CalChamber-backed study says service tax would disadvantage California businesses

Aiming to short-circuit an idea that has long captured the imagination, if not yet the votes, of legislators, a study backed by California Chamber of Commerce has found that adopting a business service tax—i.e., a tax on lawyers, accountants and consultants—would hurt the economy and put the state at a competitive disadvantage.

The 56-page report released Wednesday took aim at Sen. Bob Hertzberg’s SB 522, which would set the stage for updating California’s sales and use tax by expanding the levy to business services. Although the concept of a business services tax has been repeatedly blocked—business interests oppose it and SB 522 hasn’t even been heard this year—Hertzberg has been among policymakers calling on the state to modernize its tax structure, and the Los Angeles legislator’s measure could form the basis of an overall tax overhaul in 2020.

Such a rethinking, he says, would  reduce budget volatility and capture a greater share of tax revenues in the expanding economy. (Read our explainer on taxes here.)

California has evolved from an agricultural and manufacturing-based economy to one dominated by the service industry. According to Hertzberg’s office, sales and use taxes made up 61% of the state general fund in 1950. Today, they account for only 30%. Meanwhile, personal income taxes accounted for 12% of the general fund in 1950 compared to 70% today.

That tax structure has made state coffers more reliant on the income of high net worth Californians, which can decline dramatically in a downturn. It’s a volatile cycle that tends to create boom-and-bust revenue patterns. Would a business service tax improve that?

Not that much, argues the “Analysis of Sales Taxes on Business Services in California,” which was conducted by Encia Advisors and funded by the California Foundation for Commerce and Education, a nonprofit 501(c)(3) think tank affiliated with CalChamber.

The study found volatility was reduced by 18% assuming the tax applied to all business services and doesn’t depress economic activity. Because personal income taxes make up an outsized share of state revenues, the impact on the sales tax side was minimal.

A staff member in Hertzberg’s office said the study was overly broad because it assumes a service tax would apply to all services rather than limited to business-to-business transactions that companies could then deduct from their federal taxes.

Hertzberg’s bill also aims to make California’s tax system more progressive by capturing services such as accounting, real estate and and litigation, which tend to be used by higher-income residents. The current statewide sales and use tax is 7.25% but local jurisdictions have added taxes up to 3% on top of this rate.

While Hertzberg’s bill doesn’t specify the tax rate, the report assumes a 5% sales tax on all services.

In trying to snuff out talk of a business service tax, the report argues that it would increase costs across economic sectors, create an uneven playing field for California companies to compete with out-of-state firms, and create a tax on labor.

“These problems put California companies at a competitive disadvantage, place a burden on small businesses in particular,” the report states, “and result in higher costs for consumers.”

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