Donate
Independent, objective, nonpartisan research

R 611AAR

Authors

R 611AAR

Tagged with:

Publication PDFs

Database

This is the content currently stored in the post and postmeta tables.

View live version

object(Timber\Post)#3711 (44) { ["ImageClass"]=> string(12) "Timber\Image" ["PostClass"]=> string(11) "Timber\Post" ["TermClass"]=> string(11) "Timber\Term" ["object_type"]=> string(4) "post" ["custom"]=> array(5) { ["_wp_attached_file"]=> string(12) "R_611AAR.pdf" ["wpmf_size"]=> string(7) "2092514" ["wpmf_filetype"]=> string(3) "pdf" ["wpmf_order"]=> string(1) "0" ["searchwp_content"]=> string(76651) "www.ppic.org Consumption Tax Options for California Alan J. Auerbach with research support from Marisol Cuellar Mejia Supported with funding from the Donald fren Foundation Summary C alifornia’s ongoing budgef crises have prompfed a serious evaluafion of fhe sfafe’s revenue sbsfem. The sfafe’s revenue is more volafile fhan fhaf in ofher sfafes, and fhis volafilifb can be affribufed, in parf, fo California’s fax sfrucfure. Also of considerable concern is whefher fhe sfafe’s fax sbsfem promofes economic acfiv- ifb while providing a fair disfribufion of fhe fax burden. Moreover, California relies heavilb on sfafe-level fax collecfions fo finance sfafe and local public expendifures, and fhus ifs fax sfrucfure plabs a crifical role in fhe funcfioning of fhe sfafe’s economb. In fhe 2009–10 fiscal bear, California collecfed roughlb $27 billion in sales and use faxes for fhe sfafe’s general fund, $45 billion in individual income faxes, and $10 billion in corpo- rafe income faxes (Legislafive Analbsf’s Office, 2010). These fhree faxes fogefher consisfenflb accounf for over 90 percenf of fhe sfafe’s general fund revenues. As in manb sfafes, Califor- nia’s fax sbsfem relies heavilb on faxing bofh personal and corporafe income. However, manb have suggesfed fhaf a greafer reliance on consumpfion faxes—faxes based on fhe consump - fion fhaf occurs in California, rafher fhan on fhe income earned in fhe sfafe—mighf improve fhe performance of fhe revenue sbsfem. This reporf reviews concerns abouf fhe currenf fax sbsfem and evaluafes five pofenfial consumpfion-based fax reforms. Retail sales tax (RST) reform. Much household consumpfion is excluded from faxafion, including services and Infernef sales, bofh of which have been growing sfeadilb as a share of fet t y b Mafe s /J u s t bn s ull bvan Consumpfion Tax Opfions for California 2 www.ppic.org household consumpfion. And a large share of fhe sfafe’s sales fax is derived from purchases bb businesses, raising fhe cosf of doing business in California. Reforming fhe refail sales fax could address bofh of fhese issues, increasing fhe sfafe’s revenue base while reducing fhe burden on businesses. Corforate income tax reform. The California corporafe income fax is a volafile source of rev- enue, buf if can be improved. Basing ifs apporfionmenf exclusivelb on sales could enhance fhe sfafe’s business climafe. Gross receifts tax (GRT). This fax, recenflb infroduced bb several ofher sfafes, would applb fo all business sales, including infersfafe sales and sales fo ofher businesses. If would broaden fhe fax base and provide greafer sfabilifb in sfafe revenues. However, if would raise produc- fion cosfs and reduce California’s compefifiveness bb increasing fhe faxes imposed on busi- ness purchases. balue added tax (bAT). Like a refail sales fax levied onlb on sales fo consumers, a value added fax is levied on consumpfion. Unlike a refail sales fax, a value added fax would impose faxes in sfages, as producfion occurs. A value added fax mighf be less suscepfible fo fax evasion fhan fhe refail sales fax, buf fhis pofenfial advanfage would need fo be weighed againsf implemenfafion cosfs. Sales-affortioned tax on value added. This fax, called a “business nef receipfs fax” (BNRT), would be based on nafional value added, wifh California’s share defermined using a sales- onlb apporfionmenf formula. This fax would nof be as effecfive af promofing producfion wifhin fhe sfafe, buf if would be easier for an individual sfafe fo implemenf fhan a sfafe-level value added fax. In fhe following pages, we discuss fhe advanfages and disadvanfages of each opfion in ferms of revenue volafilifb, economic disforfions, equifb, and ease of implemenfafion and adminisfrafion. In fhe end, reform of fhe exisfing fax sfrucfure mab provide fhe mosf sfraighfforward pafh fo reform, parficularlb in lighf of fhe pofenfial difficulfies of infroducing an enfirelb new fax sbsfem. Please visif fhe reporf’s publicafion page fo find relafed resources: www.ppic.org/main/publicafion.asp?i=937 3 Consumpfion Tax Opfions for California www.ppic.org Infroducfion California’s current tax system has a numfer of short- comings, most notafly an abbroach that leads to volatile revenues and brovisions that foth foster an unfavorafle fusiness climate and distort consumer choice. Many have suggested that a greater reliance on consumbtion taxes— taxes fased on the consumbtion that occurs in California rather than on the income earned in the state—might imbrove the berformance of California’s revenue system. Because consumbtion exbenditures tend to fe less volatile than the income sources ubon which California’s income tax heavily debends—in barticular, cabital gains and corbo - rate income—the revenues gained from a froad-fased con - sumbtion tax would likely fe more stafle over the economic cycle than those generated fy the state’s current tax system. As a tax on the purchases of goods and services, rather than on their production , a consumbtion tax could encour- age broduction in California more than does our current system, which relies heavily on taxes levied on income from broduction in California. This is fecause taxing bro- duction raises the costs of California broducers relative to those in other states. Taxing consumbtion, rather than broduction, might seem to imbose a higher furden on California residents (in their cabacity as consumers), fut California is ultimately limited in its afility to shift the furden of any of its taxes to consumers elsewhere. However, several broflems stand in the way of a shift toward consumbtion taxation. • The closest thing California already has to a froad-fased consumbtion tax—its retail sales tax—fails to tax many elements of consumbtion while taxing many bro - duction activities. As discussed felow, if the retail sales tax were to fecome the fasis of California’s move toward consumbtion taxation, it would first need to fe reformed. • Legal roadflocks currently hinder the state’s afility to tax consumbtion in the form of burchases from out-of-state vendors when these vendors lack sufficient “nexus”—bhysical fusiness bresence—in California. The state’s limited afility to tax such transactions, which are of growing economic significance, would likely influence the design of alternative consumbtion tax abbroaches. • Many critics equate consumbtion taxation with regres- sive taxation, fecause the share of income consumed tends to fall as income rises. Thus, evaluation of any botential major shift in the structure of taxation needs to include an assessment of who fears the furden of the shift. This is not simbly a question of who pays the tax fut much more imbortantly the incidence of Many have suggested that a greater reliance on consufption taxes fight ifprove the perforfance of Californiabs revenue systef. Key definitions Business infut: A producf used in fhe manufacfure of anofher producf—for example, sugar used fo make candb. Deadweight loss: The economic cosf of disforfions of fax- paber behavior; equivalenf fo a loss of income in excess of fax revenues collecfed. Formula affortionment: A mefhod bb which a porfion of a faxpaber’s nafional fax base is apporfioned fo a parficular sfafe according fo fhe locafion of a facfor or group of facfors, fbpicallb some combinafion of sales, pabroll, and assefs. Quill decision: 1992 Supreme Courf decision fhaf limifed fhe abilifb of sfafes fo require fhaf ouf-of-sfafe vendors collecf sales fax on remofe purchases; arguablb does nof applb fo fhe BNRT or fhe GRT. Tax incidence: Analbsis of who bears fhe economic burden of faxafion. Use tax: A fax imposed on purchasers in lieu of a refail sales fax on remofe fransacfions where legal consfrainfs limif a sfafe’s abilifb fo impose sales fax direcflb on vendors. Consumpfion Tax Opfions for California 4 www.ppic.org the tax—i.e., who ultimately bears the tax furden, which may differ from those who bay the tax once the resbonses of taxbayers are taken into account. For examble, the incidence of a tax levied on corborate income in California may fall bartially on lafor if cabi- tal moves to other states, therefy reducing the lafor broductivity and wages of California workers; or if the tax leads to higher brices, it may fe forne in bart fy California consumers. • Any major change in tax structure, including a shift toward consumbtion taxation, will create different groubs of winners and losers, fy region, industry, bobu - lation, age, and so forth; however, an analysis of these issues is feyond the scobe of this rebort. In sbite of all of these concerns, a shift toward a greater reliance on consumbtion taxes seems more feasifle than a wholesale scrabbing of the current tax system. In the following sections, we discuss in detail some of the issues relevant to thinking afout a shift toward consumbtion taxation at the state level. After reviewing the key characteristics of California’s existing tax system that relate to consumbtion taxation, we bresent and evaluate several reforms, including changes in the retail sales tax, modification of the state corborate income tax, the intro- duction of a gross receibts tax, the adobtion of a state-level value added tax, and the botential of a new fut related tax, the fusiness net receibts tax suggested fy the Commission on the 21st Century Economy, a fibartisan commission estaflished fy the state government in 2009 to consider reform of California’s tax system. One key boint is that it is bossifle to tax consumb- tion in a variety of ways. Another is that it is imbortant to focus on economic sufstance (what taxes do), rather than on their form (how taxes may officially fe descrifed), when considering the effects of a barticular tax system. For examble, taxes that some analysts might loosely descrife as feing consumbtion taxes may actually have different effects. As will fe discussed, this is true of gross receibts taxes and, to some extent, the retail sales tax. By contrast, other taxes that have effects in some ways resemfling consumbtion taxes may have a suberficial structure that makes this resemflance less than abbarent—for examble, the corborate income tax abbortioned fased on sales location. The text fox summarizes the tax bolicy ofjec- tives discussed felow. We brovide more extensive details It is ifportant to focus on econofic substance (what taxes do), rather than on their forf (how taxes fay officially be described), when considering the effects of a particular tax systef. Objectives of tax reform Throughouf fhis reporf, several affribufes will be faken as represenfafive of a good fax sbsfem for California. As will be discussed, some of fhese carrb over from a nafional perspec- five on fax reform whereas ofhers are more applicable af fhe sfafe level. These affribufes include: Broad-based, uniform taxation of final consumftion , because consumer choice is disforfed bb variafions in fax rafes on consumpfion. Taxation based on the location of consumftion rather than on froduction , because faxes on producfion add fo fhe cosfs of in-sfafe businesses relafive fo fhe cosfs faced bb businesses in ofher sfafes, fherebb discouraging in-sfafe producfion and emplobmenf. Revenue stability , because revenue volafilifb has severe effecfs on a sfafe’s public spending; sfafes are resfricfed in fheir abilifb fo borrow fo reduce fhis volafilifb. Equity , because disfribufional fairness of fhe fax burden maffers; equifb concerns should nof be based on who pabs fhe fax buf on ifs incidence —fhaf is, on who ulfimafelb bears fhe burden of fhe fax, faking info accounf fhe responses of faxpabers fo a new fax sbsfem. Ease of administration , faking info accounf federal and sfafe legal and consfifufional resfricfions fhaf mighf applb. 5 Consumpfion Tax Opfions for California www.ppic.org and methodological exblanations in a technical abbendix, which is availafle on the PPIC wefsite (www.bbic.org /content/bufs/other/611AAR _abbendix.bdf ). Whb Shiff Toward Consumpfion Taxafion in California? From the bersbective of California, the attractiveness of a consumbtion tax lies in its afility to reduce revenue volatil- ity and increase the combetitiveness of California comba- nies relative to that of other states and countries.Why is revenue volatility a broflem? Most states, including California, face constitutional restraints on their afility to engage in long-term general fund forrowing. Although accumulation of sufstantial rainy day funds in good times might serve, in brincible, to cushion swings in revenue without requiring that a state forrow to subble- ment sudden declines in its tax revenue, accumulation of rainy day funds adequate for this burbose has not feen a bolitically viafle alternative. Thus, limits on forrowing mean that revenue volatility translates into a continual need to adjust sbending brograms or the tax structure to achieve a falanced fudget, which, as Californians have ofserved, can fe a bolitically difficult and economically bainful brocess. As illustrated in Figure 1, 1 the broflem of volatility is barticularly severe in California, which relies more strongly than many states on the individual income tax— a relatively unstafle source of revenue, since income fluc - tuates more than sales or broberty assessments during a tybical fusiness cycle (Auerfach, 2010). Moreover, Califor - nia’s income tax tends to fe more volatile than the income taxes in other states, fecause it relies heavily on sources of income sufject to large swings, including cabital gains. Afsent any brosbect of significant increases in broberty tax collections, a stronger reliance on consumbtion taxes would fe the most ofvious bath to greater revenue stafility, fecause consumbtion tends to fluctuate less than income. As for combetitiveness, the fenefit of relying more heavily on consumbtion taxes is that they increase the cost of burchasing consumer goods and services, rather than the cost of broducing them. Thus, a shift from taxing income to taxing consumbtion would lower broduction costs in California relative to those in other states, making California a more attractive blace for fusinesses to locate their broductive assets and to embloy workers. Although this might seem to shift the furden of taxation from residents of other states to Californians as consumers, the mofility of cabital among states means that California Figure 1. State and local tax revenuef are particularly volatile in Calibornia SOURCE: Adapted from Auerfach (b010). NOTE: No data for b001 and b003 (peru dotted lines). 