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Monday, March 30, 2009

No Fooling - On April 1 California will have the highest and worst sales tax system!

March 31, 2008 is the last day for what will soon seem like a low sales tax rate in California even though it is one of the highest in the country. On April 1, 2009, the California state sales tax rate goes up 1 cent. In Santa Clara County, it will be 9.25%. In South Gate, it will be highest at 10.25%.

While temporary, this is still unfortunate. California does have some problems with its tax systems, but they can't be fixed with what may seem like the easy way out of a budget shortfall - raising tax rates. Instead, the harder work of broadening the base - removing special exemptions, deductions and exclusions, is needed. That is:

Most of California's tax problems must be solved by fixing the tax base - they cannot be solved with a rate increase. A rate increase makes most of the problems worse.

For the sales tax, the base should have been broadened years ago as our ways of living changed and we started consuming more services and entertainment and less tangible personal property (partly due to two-earner families and higher living standards than existed in the 1930s when the sales tax began).

Here are a few problems with California's sales tax that arguably makes it the worst sales tax system:
  1. The rate is too high (even on March 31, 2008).
  2. We make businesses pay sales tax when they purchase manufacturing and R&D equipment (and furniture and supplies). Most states exempt these purchases. Remember, when businesses pay sales tax, it becomes a cost of doing business and is reflected in prices that then also have sales tax charged. But that tax paid by the business is not apparent to the customers - that is poor tax system design.
  3. The sales tax doesn't apply to a good amount of the higher end consumption of high income individuals. When a person buys a $15 music CD or $20 DVD, sales tax is owed. But if someone buys a $14.99 album from iTunes, or a $80 basketball game ticket or a $9 movie ticket or a $1,500 ticket to see Billy Joel and Elton John - no sales tax is owed on that consumption. Also, individuals earning over $150,000 tend to spend twice as much on food for home than those earning under $70,000 (groceries are generally exempt from the tax) - so the exemption is a better tax break for the high income individual. And this group of higher income individuals spends 5 times more on entertainment on average than lower income individuals and a lot of that entertainmen is not subject to sales tax. That's just wrong - exempting so much consumption of high income individuals - it makes the tax less equitable and fair.

The sales tax could be improved by lowering the rate and broadening the base to include more types of consumption such as personal services, entertainment and digital downloads. It should NOT be broadened to tax consumption by businesses. Some states are ahead of California on modernizing their tax base which means that they are making their tax system more fair and better enabling the state to make its business tax system more attractive to businesses.

I recently updated a report I wrote over a year ago on broadening California's sales tax base. It provides background on the sales tax, consumption trends, reasons for broadening the base, obstacles and how to overcome them, how a broader base satisfies the principles of good tax policy and I added an appendix on counterarguments to arguments often raised as to why we should not broaden the base. I hope you'll take a look and offer some comments:


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