Gerald Parsky returned to Sacramento this week to once again roll out the findings of his 2009 tax commission (the Commission on the 21st Century Economy) as policymakers considered extending the sales tax to services during a joint meeting of the Assembly and Senate Revenue and Taxation Committees.
The agenda for the September 1 hearing said the panel would discuss "Governor Arnold Schwarzenegger's tax reform proposal," but there was no specific proposal on the table, and the discussion at times ranged beyond ideas suggested by the governor. However, the governor's recent statement of support for extending the sales tax to "all services" – described by Assemblyman Anthony Portantino as a "massive expansion of the sales tax" – was a main topic of discussion.
Mr. Parsky began the hearing with a recap of his bipartisan commission's findings and recommendations, which were released almost one year ago but failed to gain any support in the Legislature. He said the goal of reforming California's tax structure would be to address declining economic activity in manufacturing, aerospace, and agriculture, and increasing activity in the service economy. He added that California needs to become more competitive in domestic and foreign markets by reducing high tax rates on sales, personal income and corporate income.
Discussing the sales tax, Mr. Parsky said that his commission found that if California extended the sales tax to all services, and structured the tax without any exemptions, the state sales tax rate would have to be about 3.59 percent to collect the same amount of revenue the state now receives from the tax on tangible items. However, he said that if the state were to exclude education and healthcare services, the sales tax rate would have to increase to 4 percent – just 1 percent lower than the 5 percent rate that will be reinstated in 2011 – to maintain the same revenue.
As he has in the past, Mr. Parksy described those who oppose the commission's recommendations as "naysayers."
Mark Hill, program budget manager for the Department of Finance, said that if the state were to broaden the sales tax to services and reduce the tax rate on tangible goods and products, there should be an "adjustment mechanism," which he described as a tool the state could use to adjust the rate up or down for several years to ensure that the tax remains "revenue neutral." He said the adjustment mechanism would stay in place until a final rate could be determined.
Assemblyman Charles Calderon said it did not make sense for the Legislature to spend time debating revenue-neutral ideas at a time when the state needs more revenue to address a $19 billion gap between proposed spending and anticipated revenue. He also questioned the usefulness of holding a hearing without a concrete proposal to discuss, saying: "We have no idea – and it was clear from the presentation of the witnesses – that we have no idea what we're talking about! This is apparently, at best, sitting around and having a cigar. The governor cannot dump a cockroach, or worse, in the punch bowl and then sit back and watch everyone react. This is not a serious effort on the part of the governor. If he wants to discuss reform, he must put it in writing so that we know exactly what it is we are talking about."
The Montebello Democrat added that while he supports the idea of major changes to the tax structure, "It is clear that even a specific proposal, even if one were offered, … would be impossible to do … before the governor retires – it would be even impossible to do one before I retire in two years."
Assemblyman Bob Blumenfield questioned the scope of the tax commission, and suggested that it should have considered increasing property taxes on businesses by adopting a split roll. Mr. Parsky responded that the commission wanted to present bipartisan recommendations that addressed state revenues. (CalTax: A split roll was, in fact, discussed during the commission's hearings, but the flawed idea did not gain any traction with commissioners. CalTax and others noted during their testimony that a split roll would be devastating to employers, and would result in many more Californians being laid off.)
Testifying on behalf of California's taxpayers, CalTax Vice President and General Counsel Michele Pielsticker explained that a sales tax on services would increase uncertainty in the tax structure. "When we come before you as a business community, one of the things we most often say is that businesses prefer predictability and certainty more than anything else," she said. "The uncertainty associated with extending sales taxes to services, the uncertainty with regard to implementation, the uncertainty with regard to the rate – Mr. Parsky said every six months the rate could change – that gives us great pause."
Legislators present at the hearing included Senators Lois Wolk (who chaired the meeting), Roy Ashburn, Loni Hancock and Alex Padilla, and Assembly members Chuck Devore and Brian Nestande.
Senator Ashburn and Assemblymen DeVore and Nestande all voiced support for tax "reform," which they said could include taxation of services. Other Republican legislators also have indicated a willingness to tax services, provided that there is a large reduction in the sales tax rate.
Senator Ashburn went further, explaining that the "Ashburn Plan" for tax reform would include replacing all existing taxes on oil production with an oil severance tax, which he claimed would give government a vested interest in oil production in California. He also explained that he would support a sales tax extended to online sales.
Legislative Analyst Mac Taylor provided the joint committee with an explanation of what the sales tax on services would look like, although he began his presentation by saying his comments would be general since he did not have a specific proposal to review. He explained that as soon as the Legislature begins to tax services, tax pyramiding for businesses will occur, and lawmakers immediately would be confronted with the question of what to exclude from the tax. Mr. Taylor noted that California has government services, K-12 education services and in-home health care services that would be impacted by the tax unless specifically exempted.
The non-partisan analyst also recommended that if the Legislature moves forward with taxing services, the tax should be designed so that it is applied at the final point of consumption, rather than at multiple points during a business' production of goods.
A Board of Equalization representative provided an overview of how the tax agency would adopt and implement any changes to the sales tax. Currently, California has 900,000 businesses registered as retailers for purposes of sales tax collection. If the law were to change, BOE Legislative Counsel Margaret Shedd said, the board would need at least a full year to implement the changes, which would include registering service industries, holding interested parties meetings and developing regulations.
Ms. Shedd noted that a sales tax on services would mean that most businesses would be double-taxed, and many small businesses would be put at a competitive disadvantage. Specifically, she referred to services that could be characterized as being sold for re-sale. While the state currently exempts re-sales from the sales tax, the exemption prompts frequent taxpayer errors, and many taxpayers do not accurately collect the tax, she said. "Ensuring that these types of exemptions have been claimed legitimately on sales of tangible items has required substantial audit resources," she said. "Determining whether a purchase of a service has been 'resold' or 'directly incorporated' into an item would have even more uncertainty and subjectivity than is the case with purchases of goods."
Using an example of a business contracting with an architect to design its California headquarters, Ms. Shedd noted that it is much easier for a multi-state business to contract with an out-of-state service provider than it would be for a homeowner. She explained that one way to solve this problem would be to also adopt a use tax for sales of services. (CalTax: The state already encounters massive problems trying to collect the use tax on tangible items. Imagine if this were applied to services, which are much more difficult to track and audit.)
Representatives from several business groups and service industries also testified. An advocate for veterinarians noted that a new tax on veterinary services would dramatically increase the cost of such services contracted by local governments, resulting in taxpayers paying more for the same level of service. A spokesman for California's amusement parks said a tax on entertainment services would make entrance to the parks more expensive, which in turn would reduce the amount of money that guests spend on food, souvenirs and other items. Ultimately, this would lead to job losses, because parks already are coping with drastically reduced sales, and they would have to lay off employees to adjust for a further downturn in business.
Cal-TaxReports, September 7, 2010
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