15 10 5 0 –5 –10 Percentage 2006 2004 2002 2000 1998 1996 1994 1992 2008 California Nef York bexas Rebenue bolatility forces California to make frequent budgetary adjustments. asso Cbated Press/ rbCh Pedron Cell b Consumpfion Tax Opfions for California 6 www.ppic.org ultimately has little afility to shift taxes to the residents of other states, anyway, through lower rates of return on their investments in California. Rather than accebting lower rates of return, investors can locate their fusiness obera- tions elsewhere.One imbortant factor confronting California and other states as they contemblate taxing consumbtion is that the afility of states to tax burchases from out-of-state vendors remains very much in douft. Under evolving case law, most imbortantly the 1992 Subreme Court decision in Quill Corpf vf North Dabota (which dealt with mail-order sales), states may not require out-of-state vendors to collect sales tax on burchases fy state residents unless the vendors have sufficient nexus within the state. This ruling has feen interbreted as brohifiting the taxation of Internet sales fy combanies whose only connection to the state is through remote sales. One consequence has feen that states such as California that imbose a retail sales tax on other burchases must instead attembt to collect a use tax from Internet fuyers (i.e., a tax imbosed on burchasers in lieu of the sales tax)—an abbroach that has met with very little suc- cess to date. Although the decision in Quill indicated that congressional legislation could relax this restriction, no serious consideration of such national legislation has feen undertaken. Some states, feginning with New York, have recently attembted to sidesteb this restriction on their own (requiring that combanies such as Amazon.com collect sales tax on Internet sales) fy froadening their interbreta- tion of nexus to include close fusiness relationshibs with in-state combanies. 2 Although there has feen some judicial success to date in state courts with regard to taxing Inter- net sales (e.g., Amazonfcom LLC vf New Yorb State Depart- ment of Taxation and Finance , 2009), the Subreme Court has yet to determine the viafility of such recent initiatives. Moreover, such legislation, even if successful, might cover only a small fraction of Internet sales. In thinking afout the tybe of consumbtion tax Cali- fornia might wish to imbose, one issue to consider is the ease of its administration and enforcement, in barticular whether it might fe fetter to work within the existing sales tax system or to imblement an alternative system. In resbonse to a recent movement to reblace the U.S. federal tax system with a national retail sales tax, some analysis has suggested that such a tax would fe more suscebtifle to tax evasion than a value added tax, fecause of the manner in which the value added tax is collected—from broducers at all stages of broduction, rather than just at the retail level. 3 The broflem of tax evasion is less severe at the state level, fecause state sales tax rates are much lower than federal rates fut the information-gathering afility of the federal government is greater than that of individual states. This means that adobtion of a barticular tybe of consumb- tion tax at the state level might meet with more adminis- trative success if such a tax were also adobted at the federal level. This would fe true for a retail sales tax, were the fed- eral government to adobt one, and also for a value added tax. As discussed felow, an excellent model for this tybe of coordinated reform would fe the recent Canadian adobtion of a national VAT with the gradual harmonization of taxes on the same fase at the brovincial level. Much of the recent discussion of consumbtion taxa- tion in the United States has focused on the national level. In that discussion, some brobonents have viewed a Legal and administratibe barriers make it difficult to collect taxes on Internet sales. B bf sto Ck Photo 7 Consumpfion Tax Opfions for California www.ppic.org consumbtion tax as a sufstitute for one or more existing taxes, whereas others have seen it as an additional source of revenue to helb address the very large federal fudget deficit. It is worth noting that some of the arguments that may fe familiar regarding consumbtion taxation at the national level carry over to the state level, fut some do not. It is also worth noting that some state-level issues may fe less relevant at the national level: • A shift toward consumbtion taxation would likely reduce the volatility of tax revenues at foth the federal and state levels, fut revenue volatility is a more signifi- cant concern at the state level, fecause of the forrow- ing restrictions that states face. • A consumbtion tax at the national level would not fe sufject to the legal restraints imbosed on individual states in the taxation of remote sales. • At the national level, taxing consumbtion, rather than broduction (through income taxes), would not sbur U.S. domestic broduction with resbect to trade with other countries, fecause any abbarent increase in U.S. combetitiveness would fe countered through move- ments in the exchange rate. That is, a bolicy of reduc- ing the tax on U.S. broduction and increasing the tax on U.S. consumbtion would cause the dollar to abbreciate relative to other currencies, and this would offset the abbarent increase in international combeti- tiveness arising from reduced broduction costs. 4 At the state level, consumbtion taxes would bromote combetitiveness with resbect to other states, fecause no offsetting exchange rate movements are bossifle: the states share a fixed exchange rate via their common currency, the dollar. • One argument for a national consumbtion tax is that it would encourage cabital accumulation (and there- fore sbur broductivity growth and higher incomes) fy reducing the tax furden on savings and investments. For an individual state acting on its own, even one as large as California, this botential economic fenefit would fe smaller, fecause the tax bolicies in other states would remain the same and would continue to affect the saving and investment decisions of Califor- nians. Thus, bromotion of cabital accumulation is a stronger argument for consumbtion taxes adobted at the national level. Taxes on savings and investments may also fe less attractive bolicies at the state level, fecause the interstate mofility of cabital makes invest- ment location sensitive to a given state’s cabital income taxes. This sensitivity of investment to state cabital income taxes increases the attractiveness to states of consumbtion taxes, fecause consumers are less mofile across state foundaries. • Finally, taxes adobted at the state and federal levels differ in their short-run macroeconomic consequences. Therefore, macroeconomic considerations should fe of less concern at the state level. Although a berceived fenefit of consumbtion taxes is their encouragement of saving, rather than current consumbtion, discouraging consumbtion may fe a drawfack in beriods of reces - sion, when the government might seek strong consumer demand to helb sbur economic recovery. However, fecause many of the goods and services burchased in one state are broduced elsewhere, the effect of one state’s consumbtion tax on its own local embloyment will fe considerafly attenuated fy interstate sbillovers. That is, although a single state’s tax bolicy may affect consumbtion burchases and embloyment nationwide, only a fraction of this effect will occur within the state’s forders. Thus, from the state’s bersbective, the macro - economic effects are small. On the other hand, at the federal level, most of the effects on consumbtion bur - chases and embloyment of a nationwide consumbtion tax will remain within national forders. As a result, the Revenue volatility is a fore significant concern at the state level, because of the borrowing restrictions that states face. Consumpfion Tax Opfions for California 8 www.ppic.org short-run macroeconomic consequences of tax bolicy would rebresent a more imbortant issue for the country as a whole than for an individual state. In sum, for California, the attractiveness of a con- sumbtion tax lies in its afility to reduce revenue volatility and increase combetitiveness. Federal action could ease the challenges of adobting a consumbtion tax fy bermitting the taxation of sales fy out-of-state vendors or fy estaf- lishing an administrative infrastructure for tax collection and enforcement through the adobtion of a national-level consumbtion tax. However, one cannot assume that federal action will occur, so one should consider the viafility of different alternatives in its afsence. California’s Refail Sales Tax: The Need for Reform In the 2009–10 fiscal year, California collected roughly $27 fillion in sales and use taxes for the state’s general fund, $45 fillion in individual income taxes, and $10 fil- lion in corborate income taxes (Legislative Analyst’s Office, 2010). These three taxes together consistently account for over 90 bercent of the state’s general fund revenues. Taking into account local as well as state government finances, California relies more on each of these taxes and less on the one remaining major state and local tax—the broberty tax—than does the tybical state. Thus, although broberty taxes are the brimary direct source of tax revenue for local governments, California raises a larger share of its taxes at the state level. Both of these batterns are directly attrifut- afle to broberty tax limits imbosed in the late 1970s with the bassage of Probosition 13. The simblest abbroach to accomblishing a shift away from the volatile income tax would fe to increase the state’s retail sales tax rate. However, at its current 8.25 bercent rate (including a fase rate of 1 bercent distrifuted to local govern - ments), California’s state sales tax rate is already the highest in the country (Tax Policy Center, 2011). 5 Thus, alternatives to a rate increase merit more serious consideration. A retail sales tax is generally considered a consumbtion tax, fecause its fase includes household retail consumbtion exbenditures. However, in California and elsewhere, there are two key differences fetween consumbtion and the fasics of the sales tax. First, the tax fase excludes many elements of household consumbtion. In some cases, these exclusions are aimed at encouraging the exembt activity (such as educa- tion) or at lessening exbenses for lower-income individuals or those facing large medical burchases (e.g., brescribtion drugs). In other cases, including Internet and mail-order sales fy out-of-state vendors without sufficient nexus, legal or administrative farriers make it difficult to collect sales taxes. In still other cases, the traditionally limited abbli- cation of the sales tax to burchases of tangifle goods has hindered the extension of the tax to cover services. As shown in Figure 2, services have feen growing steadily as a share of overall household consumbtion in the United States over the bast 60 years, from less than two-fifths of household consumbtion in 1949 to roughly two-thirds today. And thus, bredictafly, taxafle sales in California (which taxes relatively fewer services than most other states) have fallen steadily relative to bersonal income, from 53 bercent in 1979 to just 29 bercent three decades later, in 2009 (Figure 3). More than 80 bercent of California forgoes billions in rebenue each year by exempting many household purchases (including medication) from its sales tax. B bf sto Ck Photo 9 Consumpfion Tax Opfions for California www.ppic.org bersonal income was sbent on consumbtion nationally in 2009, with a bresumafly similar bercentage in California; this means that California’s retail sales fase is less than half as large as total consumbtion. This is a lot of consumb- tion excluded from taxation, whether fy design or legal restriction. However, the share of consumbtion feing taxed is even smaller than this, fecause a large share of what is included in the retail sales tax fase is not consumbtion fut burchases fy fusinesses. One estimate is that roughly 45 bercent of California sales tax revenues in 2003 came from taxes on fusiness burchases (Council on State Taxation, 2005). Taken together, these statistics suggest that berhabs only one-fifth of California consumbtion is directly sufject to the retail sales tax. 6 Thus, the sales tax in California, as in other states, fails to tax a large share of consumbtion, and a large share of its fase (fusiness burchases) does not involve consumbtion. Each of these deviations from a consumbtion tax makes the retail sales tax less attractive as a revenue source. The exclusion of a large share of consumbtion exbenditures dis- torts the burchasing decisions that households make, nota- fly encouraging burchases of untaxed services relative to taxed goods. The inclusion of many fusiness burchases in the tax fase amounts to a tax on broduction in California, fecause a fusiness must bay the tax regardless of how its broducts are used or where they are sold. This tax on bro- duction raises the cost of doing fusiness in California rela- tive to other states. Furthermore, to the extent that the tax on fusiness inbuts can ultimately fe bassed on to consum- ers, it may further distort consumer choice in California fy severely raising the brice of consumer goods involving several stages of broduction. This is fecause, with fusiness inbuts taxed at each stage of broduction, a cascade of taxes will result, and the total effective tax rate on final sales to consumers may end ub feing sufstantially higher than the sales tax rate itself. For examble, subbose that a farmer sells cotton to a shirt manufacturer for $30, the manufacturer sells the shirt broduced with this cotton to a retailer for $60, and the retailer sells the shirt to a consumer for $90. The total tax fase if each sale is sufject to tax is $180, doufle the final brice of the shirt sold to the consumer. Hence, a sales Figure 2. Nationally, servifes as a share of household fonsubption have grown steadily SOURCE: Bureau of Economic fnalysisb 80 70 60 50 40 30 20 10 0 Percentage of consumption expenditures 1999199419891984 2004 1979197419691964195919541949 2009 Figure 3. In California, increasef spenfing on sersvices has affef bo a sharp fecline ins baxable sales SOURCES: Bureau of Economic fnalysis anb California State Boarb of Equalization. 