Uneasy Reaction to Tax Proposal

Times Staff Writers

California industry dodged the worst of Gov. Gray Davis' proposed $8.3 billion in tax increases Friday, with the two biggest hits -- a 1-percentage-point boost in the sales tax and higher personal income taxes -- falling largely on consumers and upper-income individuals.

But businesses still would feel the fallout from the governor's plan to deal with California's gigantic budget mess.

Retailers fresh off a lousy Christmas season worry that higher sales taxes would further discourage consumers. California health-care professionals would be stung by falling reimbursements for Medi-Cal patients. And some small-business owners who file personal returns as sole proprietors or independent contractors would get hammered by rates as high as 11%.

Still, the governor's proposals were significant for what they didn't include. Davis didn't raise corporate tax rates or expand the sales tax to include services, and he retained a coveted manufacturing tax credit.

"I don't like any tax increase that drives costs up," said Jack Stewart, president of the California Manufacturers and Technology Assn. "But I guess it's better than targeting the business community to pay for the whole thing."

Analysts said the proposed tax hikes, though a drag on the private sector, probably wouldn't be significant enough to derail the recovery of California's $1.5-trillion economy.

"It hurts, but it won't kill California," said Steve Cochrane of the research firm Economy.com. "I don't think it's enough of a shock to put the economy into recession" again.

By recommending an increase in the sales tax, experts said, Davis moves closer to making the state's tax base broader and more stable. Much of the budget crisis stems from California's heavy reliance on personal income taxes, the bulk of which are paid by a relatively small number of wealthy residents -- many of whom saw their incomes fizzle when the tech and stock bubbles popped.

Revenue from sales taxes likewise has fallen, but nowhere near as precipitously as that from capital gains and stock options, and is thus a more reliable funding stream, according to Sung Won Sohn, chief economist of Wells Fargo & Co.

The downside, Sohn said, is that sales taxes are regressive, hitting poor Californians harder than the more well-to-do. The tax also would be an additional burden on consumers, who at least until the recent holiday season have been a bright spot in an otherwise lackluster economy.

Though Sohn doubts that an increase of 1 percentage point would slam the brakes on California consumer spending, he said buyers and sellers of big-ticket items would feel the sting. "If you are buying a piece of bubble gum it will not really matter," he said. "But if you are buying a car, then you're going to notice."

Combined state and local sales tax rates range from a low of 7.25% in counties such as Ventura to a high of 8.5% in San Francisco. Los Angeles' current rate is 8.25%.

Car dealers around Southern California said Friday that they feared the potential effects of the Davis plan, which would add $250 to the cost of a $25,000 vehicle. "Every point you add to the price of a car takes some people out of the market," said Dave Conant, president of Cerritos-based Conant Automotive Retail Group, whose dealerships include Norm Reeves Honda.

Others say there's no evidence that a jump in the sales tax causes a significant, quantifiable drop in auto sales. George Pipas, a Ford Motor Co. analyst, said previous sales tax increases often have spurred a brief flurry of business as people hurry to dealerships to buy cars before the measure takes effect.

"So the biggest impact," Pipas said with a laugh, "might be a brief sales spurt."

Other businesses -- including California's 76,000 eating-and-drinking establishments -- may not be so resilient. "We hope this is an idea that falls off the table," said John Dunlap, chief executive of the California Restaurant Assn. "This is a world of 99-cent hamburgers, and every penny counts."

Some predict that a higher sales tax would drive more California consumers to the Internet and catalogs, where they can avoid the levy.

"People will increasingly go to stores to figure out what they like but then go home and buy it online to save," said Larry Thomas, chief executive of Westlake Village-based Guitar Center Inc., which has 22 music stores in California. "This makes California less competitive."

Although online purchases account for just 1.3% of overall retail sales nationally, according to the Commerce Department, they are growing briskly.

General merchandise stores such as Wal-Mart and Target sell more than $47 billion in taxable goods annually in California, second only to the auto industry's $85.4 billion in taxable sales.

Davis' call for a sales tax increase is worrisome to Minneapolis-based Target Corp. because nearly half of the 264 stores in its Mervyn's division are in California, in addition to its 176 Target stores here.

"Certainly there is going to be an impact," said spokesman Douglas Kline. "But it is premature to say how big that will be."

But Wal-Mart Stores Inc. spokesman Tom Williams said that regardless of whether the governor's blueprint goes through, Californians "are still going to need to purchase the type of items that get used up and have to be replenished. That's a lot of what we sell."

Though California risks losing sales to neighboring states with lower sales taxes, driving across the border is impractical for most consumers. Analysts expressed more concern about the mobility of the other big group targeted for a tax increase -- wealthy Californians.

The state's top income tax rate currently is 9.3%. Under the Davis proposal, individuals would pay 10% on income in excess of $136,115, and couples on income greater than $272,230. The 11% bracket would kick in for individuals earning in excess of $272,230, and for couples with annual income of $544,460 or more.

Although taxing the rich is politically popular, analysts said raising the top rates would reinforce the volatility in California's tax structure. It also would encourage big earners to find ways to avoid taxes or leave the state, said Jack Kyser, chief economist with the Los Angeles County Economic Development Corp.

"They are mobile and they can afford good tax advisors," Kyser said. "So the state might not end up with as much revenue as it thinks it will get.... You also drive off some of the bright entrepreneurs.... At some point, you risk killing the goose that laid the golden egg."

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Sales tax by industry

The auto industry is a major contributor to state sales tax revenue.

Percentage of California sales tax contributed by each group in fiscal 2001

Automotive* -- 19.34%

General merchandise stores -- 10.69

Specialty stores -- 9.96

Restaurants -- 8.35

Building materials -- 5.48

Business, personal services -- 5.04

Food stores -- 4.26

Apparel stores -- 3.03

Furnishings and appliances -- 3.02

All other retail stores -- 2.44

Other -- 28.38

*Comprises new- and used-auto dealers, supplies and parts sellers and service stations.

Source: State Board of Equalization

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Times staff writer Alex Pham contributed to this report.

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