Firms Fear Proposed Services Tax

The $30 hourly fee for accordion lessons at Dave’s Accordion School in the Atwater Village would probably go up.

So would the cost of having a tent zipper replaced at Leslie’s Outdoor Gear Repair in Costa Mesa if the state begins taxing not just the new zipper, but the labor required to sew it in.

“It means that every time I sew up a little hole, I’d have to pass it along to my customers,” said proprietor Leslie Pemberton. “It would get really confusing.”

Dave Caballero said an additional tax, even a small one, could put his struggling studio and instrument repair shop out of business, despite the strong interest in playing the accordion. “It adds up . . . with rent and utilities and everything else we have to pay,” he said.

Such concerns have spread recently, since Assembly Speaker Willie Brown (D-San Francisco) proposed and Gov. Pete Wilson said he might consider taxing virtually every service in California to raise billions of dollars to help balance the state’s budget. The budget shortfall over the next 15 months is estimated at $12.6 billion, and each 1% tax on services would raise $1 billion to $1.3 billion.

Because such a tax would be virtually ubiquitous, potential opponents are numerous. The work of accountants, architects, bankers, contractors, lawyers, real estate agents and lobbyists would be subject to the tax. So would commercial child-care providers and the work of hairdressers, gardeners, barbers, mechanics and electricians. Only health services have been ruled off limits.

Steve Thompson, director of the California Assembly Office of Research, which is formulating the details of the tax under Brown’s direction, said opponents are not yet organized but are expected to lobby hard. “There’s not a single tax being proposed relative to the state’s budget crisis that is enthusiastically received by anybody,” Thompson said. “Taxes never are.”

The levies have never been attempted in California, but similar taxes are common in Europe and proved controversial in Massachusetts and Florida, where they were rescinded. The handful of other states that tax services generally have economies that are small or isolated, such as Hawaii and South Dakota.

Such a tax is attractive to some state leaders because services represent a vast, untapped and rapidly growing sector of the economy. Moreover, many believe that the line between transactions that involve the sale of a product and those that involve the sale of a service is becoming increasingly blurred. Why, analysts ask, should the purchase of a computer be taxed, but not the work of computer programmers or repair technicians?

“We have a tax on production, but not on services, unlike Europe, which treats the two the same,” Thompson said. Meanwhile, the service sector of the economy is growing faster than the manufacturing sector, he said.

“The advantage of this tax is that it grows with the economy,” he said. “A tax system that taxes things that are not elastic, that do not grow, is one that is doomed down the road. There is a decent and fair logic to it.”

Initially, the tax rate could be low--2% to 3%, for example, in contrast to the 7% sales tax levied in many counties, Thompson said. Eventually, the sales tax and the tax on services could be levied at the same rate, somewhere in the middle, he said. Speaker Brown, however, recently raised the possibility of initially imposing a service tax rate of up to 7%.

Although methods of levying and collecting the tax are still being discussed, the goal would be to keep the process as simple as possible. Most likely, businesses’ gross receipts would be subject to the tax, which could then be deducted as an expense for income tax purposes. Small businesses, those with gross incomes of $30,000 or less, probably would be exempt, he said.

Raising prices to offset the tax, therefore, would be optional but likely. And the effect such a tax would have on the delicate California economy is unknown.

The amount that the tax would add to individual transactions would be small. But the cumulative effect on consumers could be large. For example, a 2% tax passed on to a client by an accountant would add only $8 to a $400 fee for an income tax return. But if it were added to everything from a carwash to a haircut, from having clothes cleaned to shoes resoled, the impact would grow.

“It will produce economic dislocation, we just don’t know where,” said George Johnson, a Pasadena economist who plans to study the effects of the proposed tax on the economy for the Los Angeles Chamber of Commerce. “The individual consumer would definitely be impacted, and you can intuit that the effect would be wide-ranging.”

Some critics say that it could slow the state’s climb out of recession if it caused consumer prices to go up sharply. Others contend that it would drive businesses out of California or cause large purchasers of services to buy them elsewhere.

In addition, critics say, such a tax would add to the size of the state’s already large shadow economy by giving consumers and workers an added incentive to do business using unrecorded cash transactions.

Some purchases, such as buying a house, would be particularly affected because of the variety of services necessary to the transaction.

“Taxing services--including the vast array of services provided by Realtors, appraisers, lenders, escrow companies and many others during the home buying and selling process--will only exacerbate the affordability crisis by pushing home ownership out of reach for more Californians,” said Mack Powell, president of the California Assn. of Realtors.

Despite recent drops in housing prices, only 21% of the state’s households were earning enough in December to purchase the median-priced existing home in the state, according to the association, which opposes the tax.