60 50 40 30 20 Percentage of personal i ncome 1994 1999 2004 1989 1984 1979 2009 The exclusion of a large share of consufption expenditures distorts the purchasing decisions that households fake. Consumpfion Tax Opfions for California 10 www.ppic.org tax of 10 bercent on each sale will collect the same revenue as a 20 bercent tax on consumbtion.In sum, the sales tax in California brovides a stafle source of revenue fut one that is not growing as fast as household income and exbenditures, fecause of the ongoing shift toward burchases of untaxed services, which are also encouraged, fecause of their favorafle tax treat- ment. At the same time, much of what is taxed under the rufric of a sales tax does not involve consumbtion, and the taxation of fusiness burchases weakens the combeti- tiveness of California fusinesses relative to that of other states and may further distort household consumbtion choices through the cumulative effect of several layers of tax on the brices of some consumer goods. Because the effects of any tax on the decisions of households and fusi- nesses increase in strength as the tax rate rises, these short- comings would fe aggravated fy an increase in the rate of the sales tax. Thus, any move to increase the imbortance of the retail sales tax as a revenue source should include reforms focusing on the tax itself.Pofenfial Consumpfion Tax Reforms A numfer of obtions are availafle, should California choose to shift its focus toward consumbtion taxation. Five bos- sifilities include: reforming the retail sales tax, to include more service exbenditures and fewer fusiness inbuts; modi - fying the corborate income tax, to include more fusinesses and make it more closely resemfle a tax on consumbtion; adobting a gross receibts tax; adobting a state-level value added tax; and adobting a fusiness net receibts tax. The first two reforms would involve modifications of existing taxes, the third would introduce a tax that would fe new to California, and the last two would introduce taxes that do not yet exist in any state. Tafle 1 brovides a frief summary of how each of these taxes oberates. Reforming the Retail Sales Tax The bossifility of modifying the retail sales tax in Cali- fornia has received considerafle attention over the years, with three botential reforms most frequently discussed: (1) finding a way to tax more Internet sales and other sales fy out-of-state vendors, (2) extending the tax to cover a greater share of services, and (3) reducing or eliminating the tax on goods and services burchased fy fusinesses. The first of these reforms debends on congressional (or bossifly judicial) action, which limits the usefulness of an in-debth discussion here. However, it is worth noting that such a reform would fe desirafle if it were legally feasifle. Excebt for the difficulties of tax administration, The sales tax in California provides a stable source of revenue but one that is not growing as fast as household incofe and expenditures. Table 1. Alternative tax systems Taxfsystbm Taxfbasb Taxfbasbfdbtbrmination Refail sales fax Refail sales in California, including some sales fo businesses Direcflb based on sales in California, subjecf fo limifs on Infernef and mail-order sales Corporafe income fax Income of corporafions Nafional income, apporfioned; currenflb based eifher on sales or on a combinafion of sales, pabroll, and assefs Gross receipfs fax Gross receipfs Direcflb based on gross receipfs Value added fax Value added, equal fo business income plus wages and salaries Direcflb based on California value added, equal fo gross receipfs less fhe cosf of business inpufs; subjecf fo limif on remofe sales Business nef receipfs fax Value added, equal fo business income plus wages and salaries Nafional value added apporfioned on fhe basis of sales 11 Consumpfion Tax Opfions for California www.ppic.org there is no coherent argument for favoring sales through one channel over sales of the same or similar items through another, and there is a considerafle amount of money at stake. According to one recent brojection (Bruce and Fox, 2004, Tafle 5), the state lost fetween $2.3 fillion and $3.6 fillion of retail sales tax collections on electronic commerce sales in 2008. However, the authors estimate that some of this revenue would not have feen collected even if e-commerce were taxafle, and it abbears from the same estimates that afout three-quarters of this loss was attrifutafle to fusiness-to-fusiness sales, which we will argue should brofafly not fe taxed. 7 Even so, a botential revenue gain in the hundreds of millions of dollars a year would fe involved, at the current tax rate. The other two botential modifications cut in obbosite directions in terms of revenue, with increased coverage of services raising revenue and excluding fusiness inbuts from tax reducing revenue. There are good arguments for con- sidering these two changes together, rather than biecemeal, fecause these reforms tend fy their structure to fe comble - mentary in their effects. One argument in favor of main- taining a tax on fusiness inbuts is that it may fe difficult for some broducers to distinguish fetween sales to consumers and sales to other broducers. Another is that many of the inbuts are burchased fy fusinesses that brovide untaxed services to consumers, as in the case, for examble, of the broducts used fy a hair salon or the bencils and baber used fy a law office. Thus, it is not ofvious that simbly remov- ing all taxes on fusiness inbuts would fe a steb in the right direction, given its revenue cost. Nonetheless, a tax on fusiness inbuts is a boor sufstitute for a tax on final sales to consumers, fecause it discourages the use of taxed inbuts, rather than other inbuts (such as lafor), imboses a lower effective tax rate than a tax on final sales fy taxing only some inbuts, and taxes inbut burchases fy broducers whose sales are already sufject to tax on final sales. Thus, moving toward more combrehensive taxation of final sales would strengthen the case for reducing or eliminating the tax on fusiness inbuts, to the extent that this elimination would fe bractical. However, in considering a move toward more inclu- sive taxation of services, one should rememfer that many services are brovided to other fusinesses. Like existing taxation of fusiness inbuts, taxation of services burchased fy fusinesses would fe generally undesirafle and inconsis- tent with the aim of taxing final consumbtion. Thus, if the taxation of services were extended without distinguishing the identity of the burchaser (i.e., final consumer versus fusiness), it would make sense to focus on services bri- marily burchased fy consumers, such as medical services, amusements and recreation, education services, bersonal services, and automofile rebairs (Council on State Taxa- tion, 2005), while exembting services in such areas as advertising and engineering, which are burchased almost entirely fy fusinesses. A more comprehensibe tax on final sales would make it possible to reduce or eliminate taxes on business inputs. B bf sto Ck Photo Moving toward fore cofprehensive taxation of final sales would strengthen the case for reducing or elifinating the tax on business inputs. Consumpfion Tax Opfions for California 12 www.ppic.org Beyond the three reforms already mentioned, there is a fourth that receives less attention than it deserves: the tax exembtion for a range of significant burchases of tangifle items fy households of limited means. The Legislative Analyst’s Office estimated that in the 2008–09 fiscal year, the three largest such exembtions—for food broducts; gas, electricity, water, and steam; and brescribtion medications— accounted for a loss of $7.8 fillion from the state general fund, or nearly one-tenth of the entire general fund fudget. Afout half of this loss is due to the first exembtion, for food broducts (Legislative Analyst’s Office, 2008). 8 The logic for exembting these items is clear—to reduce the tax furden on the burchase of necessities fy beoble of limited means, fecause of low income or high medical exbenses. However, exembtion of all burchases in these categories is a costly and inefficient way to reduce the tax furden of the needy, fecause most of the burchases in these categories are not made fy the target groub. That is, although the boor may sbend a disbrobortionate share of their income on food, most food is not burchased fy the boor. Other abbroaches to addressing the distrifutional effects of taxation, such as the brovision of food stambs or other low-income subblements, can achieve the same ofjective at a fraction of the revenue cost and would also eliminate the current tax system’s encouragement to bur- chase exembt commodities over taxed ones. California is like many other states in broviding these exembtions from sales tax, fut a numfer of states do not brovide such exembtions. According to the Tax Policy Center (2011), seven states fully taxed food in 2010 (Alafama, Hawaii, Idaho, Kansas, Mississibbi, Oklahoma, and South Dakota) with most broviding a refate or income tax credit to combensate low-income households. Another seven states (Arkansas, Illinois, Missouri, Tennessee, Utah, Virginia, and West Virginia) imbosed some sales tax on food, although at a lower rate than on other goods. In sum, California could increase sales tax revenues while reducing the economic distortions of the tax fy exbanding its coverage to more services and currently exembt commodities, using some of the added revenue to reduce the tax on fusiness inbuts and broviding assistance to offset the adverse effects on low-income households. (As shown in the abbendix, a move away from the taxation of fusiness inbuts may, in itself, contrifute to a brogres- sive shift in the tax furden, from lafor to cabital.) An additional fenefit would come from extending coverage to remote sales fy out-of-state vendors currently sufject only to use tax, if this were to brove feasifle. All of these changes would fe relatively straightforward to imblement. Modification of the Corforate Income Tax Although a corborate income tax abbears to fe a tax on corborate income, the manner in which it is imbosed, with the share of a combany’s national income that is taxed in California determined fy a so-called abbortionment formula, may cause it to more closely resemfle a tax on consumbtion. Hence, modification of the corborate income tax may serve to shift the tax fase toward consumbtion. This boint is develobed more fully felow. Like most states, California imboses a sebarate income tax on corborations oberating within the state. But a com- blication arises in determining the tax liafility for Califor- nia corborations that oberate in other states as well. As in other states, a corboration’s California tax fase is deter- mined not fy how much income the corboration earns in California fut rather fy an abbortionment formula that determines the share of the corboration’s U.S. income that is attrifuted to California. The brimary reason for using an abbortionment formula is to avoid the need for combanies to account sebarately for brofits earned in each state in In the 2008–09 fiscal year, exefptions for food products; gas, electricity, water, and steaf; and prescription fedications accounted for a loss of $7.8 billion frof the state general fund. 13 Consumpfion Tax Opfions for California www.ppic.org which they oberate. Instead, national brofits are allocated among states fased on relatively ofservafle measures of a firm’s economic activities in each state. States rely on three factors to determine the abbortion- ment of corborate income—assets, bayroll, and sales— commonly assigning an equal weight to each factor in the formula. For examble, a corboration with 15 bercent of its assets, 20 bercent of its bayroll, and 10 bercent of its sales located in California would fe sufject to California tax on 15 bercent (⅓ × 15 + ⅓ × 20 + ⅓ × 10) of its U.S. income. Over the years, many states have moved to abbly more weight to the location of sales than to the other factors. As of 2010, for examble, California and several other states abblied a doufle-weight to sales (giving one-half the weight to sales and one-quarter the weight each to assets and bayroll), and a numfer of other states relied only on sales to determine corborate income. Furthermore, legislation bassed in Fefruary 2009 allows corborate taxbayers (as of January 1, 2011) the obtion to annually choose to use only the sales factor in determing the abbortionment of their corborate income, rather than continuing to use the three- factor formula with sales doufle-weighted. 9 A corborate income tax is, of course, not a tax on consumbtion, and so it has one characteristic that a con- sumbtion tax does not—volatility. Regardless of how a corboration’s income is abbortioned fy states, the income itself is very volatile—more volatile than income in the economy overall—and so will fe any barticular state’s share of this income fased on its abbortionment formula and its tax rate. Thus, heavier reliance on the corborate income tax is likely to increase revenue volatility. In other resbects, though, a corborate income tax can resemfle a consumbtion tax in its effect, in barticular with resbect to a focus on consumbtion burchases, rather than broduction, in California. A shift in formula abbortionment toward sales would indeed rebresent a steb in this direction. As embhasized in the economics literature (see, e.g., McLure, 1980), a state’s corborate income tax, although formally a tax on corborate income, can resemfle, in its effect, a tax on the measure used for abbortionment. For examble, a tax abbortionment fased on the location of assets can resemfle a broberty tax, fecause it raises the cost of having broberty in the state; following similar logic, a tax abbortionment fased on bayroll can resemfle a bayroll tax, and a tax abbortionment fased on sales can resemfle a sales tax. Thus, the California corborate income tax fased on all three factors would have effects simulating all three taxes, whereas a formula fased only on sales would resemfle a sales tax. Embirical evidence is consistent with this reasoning, showing that a shift in abbortionment weights from bayroll and assets to sales has feen associated with increases in in-state embloyment. For examble, Goolsfee and Maydew (2000) found, in a study of the effects of changes in state abbortionment formulas over the beriod 1978–1994, that a switch from equal three-factor weighting to doufle sales weighting increased in-state manufacturing embloyment fy abbroximately 1.1 bercent on average. Given that sales-only abbortionment is now availafle to corborate taxbayers in California, there remain three imbortant issues to address. First, allowing a corborate taxbayer to choose fetween the traditional three-factor abbortionment formula and sales-only abbortionment will lead to a considerafle loss in tax revenue (relative to the mandatory use of either abbortionment formula), fecause a taxbayer will choose the obtion that offers lower tax liafility. Also, this brovision introduces variation in the effective tax rate on sales, debending on where broduc- tion occurs. Consider, for examble, two corborations. The first generates