A tax that doesn’t pay

Share via
ANNETTE NELLEN is a professor of accounting and taxation at San Jose State University and a fellow at the New America Foundation.

CALIFORNIA ONCE again is weeks into a new fiscal year without an enacted budget, as legislators and the governor struggle to close the yawning gap between available revenue and the cost of state programs. One little-discussed cause of that gap: California’s sales tax, the second-largest source of state revenue, no longer does the job.

The answer is not to raise the sales tax rate, as some legislators, ballot measures and policy groups have proposed in recent years. California’s sales tax rate of 6.25% is already the eighth highest among states -- much closer to New Jersey’s top-tier rate of 7% than New York’s bottom-rung 4%. (Some states, including Oregon, have no sales tax.) Additional local sales taxes make the rate even higher: 8.25% in Los Angeles, for example.

Further hiking the sales tax rate would hurt low-income individuals, make the state less attractive to businesses -- particularly manufacturers looking to relocate or expand -- and would mark another missed opportunity to move this Depression-era tax from the Industrial Age into the Information Age.


The real problem with California’s sales tax, which provides 27% of the state’s revenue, is that it imposes too high a rate on too narrow a base. A sales tax is supposed to be a broad tax on consumption, but California’s hasn’t kept up with changes in the economy. We’re spending less on “tangible personal property” -- the 1930s terminology that’s still in place -- and more on services and intangibles.

For example, if you buy a CD at Amoeba Music, it’ll be taxed. Download the same album from iTunes, and it’s not. Buy a computer game at Best Buy and it’s taxed; download it online and it isn’t. Similarly, California taxes home video rentals but not movie tickets, lawnmowers but not gardening services, pet supplies but not dog grooming.

These changing consumption patterns have eroded the sales tax base. The Center on Budget and Policy Priorities reports that from 1990 to 2003, the percentage of sales subject to sales tax in California dropped by 13.4 percentage points (states’ median decline was only 8 points). In 1981, 48% of consumption was subject to the California sales tax, according to the California Legislative Analyst’s Office. By 2005, that amount dropped to 38%.

There is no economic rationale for taxing some forms of personal consumption while exempting others. For example, why tax washing machines but not laundry and dry cleaning services? Why tax a game in a box but not one played online?

Broadening the sales tax to include admissions, amusements and personal rentals (like storage lockers and parking spaces) would bring in nearly $1 billion a year. The Legislature could, in fact, lower the tax rate and generate more revenue.

There’s a tax exemption for food meant to exclude necessities of life, but it is too broad. The tax exemption applies to milk and vegetables -- but also to $20-a-pound artisanal cheese and imported bottled water.


The State Board of Equalization estimates that the annual revenue “loss” from the food exemption is $5 billion. Another $318 million could be gained just by taxing candy, snack foods and bottled water. But carving out segments of the grocery market is needlessly complex. A better option might be to tax all food and provide relief to low-income individuals through other means, such as a refundable income tax credit.

A broader base also would help local economies. Today, cities increase revenues by luring big-box retailers and auto malls, which generate huge amounts of sales tax. An expanded tax base could make digital businesses or personal service companies equally desirable.

These shifts in what we buy and how we buy it aren’t going away -- and it is time for California to update its sales tax to reflect the 21st century economy. We can have a lower rate, stronger local economies, added revenue (if needed) and a more equitable tax system. So let’s stop all talk about increasing the sales tax rate and instead work on the harder, but critically important, challenge of broadening the base.