The effect of the tax on home construction and purchases also would accumulate because the tax would apply to real estate fees and the work of architects, surveyors, engineers, contractors and others.

“A lot of services go into the value of a house . . . and those services are generally early in the process of building . . . (when) you have no revenue coming in,” said Robert Henninger, vice president of Foothill Properties, a Newport Beach-based residential and industrial construction firm that had $70 million in revenues in 1990. The additional cost could make builders decide not to attempt new projects, he said.

Each 1% of the tax applied to construction services would generate $242 million in revenue, making it the most lucrative sector of the economy targeted, according to Assembly Office of Research estimates. The second-largest amount, $147 million, would come from professional services, followed by general business services, which would raise an estimated $141 million and would include printing, mailing, personnel and other services.

Using the value of services reported in 1987 by the U.S. Department of Commerce, Los Angeles County businesses would pay at least $950 million in taxes annually if the rate levied were 2%. Orange County businesses would pay at least $212 million and San Diego businesses $178 million.

Janice Kamenir-Reznik, an attorney in private practice in Sherman Oaks, said such a tax would make it more difficult for small firms that have to purchase many services to compete against large law firms that have in-house accountants and other service providers. She also charged that the tax was “cowardly.”

“Even if you don’t use a lawyer . . . everybody is going to be paying this anyway, but you are hiding it in such a way it doesn’t look like a pervasive tax,” said Reznik, who said she would prefer an increase in the income tax.

David J. Pasternak, a Century City attorney who is chairman of an ad hoc committee formed by the Los Angeles County Bar Assn. to study the tax, said the Bar association has yet to take an official position. But, he said, such a tax would make legal services even more unaffordable for the poor and encourage large firms with out-of-state offices to route business elsewhere.

“If you have a major client with a major business transaction, it might be cheaper to use a New York lawyer than a California lawyer if they could avoid a 3% or 6% tax,” he said.

Larry McCarthy, the president of the California Taxpayers’ Assn., an 800-member business-oriented group, said the tax would add to the size of the so-called underground economy and hurt small businesses. Small businesses “don’t have as much flexibility of raising prices and when they are unable to pass these costs on, it directly affects their workers and their profitability,” he said.

The state’s farmers, already struggling because of the drought and last winter’s freeze, would be hurt too, if services to agriculture are taxed, said Rex Laird, executive director of the 1,800-member Ventura County Farm Bureau.

“We operate in a global economy,” Laird said, and the cost of the tax will “function as a disincentive for people to do business in California.”

One group that is at least willing to listen to arguments favoring the tax on services is the California Retailers Assn. Although the state has applied the sales tax only to purchases of tangible goods, there is little reason not to include purchases of services, said Les Howe, the association’s vice president for governmental affairs.

“From a tax policy standpoint, you can make just as good an argument that you should tax consumption in the form of services as you do in taxing tangible personal property,” he said.

But winning approval for such a tax, especially in the short time between now and June, when the state’s budget problems must be solved, will be difficult because the idea seems so foreign, he said.

It was political problems, rather than technical ones, that caused Florida’s tax on services to be rescinded Jan. 1, 1988, after being in effect only six months. That tax, which unlike the proposal in California included a levy on advertising purchases, was targeted by media interests as well as the Florida Bar Assn.

“The real merits of the tax never, never surfaced in the public’s mind,” said James Francis, director of tax research in the Florida Department of Revenues. “It was never an issue of ‘Do we need the money?’ and, if so, ‘Do we need the tax?’ ”

The issue, Francis said, was that then-Florida Gov. Bob Martinez, a Republican, campaigned on a promise to hold down government spending. After his election, he proposed the tax.

A STATE TAX ON SERVICES? Here are some key sectors of California’s service economy, along with the potential state revenue, in millions of dollars, if a 2% tax rate were imposed. The rate currently under discussion ranges from 2% to 3%.

SERVICE POTENTIAL SECTOR REVENUE Construction $486 million Professional $294 Business $282 Amusements $218 Utility/transportation $209 Hotel/lodging $109 Automotive $75 Personal $65 Miscellaneous repair $53 Computer $52 Total at 2% $1.8 billion

Here is the value of services to be taxed, in billions of dollars, by county*:

COUNTY VALUE Southern California Los Angeles $42.5 billion Orange $10.6 San Diego $8.9 San Bernardino $2.5 Riverside $2.2 Ventura $1.9 Northern California San Francisco $8 billion Santa Clara $7.1 Alameda $3.9

* Medical services not to be taxed. Agricultural, financial, real estate, industrial and mining services are to be taxed, but their value is not available.

SOURCE: 1987 Census of Service Industries, U.S. Department of Commerce, and California Assembly Office of Research