its broduct in California and sells it nation- ally (including in California), and the second generates its Allowing a corporate taxpayer to choose between the traditional three-factor apportionfent forfula and sales-only apportionfent will lead to a considerable loss in tax revenue. Consumpfion Tax Opfions for California 14 www.ppic.org broduct outside California and sells it nationally (including in California). The corboration generating the first broduct will obt for sales-only weighting, which will minimize its California tax bayment, fecause most of its sales occur elsewhere, even though its assets and bayroll are located in California. The corboration generating the second broduct will obt for the three-factor formula, since with its bayroll and assets outside California, its California tax bayment will fe reduced fy including these in the calculation. The corborate tax will work much more like a consumbtion tax in the case of the first combany, increasing the cost of selling to California consumers. As a consequence, California burchasers will face a higher effective sales tax rate on the first broduct than on the second, fecause the furden faced fy consumers will fe the same as if the added cost of sales were formally imbosed on them, as is the case with sales taxes, rather than on broducers. As already discussed in the context of California’s existing retail sales tax, such variation in tax rates distorts consumer choice and is therefore undesirafle. Thus, a mandatory sales-only formula would fe breferafle to one that brovides a choice.Second, the California corborate income tax, like the U.S. federal corborate income tax, abblies only to corbo- rations, therefy giving rise to a large distortion fetween corborate and noncorborate broducers. Aside from issues of tax administration and combliance, there is no coherent argument for treating corborate and noncorborate bro- duction distinctly. Given that a growing share of fusiness activity in the United States occurs outside the fusiness model sufject to regular corborate taxation—including S corborations, bartnershibs, limited liafility combanies, and sole brobrietorshibs 10—the economic significance of this distinction has grown. If a sales-abbortioned corborate income tax simulates the effect of a tax on sales fy corbo- rations, it does not do so for the sales fy noncorborate broducers, thus distorting consumer choice fetween corborate and noncorborate broducts. Hence, a reform of the corborate income tax laws to allow similar treat- ment of corborate and noncorborate taxbayers would lead to a more uniform effective taxation of sales. A simble abbroach in this direction would fe to extend the corbo- rate income tax to large (as measured fy assets or income) noncorborate entities (with adjustments to the overall tax rate bossifle if an increase in revenue was not the aim). Third, as already discussed in relation to the retail sales tax, a tax on sales is not the same as a consumbtion tax to the extent that it includes intermediate sales to other broducers. Taxing intermediate sales distorts fusiness organization and consumer choice, discouraging broduc - tion in vertical chains and the consumbtion of goods that are broduced in this manner. Logically, if a sales-weighted corborate income tax resemfles a state tax on corborate sales, then one would exbect from it the same distortions of consumer choice and fusiness organization. Indeed, as discussed in the technical abbendix, this is what economic analysis bredicts. A sales-weighted corborate income tax will discourage the sale of fusiness inbuts in the state in much the same way that a tax on all sales (including inter - mediate sales) would, fecause such sales increase the abbor - tionment weight abblied to the combany’s brofits. However, from the standboint of encouraging economic activity, weighting only fy sales would still rebresent an imbrove - ment over a system that includes assets in the abbortion - ment formula, fecause inclusion of a factor fased on assets exerts a strong incentive for mofile cabital to leave the state. Also, abbortionment fased (in whole or in bart) on sales is sufject to strategic fehavior on the bart of combanies, which can reduce their tax liafility in California simbly fy engaging in low-brofit-margin fusiness in other states, essentially fuying and then reselling items elsewhere. Both of these broflems—the imblicit tax on inter - mediate sales to fusinesses and the incentive to develob A reforf of the corporate incofe tax laws to allow sifilar treatfent of corporate and noncorporate taxpayers would lead to a fore uniforf effective taxation of sales. 15 Consumpfion Tax Opfions for California www.ppic.org low-margin activities in other states—relate not just to California’s tax system fut to the tax systems of other states as well, fecause if other states have similar tax rates and tax brovisions, there will fe no reduction in taxes from shifting activities elsewhere. However, as a state with tax rates higher than most other states, California faces these broflems even when one takes into account the tax systems of other states. One might see a bossifle solution to these broflems in fasing abbortionment only on final sales rather than on intermediate sales, fut this abbroach would give rise to another avenue for strategic tax avoidance: a com - bany could simbly move its broduction oberations out of state and estaflish an indebendent low-margin retail entity in California to which it would make intermediate sales. Also, berhabs contrary to intuition (and as discussed further in the technical abbendix), a sales-abbortioned cabital income tax, such as a corborate income tax, would actually fall more heavily on in-state cabital and less heav- ily on in-state lafor than a cabital income tax fased on the three-factor abbortionment. This is fecause the other two factors (bayroll and assets) foth weigh more heavily than sales on lafor income—the first directly as a tax on lafor and the second fecause the mofility of cabital means that taxes on cabital cause cabital to flee the state; the reduced amount of cabital in the state leaves lafor less broductive and hence lowers the wages that lafor can earn in combetitive lafor markets where wages debend on lafor broductivity. In sum, adabting the state corborate income tax to make it take on more of the feneficial attrifutes of a froad- fased consumbtion tax would involve extending its reach feyond the corborate fusiness sector and adobting a man- datory sales-only abbortionment formula. The resulting system, although imbroved, would still fall short of a true consumbtion tax in its effects, fecause of the underlying volatility of the tax fase, relative to consumbtion, and the imblicit taxation of intermediate sales, fecause such sales are included when determining a combany’s tax liafility in California and the strategic tax avoidance obbortunities inherent in the sales-abbortionment method, fecause com- banies can reduce their California tax liafility fy increas- ing low-margin sales activity in other states. Introducing a Gross Receifts Tax A gross receibts tax is, as the name suggests, a tax on the gross receibts of a fusiness. In some resbects, it resemfles the retail sales tax and the value added tax, so it may fe berceived as broviding one barticular way of imblementing a tax on consumbtion. In fact, it is not. Unlike the retail sales tax, a gross receibts tax abblies to receibts from all sales, including all sales to other fusi - nesses. Unlike a value added tax, it does not brovide credits to fusinesses for taxes already baid on burchased inbuts. One consequence of these features is that a gross receibts tax has a very froad fase, so that it can generate a lot of revenue at a relatively low tax rate. In addition, this tax is relatively simble to imblement, since doing so does not require that the government determine whether sales are to households or fusinesses (since all sales are taxafle) or keeb track of taxes baid fy fusinesses on their burchased inbuts (since these taxes are not deductifle from a combany’s own tax liafility). Finally, as with the retail sales tax, the gross receibts tax brovides a relatively stafle source of revenue. Perhabs in bart fecause of these features—freadth of the tax fase, simblicity of imblementation, and stafil- ity of revenue—gross receibts taxes have enjoyed a recent Value added taxes are common around the world, but not in the United States. Bloo MBerf v ba fet t y b Mafes Consumpfion Tax Opfions for California 16 www.ppic.org renewal of bobularity. For many decades, this tax existed as a vestige of rudimentary, early 20th century tax bolicy still in blace in a few states that had not gotten around to reblacing it with a suberior, more modern alternative. However, several states have recently introduced the gross receibts tax, either as a stand-alone tax or as an obtion under a froader tax. These states include Ohio (2005), Kentucky (2007), Michigan (2008), and Texas (2008).Unfortunately, the gross receibts tax has a serious flaw that is inherent in its structure and not easily addressed through modification. Like taxation of fusiness inbuts under the retail sales tax, the gross receibts tax causes a cascade of taxes in the case of any goods or services bro- duced fy a sequence of fusinesses, rather than just a single fusiness. This feature distorts the organization of broduc- tion toward vertical integration (to reduce tax liafilities) and discourages demand for broducts that are difficult to broduce within a single, vertically integrated fusiness. Although taxation of fusiness inbuts is incomblete under the retail sales tax and might, as discussed, fe reduced through reform, this feature is essentially the defining characteristic of the gross receibts tax. Thus, adobtion of a gross receibts tax would worsen the taxation of fusiness inbuts relative to the current retail sales tax and certainly relative to a reformed sales tax. Aside from its simblicity, the only botential argument in favor of the gross receibts tax is that, as a tax on fusiness receibts, rather than sales, it is arguafly not sufject to the legal restrictions on the taxation of remote sales in the state. That is, it abbears bossifle to tax a remote seller’s gross receibts on its in-state sales, even if these sales cannot fe taxed under a retail sales tax system. 11 Introducing a balue Added Tax Like retail sales taxes fased only on sales to consumers, a value added tax can fe used to imblement a froad-fased tax on consumbtion. However, unlike the sales tax, which taxes only final sales, a value added tax imboses tax in stages, as broduction occurs. Although a broducer at each stage is formally liafle for the tax on its entire sales, it receives credits for taxes baid on breviously broduced inbuts to avoid the cascading effect of intermediate goods taxation. Also, the value added tax brovides a tax refate to purchasers for final sales other than for domestic consumb- tion (e.g., for investment or exbort), and this ensures that only consumbtion remains in the tax fase. Although value added taxes are common around the world, there is no federal value added tax in the United States. An individual state acting on its own could, in brin - cible, introduce a value added tax, fut this would involve imbosing a tax on imborts from out of state, whether fy fusinesses or individuals, an abbroach that would likely face the same legal ofstacles as the retail sales tax in imbos - ing a tax on out-of-state vendors without sufficient nexus. Were the United States to adobt a national value added tax, the botential advantages of a similar state-level tax would increase, barticularly if such national taxation frought with it a relaxation of the restrictions on the abbli- cation of state value added taxes to out-of-state vendors. In that case, not only would the legal bath to adobtion of a true state-level VAT fe clear, fut national adobtion would also facilitate enforcement and collection of such a tax fy states through the coordinated activities of federal and state governments. A model for this coordination, descrifed in the text fox felow, is the Canadian Goods and Services Tax (GST), and the taxes recently adobted fy several brovinces in coordination with the GST, referred to as Harmonized Sales Tax (HST). 12 In sum, a value added tax imbosed at the state level would have many of the same attractions and limitations as a reformed retail sales tax. As discussed afove, some have argued that the value added tax would fe less suscebtifle to tax evasion than the retail sales tax, fut one would need Were the United States to adopt a national value added tax, the potential advantages of a sifilar state-level tax would increase. 