Opinion: Lower the sales tax — but reform what does and doesn’t get taxed
Originally published in the San Jose Mercury News July 23, 2011.
By Annette Nellen
Special to the Mercury News
Some people wonder why California’s sales tax rate dropped on July 1 despite the state’s fiscal problems. What we should be wondering, though, is why the rate is still so high.
The temporary 1 percentage-point increase in the state sales tax rate expired as scheduled, returning the state to a 7.25 percent rate (8.25 percent in most of Santa Clara and San Mateo counties). Even with this lower tax rate, California’s sales tax rate remains highest in the nation, where a rate of 4 percent to 6 percent is more common.
California’s sales tax system is a relic of the early 20th century. One reason it has not been modernized to reflect today’s ways of living and doing business is that it is easier to change the rate than do the harder work of changing the base — what the tax applies to. When the base of a tax is flawed, raising the rate just intensifies the effects of the flaws and the state suffers.
Two changes are needed to modernize California’s sales tax. First, the base must be changed to reflect what people buy today rather than what we bought in 1933 when the tax was created. Second, business exemptions are needed to reflect the reality of greater interstate competition today. These changes, explained next, are also justified by good tax policy.
A sales tax is a consumption tax, so it should tax what we consume. In 1933, we mostly consumed tangible personal property and that was the tax base. Today, our consumption of services, entertainment and digital goods is higher than what we spend on tangible goods. This trend started around 1970 and continues. Thus, our tax base is eroding. Trying to make up the declining revenue with a rate increase is fighting a losing battle that further weakens the tax system.The sales tax base should be broadened to include today’s personal consumption items — digital goods, personal services and entertainment. There is no reason to tax a physical book, but not its digital counterpart; in both scenarios, you get a book to read. This base broadening for consumers must be accompanied with a drop in the tax rate.
The second change requires adding exemptions for business purchases of equipment. The majority of states already have such exemptions. For example, if a business buys $1 million of manufacturing equipment in Texas, no sales tax is owed. In California, the business must pay a sales tax bill between $72,500 and $97,500, depending on the county.
When businesses pay sales tax, it usually ends up in the prices they charge, and we have a tax policy flaw — a tax on a tax. Sales tax exemptions for business equipment would not only be better tax policy, but would send a message to businesses that California wants them.
These are significant changes, but necessary ones. They should be implemented on a gradual basis, perhaps phased in over a period of two years.
California’s tax system, economy and business climate suffer when we only look at the rate of our outdated, inefficient sales tax and ignore the base. It is time to modernize the base and lower the rate. We will all benefit.
ANNETTE NELLEN, CPA, Esq. is a professor of accounting and taxation at San Jose State University. She wrote this for this newspaper.