Buy a new suit in California, you pay sales tax. Take it to a dry cleaner, and the transaction is tax-exempt.
With the state's budget deficit at $15 billion, some state officials argue it's time to end the tax-free ride on dry cleaning and many other services.
Ideas are circulating in the Capitol to overhaul the state's tax structure as California's latest budget standoff drags on. The goal isn't simply to raise more money. Officials also are trying to smooth out the revenue fluctuations that can turn California's treasury into a cash gusher when times are good and a desert when the economy falters.
Advocates say much of the problem lies with California's huge reliance on personal income tax. It's notoriously volatile. A huge decline in 2002 led to the budget battle and recall of Gov. Gray Davis a year later.
This time around, things haven't been as dramatic. Income tax payments have continued to grow, but at a much slower rate than three years ago, when the real estate and stock markets generated big windfalls. Revenue hasn't kept pace with spending growth, and legislative Democrats and Republicans are at an impasse that has left the budget more than two weeks overdue.
"It's not the first time the state's been in this situation," said Terri Sexton, a California State University, Sacramento, economist who advises the state on fiscal policy. "I think everybody agrees about the volatility of our income tax base, and here we are going down this same path again."
Sexton and some elected officials want California to rely more heavily on sales tax, which is more dependable. Instead of raising rates, which now top out at 8.75 percent, some officials are urging the Legislature to start imposing the tax on a broad range of services that are currently exempt. California taxes fewer services than most other states.
Quick fix unlikely
A quick overhaul of the tax structure isn't likely. Although Gov. Arnold Schwarzenegger and Assembly Speaker Karen Bass want to form a blue-ribbon commission to study the tax code, that won't happen until after the current budget is passed.
And even once the commission gets going, history says a thorough revamp won't pass easily. The idea of broadening the sales tax base has been floated before without much success, and may face fierce resistance in the Legislature.
Service providers such as lawyers and accountants will lobby hard to keep their professions tax-exempt, arguing that some corporate clients would try to avoid the tax by outsourcing those functions to other states. Republicans want to focus more on spending cuts but might go along with a sales tax overhaul if the overall rates are lowered, making the changes "revenue neutral."
Complicating matters, experts say the Democrats' plan to close the current deficit – by raising personal income taxes on the wealthy – would probably make the system more volatile, rather than less. That's because wealthy individuals' incomes usually fluctuate madly from year to year. Republicans have vowed to oppose the Democrats' idea.
For now, Schwarzenegger wants to plug the deficit in part by borrowing against future lottery revenue and sticking the cash in a rainy-day fund. If his plan isn't approved by voters in November, he would call for a temporary 1 percent hike in the sales tax.
Fewer peaks and valleys
Beyond that, some momentum is building for a more substantial overhaul and creation of a system with fewer peaks and valleys. "No other big state has seen such volatile ups and downs in revenues," Schwarzenegger lamented in May.
California's addiction to personal income tax revenue is greater than most states' and has crept up over time. The governor's proposed budget for the new fiscal year would rely on personal income taxes for 52 percent of the general fund's revenue. In 1980, personal income tax accounted for barely a third of the pie.
With a top rate of 9.3 percent – plus another 1 percent for those earning more than $1 million – the income tax structure places an ever-increasing reliance on the rich. In 2005, the latest year available, the top 0.3 percent of Californians paid 37 percent of all the income tax, according to the Franchise Tax Board. In 1990, they paid 24 percent.
Call The Bee's Dale Kasler, (916) 321-1066.