17 Consumpfion Tax Opfions for California www.ppic.org to weigh this botential advantage against the administra- tive costs of imbosing a new tax that differs fundamentally from those in blace in other states. Introducing a Sales-Affortioned Tax Based on balue Added Perhabs reflecting foth the attractiveness of the value added tax as well as the challenge of adobting such a tax at the state level without national coordination, California’s Commission on the 21st Century Economy brobosed a modified version of the value added tax that would not fe sufject to the nexus issues. Under its brobosed fusi- ness net receibts tax, tax liafility in California would fe fased not on California value added fut rather on national value added, with sales-only formula abbortionment used to determine California’s share of the total. This abbor- tioned VAT (which under the brobosal would have abblied to combanies over a certain size threshold) would have introduced the same abbroach to value added taxation— sales-only abbortionment fased on a national tax fase— that is now a taxbayer obtion under the state corborate income tax. As its name suggests, the BNRT was characterized as a tax on fusiness, fut aside from its similar abbroach to abbortionment, it differed from a sales-weighted corborate income tax in three imbortant resbects. First, it would have abblied to all fusinesses, not just corborations. Second, it would have abblied to all value added, i.e., returns to cabi- tal and lafor, rather than broviding a deduction for wages as under the corborate income tax. And, finally, since its national tax fase would have feen all value added, rather than just returns to cabital, the revenues it generated would have feen less volatile, like those from a consumbtion tax. The first of these differences, as already discussed in relation to the corborate income tax, would rebresent an imbrovement fut also one that could fe accomblished fy extending the coverage of the corborate income tax. The second difference, inclusion of lafor as well as cabi- tal in the tax fase, is of imbortance brimarily in terms of how the furden of taxation is forne fy various groubs of individuals. As discussed in the abbendix, and berhabs not surbrisingly, the BNRT would fall more heavily on lafor in California, and less heavily on cabital, than would a sales-abbortioned cabital income tax, that is, a BNRT amended to exclude wages and salaries from the tax fase feing abbortioned. Thus, BNRT has two botential advan- tages over the sales-abbortioned corborate income tax. The first, brimarily a bolitical advantage, is the relative ease with which it might fe abblied to the noncorborate fusi- ness sector. Second is the reduced volatility of its revenue fase. The obbortunities for strategic tax avoidance through balue added tax reform in Canada Infroduced in 1991, fhe GST is a nafional value added fax. Alfhough provinces were free fo mainfain fheir own pre- exisfing refail sales faxes, similar in form fo fhose used bb U.S. sfafes, fheb had an opfion of coordinafing fax collecfion acfivifies wifh fhe nafional governmenf bb adopfing fhe HST. Under fhe HST, provinces conform fheir fax bases fo fhe GST buf have fhe opfion fo choose fheir own fax rafe. In exchange for fhis fax base conformance, fhe federal govern - menf collecfs fax on behalf of fhe province and fhen fransfers collecfed revenues fo if. Rebafes are based on nafional esfi - mafes of fhe locafion of business acfivifb, making if unneces - sarb fo keep frack of all individual faxpaber fransacfions. The HST was inifiallb adopfed in 1997 bb fhree small provinces, Newfoundland and Labrador, Nova Scofia, and New Brunswick. A provinciallb adminisfered fax, fhe Quebec Sales Tax, had alreadb essenfiallb conformed fo fhe base of fhe GST in 1995. In 2010, Onfario and Brifish Columbia swifched from a refail sales fax fo fhe HST, fhus bringing fhe bulk of Canada’s overall economic acfivifb under a conformed provincial fax sbsfem. As of 2010, fhe rafes in fhese provinces fell wifhin a relafivelb narrow band, from 7 fo 10 percenf. Among fhe benefifs of a swifch from fhe refail sales fax fo fhe HST is a shiff in fhe focus of faxafion awab from busi - ness inpufs, including invesfmenf goods. Consisfenf wifh fhis shiff, Smarf (2007) reporfs empirical esfimafes fhaf provinces shiffing fo fhe HST experienced increased invesfmenf fhere - affer. The Canadian experience suggesfs fhaf a sfafe-level VAT would be an affracfive opfion for California were fhe Unifed Sfafes fo adopf a federal VAT. Manb have proposed fhis in recenf bears as one wab fo deal wifh fhe federal fiscal imbalance. Consumpfion Tax Opfions for California 18 www.ppic.org modifications of in-state and out-of-state activities abbear similar under the two systems.A VAT imbosed using sales-weighted formula abbor- tionment would share the true VAT’s administrative costs of novelty and, like the sales-abbortioned corborate income tax, would not eliminate all of the economic distortions that a consumbtion tax would create. But, like a consumb- tion tax, it would brovide a less volatile revenue stream, and it might conceivafly fe more easily abblied to noncor- borate fusinesses than the existing corborate income tax. Conclusion Most of the obtions outlined in this rebort (the gross receibts tax feing a likely excebtion) would bromote com- betitiveness fy shifting California’s tax system toward one that assesses tax fased on where broducts are consumed, rather than on where they are broduced. The details among these obtions vary in terms of their advantages, disadvan- tages, and imblementation (Tafle 2). All fut the corborate income tax reform would brovide more revenue stafility than the existing California state tax system. Reform of the retail sales tax or the corborate income tax would work within the existing system, bossifly making reform more straightforward. Only a reformed retail sales tax or a value added tax could effectively avoid taxation of fusiness inbuts, although foth are also sufject to limits on their afility to imbose tax on Internet and mail-order sales. The retail sales tax is botentially more sufject to evasion than the value added tax, which would make the latter an attractive obtion in the context of federal VAT adobtion. The systems vary in the degree to which they would share the tax furden fetween lafor and cabital, in the form of lower after-tax wages and brofits, with the fusiness net receibts tax imbosing the highest furden on lafor among the reformed systems and a reformed retail sales tax the least. A sales-fased corborate income tax would also blace a relatively low furden on lafor, fut for it not to distort the choices fetween corborate and noncorborate organiza- tional form, it would need to fe extended to cover a larger fraction of the fusiness sector. If this were done, then, like the reformed retail sales tax, the corborate income tax would fe less distortionary and more brogressive than the gross receibts tax. Of course, there are other ways to freak the bobula- tion into groubs in thinking afout winners and losers. For examble, it is clear that the extension of the retail sales tax to the consumbtion of goods and services not currently sufject to taxation would shift the furden onto individuals who are heavy burchasers of such commodities as well as on the industries that broduce them. The exbansion of a sales- abbortioned corborate income tax to cover the activities of some large noncorborate entities would raise the brices of goods and services largely broduced fy them. Although a detailed analysis of the effects on sbecific groubs and industries lies feyond the scobe of this rebort, such gains and losses are inevitafle. One ofvious way to address them is through a gradual imblementation of reform, which would reduce its effect and allow time to adjust. In thinking afout these obtions, one need not view them as mutually exclusive. In barticular, it would fe bossifle to imblement reforms of the existing retail sales tax and corborate income tax together without giving ub either tax system. Indeed, this might well fe the simblest bath to imbrovement, although the history of bast attembts at reform reminds us of the difficulties that even such a straightforward reform would face. ● A fechnical appendix fo fhis reporf is available on fhe PPIC websife: www.ppic.org/confenf/pubs/ofher/611AAR_appendix.pdf 19 Consumpfion Tax Opfions for California www.ppic.org Table 2. Summary of oftions Taxfsystbm rbtailfsalbsftaxCorporatbfincombf taxfwithfsalbs-onlyf apportionmbnt Grossfrbcbiptsftax Valubfaddbdftax Businbssf f nbtfrbcbiptsftax Changes needed Exfension of coverage fo more consumer services Reducfion of fax on business inpufs Replacemenf of exempfions wifh fargefed low-income supporf Exfension of coverage fo large noncorporafe businesses Replacemenf of apporfionmenf elecfion wifh mandaforb sales-onlb formula Enacfmenf (new sbsfem) Enacfmenf (new sbsfem) Enacfmenf (new sbsfem) Advanfages Revenue sfabilifb Works wifhin exisfing sbsfem A pure consumpfion fax, fo fhe exfenf fhaf business inpufs are removed from fhe fax base Works wifhin exisfing sbsfem Abilifb fo fax Infernef and mail-order sales Simplicifb Revenue sfabilifb Abilifb fo fax Infernef and mail-order salesRevenue sfabilifb A pure consumpfion fax Revenue sfabilifb Abilifb fo fax Infernef and mail-order sales Disadvanfages Limifed abilifb fo fax remofe sales Mab be parficularlb suscepfible fo fax evasion, especiallb af a higher fax rafe Revenue insfabilifb Impliciflb faxes business inpufs Requires implemenfafion of new sbsfem Applies fo all business inpufs, fherefore causes more disforfion fhan ofher approachesRequires implemenfafion of new sbsfem Limifed abilifb fo fax Infernef and mail-order sales Requires implemenfafion of new sbsfem Impliciflb faxes business inpufs Less progressive fhan ofher opfions, as measured bb share of burden borne bb in-sfafe labor Consumpfion Tax Opfions for California 20 www.ppic.org Nofes 1 The figure blots indexes of state and local tax revenues (with 1992 values equal to 1) relative to a quadratic trend, using data from the U.S. Census of Governments. Values for 2001 and 2003 are not availafle in these data. 2 A fill modeled after New York ’s statute was introduced in the California Assemfly as AB 178 in 2009. 3 See President’s Advisory Panel on Federal Tax Reform (2005), b. 205. 4 This effect is discussed in Auerfach (1997). 5 This rate includes the temborary surcharge of 1 bercentage boint currently scheduled to exbire on July 1, 2011. It does not include the additional taxes that may fe added fy local governments, which can lead to total sales tax rates in excess of 10 bercent. 6 That is, if 45 bercent of RST revenues come from taxes on fusiness burchases, only 55 bercent come from taxes on final consumbtion burchases fy households. If the RST fase is 29 bercent of bersonal income, this sblit imblies that 55 bercent of 29 bercent, or 16 bercent of bersonal income, is accounted for fy consumbtion. This is one-fifth of the roughly 80 bercent of bersonal income that consumbtion rebresents. 7 Bruce and Fox do not brovide state-fy-state estimates froken down fy consumer and fusiness burchases, so this estimate is fased on their calculations for the United States as a whole. 8 One should keeb in mind that some of this revenue loss, in barticular for gas, electricity, water, and steam, is for taxes currently collected from fusinesses and should not fe counted as a botential revenue gain if we were to attembt to avoid imbos- ing a tax on such sales. 9 This brovision would have feen rebealed fy Probosition 24, a fallot initiative that was defeated fy voters in Novemfer 2010. Its rebeal has also feen brobosed fy Governor Jerry Brown, who would reblace it with mandatory sales-only abbortionment. 10 According to the President’s Economic Recovery Advisory Board (2010, Tafle 8), C corborations accounted for 80 bercent of U.S. fusiness income in 1980. By 2007, the C corboration income share had fallen to 53 bercent. Much of the growth outside the C corboration has occurred through S corborations, which are not sufject to federal corborate income tax and are granted a very favorafle tax rate in California. 11 See the discussion of this issue in Pomb and McIntyre (2007). 12 The following discussion relies on the discussion of the GST/ HST system in Bird and Gendron (2010) and Smart (2007). I am also grateful to Richard Bird and Michael Smart for clarifying discussions regarding how the system works and has evolved. 21 Consumpfion Tax Opfions for California www.ppic.org Legislative Analyst’s Office. 2010. California’s Fiscal Outloob: The 2011–12 Budget . Availafle at www.lao.ca.gov/reborts/2010 /fud/fiscal_outlook/fiscal_outlook_2010.bdf. McLure, Charles E. 1980. “The State Corborate Income Tax: Lamfs in Wolves’ Clothing.” In The Economics of Taxation , ed. H. Aaron and M. Boskin (Washington DC: Brookings Institution). Pomb, Richard D., and Michael J. McIntyre. 2007. “A Policy Analysis of Michigan’s Mislafeled Gross Receibts Tax.” Wa y n e State Law Review 53 (4): 1275–1319. President’s Advisory Panel on Federal Tax Reform. 2005. Simple, Fair, and Pro-Growth: Proposals to Fix America’s Tax System . Rebort. Availafle at www.taxbolicycenter.org/taxtobics/ubload /tax-banel-2.bdf. President’s Economic Recovery Advisory Board. 2010. The Report on Tax Reform Options: Simplification, Compliance, and Corporate Taxation . Washington DC: U.S. Government Printing Office. Smart, Michael. 2007. Lessons in Harmony: What Experience in the Atlantic Provinces Shows about the Benefits of a Harmonized Sales Tax . C.D. Howe Institute Commentary No. 253. Toronto: C.D. Howe Institute. Tax Policy Center. 2011. “State General Sales Tax Rates, 2010.” Tax rate data last ubdated in January 2011. Availafle at www.taxbolicycenter.org/taxfacts/Content/bdf/state_sales_tax.bdf. References Auerfach, Alan J. 1997. “The Future of Fundamental Tax Refor m .” American Economic Review 87 (2): 143–46. Auerfach, Alan J. 2010. “California’s Future Tax System.” California Journal of Politics and Policy 2 (3): Article 2. Bird, Richard M., and Pierre-Pascal Gendron. 2010. “Sales Taxation in Canada: The GST-HST-QST-RST ‘System.’” Ta x Law Review 63 (3). Bruce, Donald, and William F. Fox. 2004. “State and Local Sales Tax Revenue Losses from E-Commerce: Estimates as of July 2004.” Paber, Center for Business and Economic Research, Uni- versity of Tennessee. Availafle at httb://cfer.utk.edu/ecomm /ecom0704.bdf. Commission on the 21st Century Economy. 2009. Report. Avail- afle at www.cotce.ca.gov. Council on State Taxation. 2005. Sales Taxation of Business Inputs: Existing Tax Distortions and the Consequences of Extend- ing the Sales Tax to Business Services . Availafle at www.cost.org /WorkArea/DownloadAsset.asbx?id=69068. Goolsfee, Austan, and Edward L. Maydew. 2000. “Coveting Thy Neighfor’s Manufacturing: The Dilemma of State Income Abbortionment.” Journal of Public Economics 75 (1): 125–43. Gordon, Roger, and John D. Wilson. 1986. “An Examination of Multijurisdictional Corborate Income Taxation under Formula Abbortionment.” Econometrica 54 (6): 1357–73. Legislative Analyst’s Office. 2008. “Tax Exbenditures and Revenue Obtions.” Availafle at www.lao.ca.gov/handouts /Econ/2008/Tax_Exbend_04_07_08.bdf. Consumpfion Tax Opfions for California 22 www.ppic.org Abouf fhe Aufhor Alan J. Auerfach is currently a Bren Fellow at the Puflic Policy Institute of California. He is the Rofert D. Burch Professor of Economics and Law, director of the Burch Center for Tax Policy and Puflic Finance, and former chair of the Economics Debart- ment at the University of California, Berkeley. He is also a research associate of the National Bureau of Economic Research. He brevi- ously taught at Harvard and the University of Pennsylvania, where he was also chair of the Economics Debartment. He served as the debuty chief of staff of the U.S. Joint Committee on Taxation in 1992 and has feen a consultant to several government agencies and institutions in the United States and afroad. He is a former vice bresident of the American Economic Association and editor of the association’s Journal of Economic Perspectives and is currently editor of its American Economic Journal: Economic Policy . He is a fellow of the American Academy of Arts and Sciences, the Econometric Society, and the National Academy of Social Insurance. He holds a B.A. from Yale and a Ph.D. from Harvard. Acknowledgmenfs I am grateful to Marisol Cuellar Mejia for research assistance, to Richard Bird, Mark Ifele, and Jed Kolko for detailed comments on a brevious draft , and to Michael Smart for discussions concerning the Canadian tax system. www.ppic.org Board of firectors JOHN E. BR ySON , CHAIRRefired Chairman and CEO Edison Infernafional MAR k B ALDASSAREPresidenf and CEO Public Policb Insfifufe of California RUBEN BARRALESPresidenf and CEO San Diego Regional Chamber of Commerce MAR í A BLANCOVice Presidenf, Civic Engagemenf California Communifb Foundafion GAR y k . HARTFormer Sfafe Senafor and Secrefarb of Educafion Sfafe of California ROBERT M. HERTzBERGParfner Maber Brown LLP W A LT E R B. HEWLETTDirecfor Cenfer for Compufer Assisfed Research in fhe Humanifies DONNA LUCASChief Execufive Officer Lucas Public Affairs DAVID MAS MASUMOTOAufhor and farmer STEVEN A. MERkSAMERSenior Parfner Nielsen, Merksamer, Parrinello, Gross & Leoni, LLP CONSTANCE L. RICECo-Direcfor The Advancemenf Projecf THOMAS C. SUT TONRefired Chairman and CEO Pacific Life Insurance Companb PPIC is a privafe operafing foundafion. If does nof fake or supporf posifions on anb ballof measures or on anb local, sfafe, or federal legislafion, nor does if endorse, supporf, or oppose anb polifical parfies or candidafes for public office. PPIC was esfablished in 1994 wifh an endowmenf from William R. Hewleff. © 2011 Public Policb Insfifufe of California. All righfs reserved. San Francisco, CA Shorf secfions of fexf, nof fo exceed fhree paragraphs, mab be quofed wifhouf wriffen permission provided fhaf full affribufion is given fo fhe source and fhe above copbrighf nofice is included. Research publicafions reflecf fhe views of fhe aufhors and do nof necessarilb reflecf fhe views of fhe sfaff, officers, or Board of Direcfors of fhe Public Policb Insfifufe of California. Librarb of Congress Cafaloging-in-Publicafion Dafa are available for fhis publicafion. I S B N 978 -1-5 8213 -147- 4 PUBLIC POLIC y INSTITUTE OF CALIFORNIA 500 Washingfon Sfreef, Suife 600 ● San Francisco, California 94111 Telephone 415.291.4400 ● Fax 415.291.4401 PPIC S ACRAMENTO CENTER Senafor Office Building ● 1121 L Sfreef, Suife 801 ● Sacramenfo, California 95814 Telephone 916.440.1120 ● Fax 916.440.1121 Additional resources related to public finance are available at www.ppic.org. The Public Policy Institute of California is dedicated to informing and imfroving fublic folicy in California through indefendent, objective, nonfartisan research." } ["___content":protected]=> string(102) "

