ask voters to reduce the taxes of the very wealthy Californians and raise the taxes on themselves. I don't see that happening, do you?

So they'd have to reduce the taxes on movie stars and make that up for themselves or make it up with sales taxes on services.

That's right. Which is what they'll be winding up paying anyway.

It's probably unlikely they're going to vote for that.

I would be very surprised if voters decided to give rich people a break.

Okay. And impose taxes on themselves to do so. Let's go back to why do people want to do this? Why did the governor propose this? Don't we have at least a $21 billion surplus? I mean, we spent a lot of money in the budget, which the governor just signed last week on one time, benefits to certain pensions funds might have been necessary, but wasn't an ongoing expense. Is it 21 billion? Is it 30 billion? Where are we?

The number is so big, it's even hard to figure out just how big it is. But the point is that California's revenue system is throwing off more money than we can even dream of spending. Thank goodness they're saving it because they need to save it for a rainy day. But the fact is we have more money than anybody ever anticipated at this time in the recovery.

And that's due to the income taxes that were adopted when Jerry Brown was governor. When you say we have the highest income taxes in the country and that maxes out at 13.3%?

That's correct.

Okay, so that's what's driving the revenue. But it's also what scares people about the volatility. Because if that creates the revenue and there's a downturn, there's no say all stock. There's going to be a big dip in our revenues in the state.

Well, the very simple fact, Alan, is that you can't have it both ways. You can't have enormous revenue gains when the stock market is good, when without having the threat of big dips when we hit a recession. It just doesn't work any other way. If you want to solve the volatility, you gotta give up the big revenue bumps. And I don't know anybody who's really sincerely committed to that.

Okay, in light of the fact that we have an over $20 billion surplus, we'll just use that number even though it's probably higher. So you said this isn't gonna solve volatility and you can't replace the existing income tax rates cause they're in the constitution and nobody's gonn to reduce taxes on high wealth individuals, especially if they have to pay it themselves to replace it. So if it doesn't solve volatility, what are we going to end up with? Just more revenue.

Just more revenue is exactly what we're going to end up with. But while you and I may think that that's troublesome when you've got a $20 billion surplus, there are a lot of special interests out there that are very, very anxious to have an ongoing steady source of revenues going off into the future indefinitely.

So just so we can discuss why people think in light of the fact we have over a $20 billion surplus, why do we need to raise more money? Are there certain. I mean I think we saw whether it be in Los Angeles where they tried to get a tax passed on parcel taxes and in Sacramento, cause they're concerned about running a deficit in three years. Sacramento is also on the brink of deficits. Oakland has problems. We see this throughout the state. Is this one of the driving factors here? And why are schools with declining enrollments seeking more money?

I'd say there's two very, very strong demands out there that the special interests are trying to solve. Number one is, as you said, the need for schools to increase their budgets. The big problem that schools have is that the state and school boards made promises for pensions and health care that they just can't keep. That those pension and health care costs are rampaging much, much higher. And it's eating into the ability to pay teachers a reasonable salary increases and to hire more teachers to reduce class sizes. That's number one. The second issue is that we have a health care program for the poor called Medi Cal that serves one third of Californians. One out of three Californians gets Medi Cal and the legislature and the governor are even increasing that eligibility more than these days. Health care costs increase very quickly and that will be eating up the budget as well. So those two things are going to be a big demand for more tax.

Money just to go back to the schools for a minute. So even though per pupil spending may be increasing, we see a declining population of students. So school districts who have these legacy costs may not be getting as much revenue from the state as they need to pay their pension and healthcare costs for their retired teachers. Is that right?

That's right. Plus they've made promises in collective bargaining for multi year salary increases that they just can't meet.

Okay, we see this on the horizon. This is not the first time the sales tax on services has been proposed, but we've never seen it out there with a huge budget surplus. Do you see businesses who might be the target of these taxes gearing up to oppose it?

Yes, a number of businesses that would be on the front lines, mostly professional businesses that market their services here in California, especially to other businesses. They're mobilizing and I think they're trying to educate the rest of the business community of the effect it would have on them because it's going to hit everybody. It's going to hit big businesses, consulting services, small businesses. Anybody that hires a contractor, a consultant, any sort of a service business is going to be affected.

So we're here today because architects, attorneys, accountants, they may be able to hire their own lobbyists, but small business who has to go out can't hire all these people on their own is the ones who need help in making sure that they have an alternative. They're not the target of this tax as others who can get around it. If you can hire your own people, if you hire your own accountants, you hire your own architects, you hire your own HR people, you won't necessarily be taxed on those. But if you're a small business, you have to go outside your business and hire all these professionals who provide services, all of which are going to increase your costs.

That's right. And you'll be at the forefront of the billions of dollars in new taxes.

Well, thank you, Loren. We look forward to having you join us the next time on the Workplace. Please comment, subscribe and share Kal Chambers podcast by visiting cowchamber Dot.