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Friday, July 1, 2011

July 1 tax rate reductions

Today, the California sales tax rate drops 1 percentage point to a state rate of 7.25% (BOE Notice). The federal unemployment tax (FUTA) tax rate drops from 6.2% to 6.0 (IRS info).

Both reductions are due to expiration of temporary increases that were not renewed. The California sales tax temporary increase dates back to 2009 when it was increased to help address the deficit. The FUTA tax dates back to 1976 and had been renewed eight times (Accounting Today article of 6/30/11).

The FUTA tax decrease is arguably intended to help employers (who are the ones that pay this tax), but given high unemployment rates, the fund likely needs the money.

The California sales tax rate drop is a good thing. The 8.25% rate (higher in most areas because of additional local sales tax) is too high. The next highest state rate is 7% (see table from the Federation of Tax Administrators). And, the California sales tax applies to all equipment purchases of businesses (unless for resale), making it a high burden on businesses and a pyramiding problem.

The improvement needed to the California sales tax is not a rate increase, but base broadening. The California sales tax never left the 20th century and assumes that personal consumption consists primarily of tangible personal property. It does not. Since about 1970, consumers have been a growing amount on services and a declining amount on tangible goods, leading to an erosion of the California sales tax base - which is part of the reason for California budget deficits.

It is way past time to modernize the California sales tax - extending it to include most types of personal services (likely continuing to exclude medical services), entertainment and digital goods purchased by individuals. This would enable the rate to be lowered further and for some of it to be used to start exempting business inputs. For more see my reports on this topic and reasons why California tax reform should focus on tax bases rather than raising rates (which exacerbates the problems).

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