Taxing some services could help if it's fair and simple, 6/29/08
Don’t link school spending to oil companies’ profits, 3/21/08
Revamp tax laws to support California spending, 8/20/07
Taxing some services could help if it's fair and simple, 6/29/08
By Annette Nellen
California State Board of Equalization Chair Judy Chu believes it is time to address our deficit and modernize our sales tax by applying it to services. Her call to modernize our sales tax would be a good start in addressing an underlying cause of our budget problems.
Taxing services is not an outlandish idea. Most states already tax more types of services than does California.
Taxing services is also not a bad idea. Lifestyle changes have led us to spend less on goods subject to California sales tax and more on non-taxable services. For example, two-earner households have greater needs for laundry and child care services. They also have more money to pay for non-taxable entertainment and high-end personal services. This change has eroded our tax base and is one reason for our budget problems.
We must be thoughtful in making this major change though. We don't want a rerun of the snack tax fiasco of the early 1990s. That tax was so complicated that voters not only repealed it, but also changed our constitution so we'd never again tax food.
Being thoughtful means considering three factors: fairness, simplicity and the realities of business taxation.
First is fairness. Expansion of the tax base should be accompanied by a rate reduction. Besides making the change more tolerable and the state more business friendly, it makes the sales tax fairer.
California's 7.25 percent state sales tax rate is the highest among states (and even higher in many counties) Imposed at a flat rate regardless of one's income, a sales tax is a more significant cost to low-income individuals relative to higher-income individuals. This inequity can be reduced by lowering the tax rate.
Services, particularly high-end ones like personal trainers and gardening, are purchased by high-income individuals. A fairer system would not exempt this consumption while taxing consumption of tangible goods by lower-income individuals.
Fairness also means helping service businesses that must start collecting and remitting sales tax. The Board of Equalization should be allotted funds to help businesses get ready. These businesses should also get refundable tax credits to help cover costs of getting ready to collect the tax for the state.
Second, simplicity should be considered, particularly for small service businesses. For example, rather than monthly reporting, there should be quarterly or annual reporting. Reporting forms should also be as simple as possible.
Finally, we should avoid taxing services that are primarily used by businesses. This may seem too generous, but making businesses pay sales tax creates many problems. Any sales tax paid by a business will be factored into prices they charge for goods and services. Since those goods and services are subject to sales tax, consumers end up paying a tax on a tax. This is called pyramiding.
Pyramiding hides the true tax amount consumers pay, making the tax system less transparent. Think about it - while food is tax-exempt in California, prices include sales tax paid by the food producers, wholesalers and retailers. We just don't see it in the price we pay.
Imposing sales tax on businesses can affect operational decisions. For example, taxing services may lead larger businesses to provide more services in-house rather than hiring service businesses. This also raises a fairness issue for small businesses that must continue to rely on taxable outsourcing.
To avoid pyramiding, services primarily used by businesses, such as consulting, should remain non-taxable. This also simplifies the system. For example, if a California business hires an advertising firm with employees in California and Nevada to prepare ads to run in 10 different states, how much of the fee should be subject to California sales tax? In 1987, this type of issue led to the repeal of a services tax in Florida after only six months.
So, let's address budget problems caused by an eroding sales tax base by taxing personal services. Accompanied by a rate reduction and simplification efforts, we'll also improve our overall tax system and help bring it into the 21st century.
ANNETTE NELLEN is a professor of accounting and taxation at San Jose State University and an Irvine fellow at the New America Foundation. She wrote this article for the Mercury News.
Don’t link school spending to oil companies’ profits, 3/21/08
By Annette Nellen
Last week, a bill was proposed by a majority of Assemly Democrats to impose extra taxes on oil companies to help prevent pink slips for teachers. A March 12 vote, mostly along party lines, failed to garner the required two-thirds majority for passage of a tax increase.
But Assembly Speaker Fabian Núñez has said he does not plan to give up on the idea.
Despite the importance of not laying off teachers, failure to pass was a good result. The bill, ABX3 9, is not the solution for keeping teachers employed or solving California's budget problems.
Budget problems cannot be solved with taxes that are earmarked and unfair. More importantly, budget problems cannot be solved by ignoring budget and tax system weaknesses and how best to remedy them.
The bill proposed to create an oil severance tax of 6 percent on the value of each barrel of oil removed from the ground or water in California. It would also impose an extra tax on oil companies. This 2 percent tax would apply to taxable income in excess of $10 million. Finally, the bill directed that all revenue generated be appropriated to the superintendent of public instruction to alleviate the budget cuts leading to layoffs of school employees.
Three key problems plagued ABX3 9. First, it was designed more as an effort to highlight K-12 education cuts in light of oil company profits, rather than to address the underlying causes of California's budget problems. The bill attempted to draw a connection between oil company profits and education spending cuts, when no connection exists.
