Is a Do-Over on the Horizon for California's Sales Tax?

Sales taxes are used by both state and local government, but cover fewer and fewer of the things Californians buy. (Paul Richards/Getty Images)

Few sentences may have ever captured California's bizarre sales tax rules better than the one in a new report from the state's nonpartisan Legislative Analyst's Office.

"A sandwich purchased to go," says the report, "may shift from tax-exempt to taxable if the customer chooses to have the bread toasted."

Seriously? Toasted bread and the price of the sandwich goes up?

The reason is buried deep in a system that's so full of what feels like Byzantine requirements and exclusions that it has sparked a steady chorus of voices -- for years -- to remake the sales tax system. Into what, you ask? Something that's more uniform, more broadly applied, and probably set at a lower rate. And this year, that chorus seems to be a little louder.

The LAO report offers some fascinating detail into how we got here, and what the sales tax -- technically, a sales and use tax -- means to local and state government. In short: California first imposed a sales tax in 1933 and now averages about 8.5 percent (rates vary because some cities and counties place their own local tax on top of the state's base sales tax).

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Lawmakers have gradually raised the state rate or shifted its allocations, often in reaction to whopping budget deficits. And voters approved a temporary boost in the state's portion through Proposition 30 in 2012 -- a boost that is scheduled to expire at the end of 2016.

Sales Tax: Slow and Steady

The sales tax used to be the most important source of state government revenue, but was long ago eclipsed by personal income tax, which now provides two-thirds of California's general fund tax dollars.

But the sales tax often gets labeled with the two "R's": reliable and regressive. On reliability, it's proved to be far less volatile than income tax revenues; the LAO report calculates annual sales tax growth since 1970-71 (after adjusting for inflation and rate changes) at only about 1.4 percent. Critics, though, argue it's also the most regressive tax -- in that low-income Californians, who pay the same sales tax rate as everyone else, end up paying a higher share of their income to sales taxes than the more wealthy. In contrast, the personal income tax increases along with wages -- a more progressive structure.

OK, enough background. The fact is that the sales tax is imposed in ways that can make your head spin: Sales tax on hot but not cold foods; sales tax on a newspaper subscription but not one to a magazine; sales tax on a new car but not on car maintenance or repair services.

And then there were the great sales tax fights of days gone by, like the 1991 law that deemed bottled water and candy as non-foods, which then led to a quirky political campaign in 1992 for Proposition 163, which repealed the "snack tax."

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California's sales tax rules are, to put it mildly, confusing. (Graphic: Legislative Analyst's Office) (Graphic: Legislative Analyst's Office)

But the broader issue is that California's sales tax remains largely focused on goods and not services, while the state's economy has decidedly shifted toward more growth and reliance on services.

So ... does that mean changes are overdue? Or, more importantly, are they politically doable?

Broadening Sales Taxes: Big Money, Big Political Hurdles

There's a lot of buzz about new efforts in Sacramento to overhaul the sales tax system, but they are really a continuation of a discussion that began in the depths of the Great Recession.

In his proposed 2009-2010 budget, Gov. Arnold Schwarzenegger proposed imposing sales taxes on a portion of the state's service economy. In two stages, Schwarzenegger wanted to include repair services (for appliances and cars); visits to the veterinarian; amusement parks; sporting events; and rounds of playing golf. The proposal promptly went nowhere, but it led to a much larger -- and contentious -- debate.

That debate was centered on the work of Schwarzenegger's Commission on the 21st Century Economy, dubbed the "Parsky Commission" after its chairman, financier and GOP activist Gerald Parsky. For most of 2009, the bipartisan commission contemplated and clashed over the idea of a vastly different sales tax -- one that would be completely redesigned with an eye on flattening and expanding to more sectors of the economy. The commission called it a "business net receipts tax," and it was often described as looking something like the European value added tax (VAT).

In the end, the idea was hammered by liberal groups and on opinion pages as too much of a new burden on low-income Californians. The 415-page Parsky Commission report landed with a thud in the state Capitol, where's it's been gathering dust ever since.

2015's version of the debate is the work-in-progress Senate Bill 8 by state Sen. Bob Hertzberg (D-Van Nuys), an omnibus tax overhaul proposal that's generated a lot of discussion -- so much that some think it could provide the basis of a 2016 ballot initiative if the Legislature takes a pass.

Hertzberg, a former Assembly speaker who spent a few years leading the bipartisan think tank California Forward, has become a passionate activist for getting away from the traditional sales tax structure.

"The economy's changed," said Hertzberg earlier this year in a Senate Democratic caucus video. "If you're a lawyer, if you're an accountant, if you're an engineer, if you're a political consultant, those are services which should be taxed."

SB8 has yet to get an actual vote in the Senate, and its prospects are a bit unclear. Even so, it's generated some interesting discussion.That included an analysis in mid-April by the state Board of Equalization that suggested a broad sales tax could produce $122.6 billion in revenues -- a whopper of an amount, and one that sent critics of sales tax changes into a tizzy.

Whether any of this results in actual change remains to be seen. In fact, the most likely sales tax changes from the state Capitol in 2015 are special exclusions, like a high-profile effort to exempt diapers from items that are charged a sales tax.

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Still, the broader debate raises important questions about the relationship between California's economy and its tax structure -- a relationship that seems to be changing all the time, and redefining who bears which part of the load when it comes to California's tax burden.