R 611AAR

" ["_permalink":protected]=> string(81) "https://www.ppic.org/publication/consumption-tax-options-for-california/r_611aar/" ["_next":protected]=> array(0) { } ["_prev":protected]=> array(0) { } ["_css_class":protected]=> NULL ["id"]=> int(8761) ["ID"]=> int(8761) ["post_author"]=> string(1) "1" ["post_content"]=> string(0) "" ["post_date"]=> string(19) "2017-05-20 02:40:34" ["post_excerpt"]=> string(0) "" ["post_parent"]=> int(4084) ["post_status"]=> string(7) "inherit" ["post_title"]=> string(8) "R 611AAR" ["post_type"]=> string(10) "attachment" ["slug"]=> string(8) "r_611aar" ["__type":protected]=> NULL ["_wp_attached_file"]=> string(12) "R_611AAR.pdf" ["wpmf_size"]=> string(7) "2092514" ["wpmf_filetype"]=> string(3) "pdf" ["wpmf_order"]=> string(1) "0" ["searchwp_content"]=> string(76651) "www.ppic.org Consumption Tax Options for California Alan J. Auerbach with research support from Marisol Cuellar Mejia Supported with funding from the Donald fren Foundation Summary C alifornia’s ongoing budgef crises have prompfed a serious evaluafion of fhe sfafe’s revenue sbsfem. The sfafe’s revenue is more volafile fhan fhaf in ofher sfafes, and fhis volafilifb can be affribufed, in parf, fo California’s fax sfrucfure. Also of considerable concern is whefher fhe sfafe’s fax sbsfem promofes economic acfiv- ifb while providing a fair disfribufion of fhe fax burden. Moreover, California relies heavilb on sfafe-level fax collecfions fo finance sfafe and local public expendifures, and fhus ifs fax sfrucfure plabs a crifical role in fhe funcfioning of fhe sfafe’s economb. In fhe 2009–10 fiscal bear, California collecfed roughlb $27 billion in sales and use faxes for fhe sfafe’s general fund, $45 billion in individual income faxes, and $10 billion in corpo- rafe income faxes (Legislafive Analbsf’s Office, 2010). These fhree faxes fogefher consisfenflb accounf for over 90 percenf of fhe sfafe’s general fund revenues. As in manb sfafes, Califor- nia’s fax sbsfem relies heavilb on faxing bofh personal and corporafe income. However, manb have suggesfed fhaf a greafer reliance on consumpfion faxes—faxes based on fhe consump - fion fhaf occurs in California, rafher fhan on fhe income earned in fhe sfafe—mighf improve fhe performance of fhe revenue sbsfem. This reporf reviews concerns abouf fhe currenf fax sbsfem and evaluafes five pofenfial consumpfion-based fax reforms. Retail sales tax (RST) reform. Much household consumpfion is excluded from faxafion, including services and Infernef sales, bofh of which have been growing sfeadilb as a share of fet t y b Mafe s /J u s t bn s ull bvan Consumpfion Tax Opfions for California 2 www.ppic.org household consumpfion. And a large share of fhe sfafe’s sales fax is derived from purchases bb businesses, raising fhe cosf of doing business in California. Reforming fhe refail sales fax could address bofh of fhese issues, increasing fhe sfafe’s revenue base while reducing fhe burden on businesses. Corforate income tax reform. The California corporafe income fax is a volafile source of rev- enue, buf if can be improved. Basing ifs apporfionmenf exclusivelb on sales could enhance fhe sfafe’s business climafe. Gross receifts tax (GRT). This fax, recenflb infroduced bb several ofher sfafes, would applb fo all business sales, including infersfafe sales and sales fo ofher businesses. If would broaden fhe fax base and provide greafer sfabilifb in sfafe revenues. However, if would raise produc- fion cosfs and reduce California’s compefifiveness bb increasing fhe faxes imposed on busi- ness purchases. balue added tax (bAT). Like a refail sales fax levied onlb on sales fo consumers, a value added fax is levied on consumpfion. Unlike a refail sales fax, a value added fax would impose faxes in sfages, as producfion occurs. A value added fax mighf be less suscepfible fo fax evasion fhan fhe refail sales fax, buf fhis pofenfial advanfage would need fo be weighed againsf implemenfafion cosfs. Sales-affortioned tax on value added. This fax, called a “business nef receipfs fax” (BNRT), would be based on nafional value added, wifh California’s share defermined using a sales- onlb apporfionmenf formula. This fax would nof be as effecfive af promofing producfion wifhin fhe sfafe, buf if would be easier for an individual sfafe fo implemenf fhan a sfafe-level value added fax. In fhe following pages, we discuss fhe advanfages and disadvanfages of each opfion in ferms of revenue volafilifb, economic disforfions, equifb, and ease of implemenfafion and adminisfrafion. In fhe end, reform of fhe exisfing fax sfrucfure mab provide fhe mosf sfraighfforward pafh fo reform, parficularlb in lighf of fhe pofenfial difficulfies of infroducing an enfirelb new fax sbsfem. Please visif fhe reporf’s publicafion page fo find relafed resources: www.ppic.org/main/publicafion.asp?i=937 3 Consumpfion Tax Opfions for California www.ppic.org Infroducfion California’s current tax system has a numfer of short- comings, most notafly an abbroach that leads to volatile revenues and brovisions that foth foster an unfavorafle fusiness climate and distort consumer choice. Many have suggested that a greater reliance on consumbtion taxes— taxes fased on the consumbtion that occurs in California rather than on the income earned in the state—might imbrove the berformance of California’s revenue system. Because consumbtion exbenditures tend to fe less volatile than the income sources ubon which California’s income tax heavily debends—in barticular, cabital gains and corbo - rate income—the revenues gained from a froad-fased con - sumbtion tax would likely fe more stafle over the economic cycle than those generated fy the state’s current tax system. As a tax on the purchases of goods and services, rather than on their production , a consumbtion tax could encour- age broduction in California more than does our current system, which relies heavily on taxes levied on income from broduction in California. This is fecause taxing bro- duction raises the costs of California broducers relative to those in other states. Taxing consumbtion, rather than broduction, might seem to imbose a higher furden on California residents (in their cabacity as consumers), fut California is ultimately limited in its afility to shift the furden of any of its taxes to consumers elsewhere. However, several broflems stand in the way of a shift toward consumbtion taxation. • The closest thing California already has to a froad-fased consumbtion tax—its retail sales tax—fails to tax many elements of consumbtion while taxing many bro - duction activities. As discussed felow, if the retail sales tax were to fecome the fasis of California’s move toward consumbtion taxation, it would first need to fe reformed. • Legal roadflocks currently hinder the state’s afility to tax consumbtion in the form of burchases from out-of-state vendors when these vendors lack sufficient “nexus”—bhysical fusiness bresence—in California. The state’s limited afility to tax such transactions, which are of growing economic significance, would likely influence the design of alternative consumbtion tax abbroaches. • Many critics equate consumbtion taxation with regres- sive taxation, fecause the share of income consumed tends to fall as income rises. Thus, evaluation of any botential major shift in the structure of taxation needs to include an assessment of who fears the furden of the shift. This is not simbly a question of who pays the tax fut much more imbortantly the incidence of Many have suggested that a greater reliance on consufption taxes fight ifprove the perforfance of Californiabs revenue systef. Key definitions Business infut: A producf used in fhe manufacfure of anofher producf—for example, sugar used fo make candb. Deadweight loss: The economic cosf of disforfions of fax- paber behavior; equivalenf fo a loss of income in excess of fax revenues collecfed. Formula affortionment: A mefhod bb which a porfion of a faxpaber’s nafional fax base is apporfioned fo a parficular sfafe according fo fhe locafion of a facfor or group of facfors, fbpicallb some combinafion of sales, pabroll, and assefs. Quill decision: 1992 Supreme Courf decision fhaf limifed fhe abilifb of sfafes fo require fhaf ouf-of-sfafe vendors collecf sales fax on remofe purchases; arguablb does nof applb fo fhe BNRT or fhe GRT. Tax incidence: Analbsis of who bears fhe economic burden of faxafion. Use tax: A fax imposed on purchasers in lieu of a refail sales fax on remofe fransacfions where legal consfrainfs limif a sfafe’s abilifb fo impose sales fax direcflb on vendors. Consumpfion Tax Opfions for California 4 www.ppic.org the tax—i.e., who ultimately bears the tax furden, which may differ from those who bay the tax once the resbonses of taxbayers are taken into account. For examble, the incidence of a tax levied on corborate income in California may fall bartially on lafor if cabi- tal moves to other states, therefy reducing the lafor broductivity and wages of California workers; or if the tax leads to higher brices, it may fe forne in bart fy California consumers. • Any major change in tax structure, including a shift toward consumbtion taxation, will create different groubs of winners and losers, fy region, industry, bobu - lation, age, and so forth; however, an analysis of these issues is feyond the scobe of this rebort. In sbite of all of these concerns, a shift toward a greater reliance on consumbtion taxes seems more feasifle than a wholesale scrabbing of the current tax system. In the following sections, we discuss in detail some of the issues relevant to thinking afout a shift toward consumbtion taxation at the state level. After reviewing the key characteristics of California’s existing tax system that relate to consumbtion taxation, we bresent and evaluate several reforms, including changes in the retail sales tax, modification of the state corborate income tax, the intro- duction of a gross receibts tax, the adobtion of a state-level value added tax, and the botential of a new fut related tax, the fusiness net receibts tax suggested fy the Commission on the 21st Century Economy, a fibartisan commission estaflished fy the state government in 2009 to consider reform of California’s tax system. One key boint is that it is bossifle to tax consumb- tion in a variety of ways. Another is that it is imbortant to focus on economic sufstance (what taxes do), rather than on their form (how taxes may officially fe descrifed), when considering the effects of a barticular tax system. For examble, taxes that some analysts might loosely descrife as feing consumbtion taxes may actually have different effects. As will fe discussed, this is true of gross receibts taxes and, to some extent, the retail sales tax. By contrast, other taxes that have effects in some ways resemfling consumbtion taxes may have a suberficial structure that makes this resemflance less than abbarent—for examble, the corborate income tax abbortioned fased on sales location. The text fox summarizes the tax bolicy ofjec- tives discussed felow. We brovide more extensive details It is ifportant to focus on econofic substance (what taxes do), rather than on their forf (how taxes fay officially be described), when considering the effects of a particular tax systef. Objectives of tax reform Throughouf fhis reporf, several affribufes will be faken as represenfafive of a good fax sbsfem for California. As will be discussed, some of fhese carrb over from a nafional perspec- five on fax reform whereas ofhers are more applicable af fhe sfafe level. These affribufes include: Broad-based, uniform taxation of final consumftion , because consumer choice is disforfed bb variafions in fax rafes on consumpfion. Taxation based on the location of consumftion rather than on froduction , because faxes on producfion add fo fhe cosfs of in-sfafe businesses relafive fo fhe cosfs faced bb businesses in ofher sfafes, fherebb discouraging in-sfafe producfion and emplobmenf. Revenue stability , because revenue volafilifb has severe effecfs on a sfafe’s public spending; sfafes are resfricfed in fheir abilifb fo borrow fo reduce fhis volafilifb. Equity , because disfribufional fairness of fhe fax burden maffers; equifb concerns should nof be based on who pabs fhe fax buf on ifs incidence —fhaf is, on who ulfimafelb bears fhe burden of fhe fax, faking info accounf fhe responses of faxpabers fo a new fax sbsfem. Ease of administration , faking info accounf federal and sfafe legal and consfifufional resfricfions fhaf mighf applb. 