As part of their plan to close the state's huge budget deficit, some California legislators and staffers are considering extending the state-local sales tax -- already more than 8% in some counties -- to services. From a tax policy standpoint, this is the worst possible idea.
A sales tax on services flunks the good-government test on every possible criterion. The defects are as follows:
* It discriminates against small business. Many large businesses have people on their payrolls who perform business services, such as lawyers, accountants, janitors, etc. They would not be taxed. But small businesses that must contract out for those services would pay the tax, adding yet another competitive disadvantage in the state's tax system.
* It's harmful to the business climate in general. California services would immediately have an 8% competitive disadvantage compared with services provided in other states. Companies based in California that could obtain services cheaper out of state would do so. The motion picture industry, already hurt by runaway production, would suffer a major blow if this tax was added to all its services.
Individual taxpayers too would be likely to purchase services out of state. Instead of having a California lawyer handle a case in another state, you could beat the tax by retaining a non-California attorney.
Whenever possible, people would avoid the tax by just performing the service themselves. Some examples: mowing your own lawn, painting your own house, computing your own tax return, instead of hiring a gardener, painter or tax preparer. Many Californians would no doubt take on these tasks to avoid the tax. Small service providers would suffer a loss in business, and some would shut their doors.
* It will be an administrative nightmare. A sales tax on services cannot be administered efficiently. Think of all the baby-sitters who would have to register with the State Board of Equalization and file quarterly tax returns.
* It's inflationary. Taxation of services would ripple through the economy, creating greater pressure for wage increases. The added cost would create a significant hardship for many.
* It discriminates against private enterprise in competition with government. Where private enterprise is providing a service that government also provides, a tax on the private sector creates greater competitive discrimination, unless the state agrees to impose a tax on the value of all services it provides, which is unlikely.
* It could pose an exemptions problem. Does anyone expect a tax on services to be free of exemptions that would allow those who are politically well connected to avoid the tax? These exemptions would distort consumer decisions and make a mockery of the whole idea in the first place.
Expansion of the sales tax to services would produce more revenue for the state, which is why it is under consideration by policymakers, but this revenue would be fool's gold because of the immense underlying problems.