There are few politicians in California with the expertise in California and how its tax policies impact California and its taxpayers more than State Board of Equalization Member Bill Leonard. So I am very pleased to present the following Guest Commentary from Leonard for FR readers:
State’s Retailers Will Get Clobbered by Perata’s Tax Hike
By Bill Leonard
Senate President Don Perata (D – Oakland) has thrown down the gauntlet in saying he will hold up the state budget rather than accept the across-the-board cuts the Governor has proposed. It is disheartening to see Perata’s solution is a one-cent increase in the state portion of the sales tax, which by the way is a 16% increase in the tax (6.25% to 7.25%). Remember, this is a tax that must be paid by retailers only — not lawyers, therapists, web designers, political consultants, gardeners, etc. The sales tax was meant to tax consumption, but the amount of consumption being captured by it is decreasing every year relative to the whole economy.
In 1990 the state had roughly 900,000 retailers. 18 years later, we have roughly 1 million. This is an 11% increase, which might sound good except for the fact the state’s population went up 44% in the same period. Yet, the Democrats are looking to this diminishing class of businesses for more revenue. Our retailers are under siege already. The vacancies in the strip malls will get even worse if this tax increase becomes law.
George Skelton’s column earlier in the week credited Pete Wilson for a $7 billion tax hike in the early 90s. What Skelton left out is that less than $5 billion of what was promised actually came in, and one of the worst recessions in memory was exacerbated. Although it is common sense that people change their behavior in response to changes in the price of goods, the taxpayers’ response to new taxes is not factored in when revenue forecasts are made. These static estimates assume people are like cattle. The tax-hike proponents just whip out a calculator and multiply the tax hike by the number of people, and voila, that is their revenue number. This utterly ignores reality. In fact, the revenues from the Wilson tax hike came in 20 percent short of expectations, or $800 million short, the first year after the hike. Even as the economy recovered, revenues still came in short of forecasts by half a billion per year for several years.
Now Perata is promising $5 billion from a one-cent increase in the state’s sales tax rate. Unlike a static model, a dynamic revenue model factors in the response of taxpayers to changes in price. The Department of Finance has the ability to do dynamic modeling, but rarely makes that information public. I have a dynamic revenue model from the Department of Finance that shows an 8% decrease in revenue for every one-cent hike in the sales tax rate. This means Perata’s tax hike would only bring in maybe $4.2 billion. But wait, this dynamic estimate was done in 2003. Since 2003, people are even more likely to choose the Internet than put up with a 9% surcharge on tangible goods. I doubt Perata’s plan will even bring in $4 billion and even that assumes that we do not enter a full recession that could make it even less.
From a supply-side standpoint, it is better to tax consumption rather than savings and investment. However, the current tax scheme does not tax consumption as much as it taxes one group of businesses over another. The solution is not to extend the sales tax to services. That would only put new pressure on businesses, many of which would choose to provide their services from comfortable offices in Nevada, deliver their product over the Internet, and no longer bother with California income tax either. Higher and more taxes is not a long term solution that makes sense.
What is clear is the Perata tax hike is not worth the cost of increasing pressure on the state’s retailers at a time when retailers are desperately fighting for survival. In the Skelton article, former Governor Pete Wilson was quoted saying the solution to the current crisis is to revisit the massive spending increases during Davis’ last couple of years.
California had an extraordinary revenue boom in the late 1990s. The subsequent revenue bust in the early 2000s was the result of the popping Internet bubble, and the failure to recognize that revenues were in an unsustainable spike. The personal income tax soared from $28 billion in 1997-98 to a peak of nearly $45 billion in 2000-01, before plummeting to below $34 billion in 2001-02. The state’s fiscal problem has its roots in how we treated this spike in revenue. Had we treated it as one-time money and invested in capital projects, rather than committing the state to those lofty spending levels permanently there would not be a budget deficit today.
But instead, as of 2002 the state had a $2 billion deficit that year and $5 billion more the next. California went from a $5 billion surplus to a $5 billion deficit in just two years, and we have not since closed this gap.
Given this set of facts, Senator Perata, along with the Legislative Democrats, cannot credibly argue we have a revenue problem. It is obvious how the state’s finances got off track. To say we have a revenue problem is to commit to imposing another massive spike in revenue. Rather than have that revenue come naturally from good economic conditions, the Democrats want to collect the extra money through more taxation, whether or not the economy can deliver it.
In this new economy, tax hikes only generate a race to the bottom. We need to compete for people and businesses. If we do not lower both taxes and state spending, California is going to lose, and lose big.
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