Second, the bill would not really help teachers or K-12 education funding. Education is a key function of state governments. Its funding should come from general tax revenues, not narrow, special taxes. What happens when oil company profits drop? Education should not take a hit. Funding for education should not be at the mercy of continued high profits of oil companies. Because there is no connection between oil profits and funds needed for education, it is not wise to earmark oil taxes for education.
Finally, the proposed taxes would create new problems. Equity calls for treating similarly situated taxpayers similarly. Singling out companies in one industry to pay an extra tax that other profitable companies do not have to pay is not equitable. Also, singling out an industry to pay a special tax makes the tax law more complex because special rules are needed to define that industry and the base the special tax applies to.
In changing tax rules, consideration should be given to where weaknesses exist and how best to address them. Should legislators find that corporate income tax rates are too low, they should address that. Should legislators find that a new source of revenue is needed, debate should focus on finding a new tax that would be equitable, simple, efficient and support other state policy goals. For example, given efforts to reduce carbon emissions, perhaps an oil severance tax that would increase the price of gas is appropriate. However, evaluation of several approaches should be considered rather than focusing on just one possibility.
No doubt, cuts to education funding in California call for intervention. Such intervention though should not single out one industry as the solution and should not earmark tax revenue. Such approaches will not lead to better tax and budget systems.
We need to find solutions that genuinely solve budget problems while not harming the tax system or education funding.
ANNETTE NELLEN is a professor of accounting and taxation at San Jose State University and an Irvine fellow at the New America Foundation. She wrote this article for the Mercury News.
Revamp tax laws to support California spending, 8/20/07
By Annette Nellen
An individual knows that if he is content with his spending, but struggles to pay for it, he needs to rethink his income stream. Perhaps his salary hasn’t kept up with inflation or he needs to retool and get a better job. An individual also knows that if he wants or needs to spend more -- get a finer car or raise another child -- he needs a raise, an extra job, or a better paying one.
California needs to do the same. If legislators and the governor are content with the spending side of the budget and want or need to spend more, such as on health care or education, they need to rethink the state’s revenues -- they need to get the state a better paying job.
Can’t the state just get a "raise" by increasing tax rates? Sure, but California’s personal income tax top rate of 9.3 percent is already high, as is our sales tax (8.75 percent in some California cities). Increasing these rates could lead to loss of business activity in the state, tax evasion and damage to both low-income and high-income taxpayers.
How can California get that "better paying job?" It can improve its tax structure. Three of several possibilities: improve use tax collection; broaden the sales tax; and reduce generous income tax breaks.
First, improve use tax collection. When individuals and businesses buy goods from out of state and are not charged sales tax, they usually owe use tax. It is the complement to the sales tax and is owed on catalog and Internet sales when the seller has no physical presence in California. There is a line on state income tax forms for reporting it, but compliance is low. Every year, $1 billion goes uncollected. More can be done to collect this tax. Not doing so is like an employer not paying employees for all of their work.
Second, broaden the sales tax. Since the inception of this consumption tax in 1933, it has applied only to tangible personal property. Yet, today we live in a world where we consume lots of services and intangibles as well (music and software downloads, movie tickets, pet care, nannies, personal trainers, and more). California’s sales tax has not kept pace with today’s way of living. When people shift from buying music on CDs to buying it online, California loses sales tax revenue. California needs to update its sales tax. Not doing so is like an employer only paying for work completed with paper and pencil rather than with modern technology.
Third, some taxpayers get income tax breaks that are not available to everyone. Some of these breaks don’t make sense and some have outlived their original purpose. These tax breaks should be carefully reviewed. Those for which no valid purpose can be found should be eliminated or modified to meet a valid purpose.
For example, both federal and California income tax rules allow individuals to deduct home mortgage interest on two homes. The mortgages can total as much as $1.1 million. There are good reasons for the government to encourage home ownership through tax incentives, such as a mortgage interest deduction. But why two homes? Also, even in high cost-of-living areas in California, the median home price is under $1.1 million. Why give unnecessary tax breaks to wealthy individuals? This deduction should be modified to meet a more targeted purpose.
Reviewing and modifying the mortgage interest deduction and other special rules -- such as for employer-provided health and life insurance, senior exemptions, and various tax credits -- can ensure they serve a valid purpose. It can also help California’s revenues.
While there are many reasons for budget stalemates, one is certainly the challenge of covering state spending needs. California must do what any individual would do -- get a better job. For California, that job would be to improve its tax laws.
ANNETTE NELLEN is a professor of accounting and taxation at San Jose State University and a fellow at the New America Foundation. She wrote this article for the Mercury News.
Back to Professor Nellen's 21st Century Taxation website - here.