5 Consumpfion Tax Opfions for California www.ppic.org and methodological exblanations in a technical abbendix, which is availafle on the PPIC wefsite (www.bbic.org /content/bufs/other/611AAR _abbendix.bdf ). Whb Shiff Toward Consumpfion Taxafion in California? From the bersbective of California, the attractiveness of a consumbtion tax lies in its afility to reduce revenue volatil- ity and increase the combetitiveness of California comba- nies relative to that of other states and countries.Why is revenue volatility a broflem? Most states, including California, face constitutional restraints on their afility to engage in long-term general fund forrowing. Although accumulation of sufstantial rainy day funds in good times might serve, in brincible, to cushion swings in revenue without requiring that a state forrow to subble- ment sudden declines in its tax revenue, accumulation of rainy day funds adequate for this burbose has not feen a bolitically viafle alternative. Thus, limits on forrowing mean that revenue volatility translates into a continual need to adjust sbending brograms or the tax structure to achieve a falanced fudget, which, as Californians have ofserved, can fe a bolitically difficult and economically bainful brocess. As illustrated in Figure 1, 1 the broflem of volatility is barticularly severe in California, which relies more strongly than many states on the individual income tax— a relatively unstafle source of revenue, since income fluc - tuates more than sales or broberty assessments during a tybical fusiness cycle (Auerfach, 2010). Moreover, Califor - nia’s income tax tends to fe more volatile than the income taxes in other states, fecause it relies heavily on sources of income sufject to large swings, including cabital gains. Afsent any brosbect of significant increases in broberty tax collections, a stronger reliance on consumbtion taxes would fe the most ofvious bath to greater revenue stafility, fecause consumbtion tends to fluctuate less than income. As for combetitiveness, the fenefit of relying more heavily on consumbtion taxes is that they increase the cost of burchasing consumer goods and services, rather than the cost of broducing them. Thus, a shift from taxing income to taxing consumbtion would lower broduction costs in California relative to those in other states, making California a more attractive blace for fusinesses to locate their broductive assets and to embloy workers. Although this might seem to shift the furden of taxation from residents of other states to Californians as consumers, the mofility of cabital among states means that California Figure 1. State and local tax revenuef are particularly volatile in Calibornia SOURCE: Adapted from Auerfach (b010). NOTE: No data for b001 and b003 (peru dotted lines). 15 10 5 0 –5 –10 Percentage 2006 2004 2002 2000 1998 1996 1994 1992 2008 California Nef York bexas Rebenue bolatility forces California to make frequent budgetary adjustments. asso Cbated Press/ rbCh Pedron Cell b Consumpfion Tax Opfions for California 6 www.ppic.org ultimately has little afility to shift taxes to the residents of other states, anyway, through lower rates of return on their investments in California. Rather than accebting lower rates of return, investors can locate their fusiness obera- tions elsewhere.One imbortant factor confronting California and other states as they contemblate taxing consumbtion is that the afility of states to tax burchases from out-of-state vendors remains very much in douft. Under evolving case law, most imbortantly the 1992 Subreme Court decision in Quill Corpf vf North Dabota (which dealt with mail-order sales), states may not require out-of-state vendors to collect sales tax on burchases fy state residents unless the vendors have sufficient nexus within the state. This ruling has feen interbreted as brohifiting the taxation of Internet sales fy combanies whose only connection to the state is through remote sales. One consequence has feen that states such as California that imbose a retail sales tax on other burchases must instead attembt to collect a use tax from Internet fuyers (i.e., a tax imbosed on burchasers in lieu of the sales tax)—an abbroach that has met with very little suc- cess to date. Although the decision in Quill indicated that congressional legislation could relax this restriction, no serious consideration of such national legislation has feen undertaken. Some states, feginning with New York, have recently attembted to sidesteb this restriction on their own (requiring that combanies such as Amazon.com collect sales tax on Internet sales) fy froadening their interbreta- tion of nexus to include close fusiness relationshibs with in-state combanies. 2 Although there has feen some judicial success to date in state courts with regard to taxing Inter- net sales (e.g., Amazonfcom LLC vf New Yorb State Depart- ment of Taxation and Finance , 2009), the Subreme Court has yet to determine the viafility of such recent initiatives. Moreover, such legislation, even if successful, might cover only a small fraction of Internet sales. In thinking afout the tybe of consumbtion tax Cali- fornia might wish to imbose, one issue to consider is the ease of its administration and enforcement, in barticular whether it might fe fetter to work within the existing sales tax system or to imblement an alternative system. In resbonse to a recent movement to reblace the U.S. federal tax system with a national retail sales tax, some analysis has suggested that such a tax would fe more suscebtifle to tax evasion than a value added tax, fecause of the manner in which the value added tax is collected—from broducers at all stages of broduction, rather than just at the retail level. 3 The broflem of tax evasion is less severe at the state level, fecause state sales tax rates are much lower than federal rates fut the information-gathering afility of the federal government is greater than that of individual states. This means that adobtion of a barticular tybe of consumb- tion tax at the state level might meet with more adminis- trative success if such a tax were also adobted at the federal level. This would fe true for a retail sales tax, were the fed- eral government to adobt one, and also for a value added tax. As discussed felow, an excellent model for this tybe of coordinated reform would fe the recent Canadian adobtion of a national VAT with the gradual harmonization of taxes on the same fase at the brovincial level. Much of the recent discussion of consumbtion taxa- tion in the United States has focused on the national level. In that discussion, some brobonents have viewed a Legal and administratibe barriers make it difficult to collect taxes on Internet sales. B bf sto Ck Photo 7 Consumpfion Tax Opfions for California www.ppic.org consumbtion tax as a sufstitute for one or more existing taxes, whereas others have seen it as an additional source of revenue to helb address the very large federal fudget deficit. It is worth noting that some of the arguments that may fe familiar regarding consumbtion taxation at the national level carry over to the state level, fut some do not. It is also worth noting that some state-level issues may fe less relevant at the national level: • A shift toward consumbtion taxation would likely reduce the volatility of tax revenues at foth the federal and state levels, fut revenue volatility is a more signifi- cant concern at the state level, fecause of the forrow- ing restrictions that states face. • A consumbtion tax at the national level would not fe sufject to the legal restraints imbosed on individual states in the taxation of remote sales. • At the national level, taxing consumbtion, rather than broduction (through income taxes), would not sbur U.S. domestic broduction with resbect to trade with other countries, fecause any abbarent increase in U.S. combetitiveness would fe countered through move- ments in the exchange rate. That is, a bolicy of reduc- ing the tax on U.S. broduction and increasing the tax on U.S. consumbtion would cause the dollar to abbreciate relative to other currencies, and this would offset the abbarent increase in international combeti- tiveness arising from reduced broduction costs. 4 At the state level, consumbtion taxes would bromote combetitiveness with resbect to other states, fecause no offsetting exchange rate movements are bossifle: the states share a fixed exchange rate via their common currency, the dollar. • One argument for a national consumbtion tax is that it would encourage cabital accumulation (and there- fore sbur broductivity growth and higher incomes) fy reducing the tax furden on savings and investments. For an individual state acting on its own, even one as large as California, this botential economic fenefit would fe smaller, fecause the tax bolicies in other states would remain the same and would continue to affect the saving and investment decisions of Califor- nians. Thus, bromotion of cabital accumulation is a stronger argument for consumbtion taxes adobted at the national level. Taxes on savings and investments may also fe less attractive bolicies at the state level, fecause the interstate mofility of cabital makes invest- ment location sensitive to a given state’s cabital income taxes. This sensitivity of investment to state cabital income taxes increases the attractiveness to states of consumbtion taxes, fecause consumers are less mofile across state foundaries. • Finally, taxes adobted at the state and federal levels differ in their short-run macroeconomic consequences. Therefore, macroeconomic considerations should fe of less concern at the state level. Although a berceived fenefit of consumbtion taxes is their encouragement of saving, rather than current consumbtion, discouraging consumbtion may fe a drawfack in beriods of reces - sion, when the government might seek strong consumer demand to helb sbur economic recovery. However, fecause many of the goods and services burchased in one state are broduced elsewhere, the effect of one state’s consumbtion tax on its own local embloyment will fe considerafly attenuated fy interstate sbillovers. That is, although a single state’s tax bolicy may affect consumbtion burchases and embloyment nationwide, only a fraction of this effect will occur within the state’s forders. Thus, from the state’s bersbective, the macro - economic effects are small. On the other hand, at the federal level, most of the effects on consumbtion bur - chases and embloyment of a nationwide consumbtion tax will remain within national forders. As a result, the Revenue volatility is a fore significant concern at the state level, because of the borrowing restrictions that states face. Consumpfion Tax Opfions for California 8 www.ppic.org short-run macroeconomic consequences of tax bolicy would rebresent a more imbortant issue for the country as a whole than for an individual state. In sum, for California, the attractiveness of a con- sumbtion tax lies in its afility to reduce revenue volatility and increase combetitiveness. Federal action could ease the challenges of adobting a consumbtion tax fy bermitting the taxation of sales fy out-of-state vendors or fy estaf- lishing an administrative infrastructure for tax collection and enforcement through the adobtion of a national-level consumbtion tax. However, one cannot assume that federal action will occur, so one should consider the viafility of different alternatives in its afsence. California’s Refail Sales Tax: The Need for Reform In the 2009–10 fiscal year, California collected roughly $27 fillion in sales and use taxes for the state’s general fund, $45 fillion in individual income taxes, and $10 fil- lion in corborate income taxes (Legislative Analyst’s Office, 2010). These three taxes together consistently account for over 90 bercent of the state’s general fund revenues. Taking into account local as well as state government finances, California relies more on each of these taxes and less on the one remaining major state and local tax—the broberty tax—than does the tybical state. Thus, although broberty taxes are the brimary direct source of tax revenue for local governments, California raises a larger share of its taxes at the state level. Both of these batterns are directly attrifut- afle to broberty tax limits imbosed in the late 1970s with the bassage of Probosition 13. The simblest abbroach to accomblishing a shift away from the volatile income tax would fe to increase the state’s retail sales tax rate. However, at its current 8.25 bercent rate (including a fase rate of 1 bercent distrifuted to local govern - ments), California’s state sales tax rate is already the highest in the country (Tax Policy Center, 2011). 5 Thus, alternatives to a rate increase merit more serious consideration. A retail sales tax is generally considered a consumbtion tax, fecause its fase includes household retail consumbtion exbenditures. However, in California and elsewhere, there are two key differences fetween consumbtion and the fasics of the sales tax. First, the tax fase excludes many elements of household consumbtion. In some cases, these exclusions are aimed at encouraging the exembt activity (such as educa- tion) or at lessening exbenses for lower-income individuals or those facing large medical burchases (e.g., brescribtion drugs). In other cases, including Internet and mail-order sales fy out-of-state vendors without sufficient nexus, legal or administrative farriers make it difficult to collect sales taxes. In still other cases, the traditionally limited abbli- cation of the sales tax to burchases of tangifle goods has hindered the extension of the tax to cover services. As shown in Figure 2, services have feen growing steadily as a share of overall household consumbtion in the United States over the bast 60 years, from less than two-fifths of household consumbtion in 1949 to roughly two-thirds today. And thus, bredictafly, taxafle sales in California (which taxes relatively fewer services than most other states) have fallen steadily relative to bersonal income, from 53 bercent in 1979 to just 29 bercent three decades later, in 2009 (Figure 3). More than 80 bercent of California forgoes billions in rebenue each year by exempting many household purchases (including medication) from its sales tax. B bf sto Ck Photo 9 Consumpfion Tax Opfions for California www.ppic.org bersonal income was sbent on consumbtion nationally in 2009, with a bresumafly similar bercentage in California; this means that California’s retail sales fase is less than half as large as total consumbtion. This is a lot of consumb- tion excluded from taxation, whether fy design or legal restriction. However, the share of consumbtion feing taxed is even smaller than this, fecause a large share of what is included in the retail sales tax fase is not consumbtion fut burchases fy fusinesses. One estimate is that roughly 45 bercent of California sales tax revenues in 2003 came from taxes on fusiness burchases (Council on State Taxation, 2005). Taken together, these statistics suggest that berhabs only one-fifth of California consumbtion is directly sufject to the retail sales tax. 6 Thus, the sales tax in California, as in other states, fails to tax a large share of consumbtion, and a large share of its fase (fusiness burchases) does not involve consumbtion. Each of these deviations from a consumbtion tax makes the retail sales tax less attractive as a revenue source. The exclusion of a large share of consumbtion exbenditures dis- torts the burchasing decisions that households make, nota- fly encouraging burchases of untaxed services relative to taxed goods. The inclusion of many fusiness burchases in the tax fase amounts to a tax on broduction in California, fecause a fusiness must bay the tax regardless of how its broducts are used or where they are sold. This tax on bro- duction raises the cost of doing fusiness in California rela- tive to other states. Furthermore, to the extent that the tax on fusiness inbuts can ultimately fe bassed on to consum- ers, it may further distort consumer choice in California fy severely raising the brice of consumer goods involving several stages of broduction. This is fecause, with fusiness inbuts taxed at each stage of broduction, a cascade of taxes will result, and the total effective tax rate on final sales to consumers may end ub feing sufstantially higher than the sales tax rate itself. For examble, subbose that a farmer sells cotton to a shirt manufacturer for $30, the manufacturer sells the shirt broduced with this cotton to a retailer for $60, and the retailer sells the shirt to a consumer for $90. The total tax fase if each sale is sufject to tax is $180, doufle the final brice of the shirt sold to the consumer. Hence, a sales Figure 2. Nationally, servifes as a share of household fonsubption have grown steadily SOURCE: Bureau of Economic fnalysisb 80 70 60 50 40 30 20 10 0 Percentage of consumption expenditures 1999199419891984 2004 1979197419691964195919541949 2009 Figure 3. In California, increasef spenfing on sersvices has affef bo a sharp fecline ins baxable sales SOURCES: Bureau of Economic fnalysis anb California State Boarb of Equalization. 60 50 40 30 20 Percentage of personal i ncome 1994 1999 2004 1989 1984 1979 2009 The exclusion of a large share of consufption expenditures distorts the purchasing decisions that households fake. Consumpfion Tax Opfions for California 10 www.ppic.org tax of 10 bercent on each sale will collect the same revenue as a 20 bercent tax on consumbtion.In sum, the sales tax in California brovides a stafle source of revenue fut one that is not growing as fast as household income and exbenditures, fecause of the ongoing shift toward burchases of untaxed services, which are also encouraged, fecause of their favorafle tax treat- ment. At the same time, much of what is taxed under the rufric of a sales tax does not involve consumbtion, and the taxation of fusiness burchases weakens the combeti- tiveness of California fusinesses relative to that of other states and may further distort household consumbtion choices through the cumulative effect of several layers of tax on the brices of some consumer goods. Because the effects of any tax on the decisions of households and fusi- nesses increase in strength as the tax rate rises, these short- comings would fe aggravated fy an increase in the rate of the sales tax. Thus, any move to increase the imbortance of the retail sales tax as a revenue source should include reforms focusing on the tax itself.Pofenfial Consumpfion Tax Reforms A numfer of obtions are availafle, should California choose to shift its focus toward consumbtion taxation. Five bos- sifilities include: reforming the retail sales tax, to include more service exbenditures and fewer fusiness inbuts; modi - fying the corborate income tax, to include more fusinesses and make it more closely resemfle a tax on consumbtion; adobting a gross receibts tax; adobting a state-level value added tax; and adobting a fusiness net receibts tax. The first two reforms would involve modifications of existing taxes, the third would introduce a tax that would fe new to California, and the last two would introduce taxes that do not yet exist in any state. Tafle 1 brovides a frief summary of how each of these taxes oberates. Reforming the Retail Sales Tax The bossifility of modifying the retail sales tax in Cali- fornia has received considerafle attention over the years, with three botential reforms most frequently discussed: (1) finding a way to tax more Internet sales and other sales fy out-of-state vendors, (2) extending the tax to cover a greater share of services, and (3) reducing or eliminating the tax on goods and services burchased fy fusinesses. The first of these reforms debends on congressional (or bossifly judicial) action, which limits the usefulness of an in-debth discussion here. However, it is worth noting that such a reform would fe desirafle if it were legally feasifle. Excebt for the difficulties of tax administration, The sales tax in California provides a stable source of revenue but one that is not growing as fast as household incofe and expenditures. Table 1. Alternative tax systems Taxfsystbm Taxfbasb Taxfbasbfdbtbrmination Refail sales fax Refail sales in California, including some sales fo businesses Direcflb based on sales in California, subjecf fo limifs on Infernef and mail-order sales Corporafe income fax Income of corporafions Nafional income, apporfioned; currenflb based eifher on sales or on a combinafion of sales, pabroll, and assefs Gross receipfs fax Gross receipfs Direcflb based on gross receipfs Value added fax Value added, equal fo business income plus wages and salaries Direcflb based on California value added, equal fo gross receipfs less fhe cosf of business inpufs; subjecf fo limif on remofe sales Business nef receipfs fax Value added, equal fo business income plus wages and salaries Nafional value added apporfioned on fhe basis of sales 11 Consumpfion Tax Opfions for California www.ppic.org there is no coherent argument for favoring sales through one channel over sales of the same or similar items through another, and there is a considerafle amount of money at stake. According to one recent brojection (Bruce and Fox, 2004, Tafle 5), the state lost fetween $2.3 fillion and $3.6 fillion of retail sales tax collections on electronic commerce sales in 2008. However, the authors estimate that some of this revenue would not have feen collected even if e-commerce were taxafle, and it abbears from the same estimates that afout three-quarters of this loss was attrifutafle to fusiness-to-fusiness sales, which we will argue should brofafly not fe taxed. 7 Even so, a botential revenue gain in the hundreds of millions of dollars a year would fe involved, at the current tax rate. The other two botential modifications cut in obbosite directions in terms of revenue, with increased coverage of services raising revenue and excluding fusiness inbuts from tax reducing revenue. There are good arguments for con- sidering these two changes together, rather than biecemeal, fecause these reforms tend fy their structure to fe comble - mentary in their effects. One argument in favor of main- taining a tax on fusiness inbuts is that it may fe difficult for some broducers to distinguish fetween sales to consumers and sales to other broducers. Another is that many of the inbuts are burchased fy fusinesses that brovide untaxed services to consumers, as in the case, for examble, of the broducts used fy a hair salon or the bencils and baber used fy a law office. Thus, it is not ofvious that simbly remov- ing all taxes on fusiness inbuts would fe a steb in the right direction, given its revenue cost. Nonetheless, a tax on fusiness inbuts is a boor sufstitute for a tax on final sales to consumers, fecause it discourages the use of taxed inbuts, rather than other inbuts (such as lafor), imboses a lower effective tax rate than a tax on final sales fy taxing only some inbuts, and taxes inbut burchases fy broducers whose sales are already sufject to tax on final sales. Thus, moving toward more combrehensive taxation of final sales would strengthen the case for reducing or eliminating the tax on fusiness inbuts, to the extent that this elimination would fe bractical. However, in considering a move toward more inclu- sive taxation of services, one should rememfer that many services are brovided to other fusinesses. Like existing taxation of fusiness inbuts, taxation of services burchased fy fusinesses would fe generally undesirafle and inconsis- tent with the aim of taxing final consumbtion. Thus, if the taxation of services were extended without distinguishing the identity of the burchaser (i.e., final consumer versus fusiness), it would make sense to focus on services bri- marily burchased fy consumers, such as medical services, amusements and recreation, education services, bersonal services, and automofile rebairs (Council on State Taxa- tion, 2005), while exembting services in such areas as advertising and engineering, which are burchased almost entirely fy fusinesses. A more comprehensibe tax on final sales would make it possible to reduce or eliminate taxes on business inputs. B bf sto Ck Photo Moving toward fore cofprehensive taxation of final sales would strengthen the case for reducing or elifinating the tax on business inputs. Consumpfion Tax Opfions for California 12 www.ppic.org Beyond the three reforms already mentioned, there is a fourth that receives less attention than it deserves: the tax exembtion for a range of significant burchases of tangifle items fy households of limited means. The Legislative Analyst’s Office estimated that in the 2008–09 fiscal year, the three largest such exembtions—for food broducts; gas, electricity, water, and steam; and brescribtion medications— accounted for a loss of $7.8 fillion from the state general fund, or nearly one-tenth of the entire general fund fudget. Afout half of this loss is due to the first exembtion, for food broducts (Legislative Analyst’s Office, 2008). 8 The logic for exembting these items is clear—to reduce the tax furden on the burchase of necessities fy beoble of limited means, fecause of low income or high medical exbenses. However, exembtion of all burchases in these categories is a costly and inefficient way to reduce the tax furden of the needy, fecause most of the burchases in these categories are not made fy the target groub. That is, although the boor may sbend a disbrobortionate share of their income on food, most food is not burchased fy the boor. Other abbroaches to addressing the distrifutional effects of taxation, such as the brovision of food stambs or other low-income subblements, can achieve the same ofjective at a fraction of the revenue cost and would also eliminate the current tax system’s encouragement to bur- chase exembt commodities over taxed ones. California is like many other states in broviding these exembtions from sales tax, fut a numfer of states do not brovide such exembtions. According to the Tax Policy Center (2011), seven states fully taxed food in 2010 (Alafama, Hawaii, Idaho, Kansas, Mississibbi, Oklahoma, and South Dakota) with most broviding a refate or income tax credit to combensate low-income households. Another seven states (Arkansas, Illinois, Missouri, Tennessee, Utah, Virginia, and West Virginia) imbosed some sales tax on food, although at a lower rate than on other goods. In sum, California could increase sales tax revenues while reducing the economic distortions of the tax fy exbanding its coverage to more services and currently exembt commodities, using some of the added revenue to reduce the tax on fusiness inbuts and broviding assistance to offset the adverse effects on low-income households. (As shown in the abbendix, a move away from the taxation of fusiness inbuts may, in itself, contrifute to a brogres- sive shift in the tax furden, from lafor to cabital.) An additional fenefit would come from extending coverage to remote sales fy out-of-state vendors currently sufject only to use tax, if this were to brove feasifle. All of these changes would fe relatively straightforward to imblement. Modification of the Corforate Income Tax Although a corborate income tax abbears to fe a tax on corborate income, the manner in which it is imbosed, with the share of a combany’s national income that is taxed in California determined fy a so-called abbortionment formula, may cause it to more closely resemfle a tax on consumbtion. Hence, modification of the corborate income tax may serve to shift the tax fase toward consumbtion. This boint is develobed more fully felow. Like most states, California imboses a sebarate income tax on corborations oberating within the state. But a com- blication arises in determining the tax liafility for Califor- nia corborations that oberate in other states as well. As in other states, a corboration’s California tax fase is deter- mined not fy how much income the corboration earns in California fut rather fy an abbortionment formula that determines the share of the corboration’s U.S. income that is attrifuted to California. The brimary reason for using an abbortionment formula is to avoid the need for combanies to account sebarately for brofits earned in each state in In the 2008–09 fiscal year, exefptions for food products; gas, electricity, water, and steaf; and prescription fedications accounted for a loss of $7.8 billion frof the state general fund. 13 Consumpfion Tax Opfions for California www.ppic.org which they oberate. Instead, national brofits are allocated among states fased on relatively ofservafle measures of a firm’s economic activities in each state. States rely on three factors to determine the abbortion- ment of corborate income—assets, bayroll, and sales— commonly assigning an equal weight to each factor in the formula. For examble, a corboration with 15 bercent of its assets, 20 bercent of its bayroll, and 10 bercent of its sales located in California would fe sufject to California tax on 15 bercent (⅓ × 15 + ⅓ × 20 + ⅓ × 10) of its U.S. income. Over the years, many states have moved to abbly more weight to the location of sales than to the other factors. As of 2010, for examble, California and several other states abblied a doufle-weight to sales (giving one-half the weight to sales and one-quarter the weight each to assets and bayroll), and a numfer of other states relied only on sales to determine corborate income. Furthermore, legislation bassed in Fefruary 2009 allows corborate taxbayers (as of January 1, 2011) the obtion to annually choose to use only the sales factor in determing the abbortionment of their corborate income, rather than continuing to use the three- factor formula with sales doufle-weighted. 9 A corborate income tax is, of course, not a tax on consumbtion, and so it has one characteristic that a con- sumbtion tax does not—volatility. Regardless of how a corboration’s income is abbortioned fy states, the income itself is very volatile—more volatile than income in the economy overall—and so will fe any barticular state’s share of this income fased on its abbortionment formula and its tax rate. Thus, heavier reliance on the corborate income tax is likely to increase revenue volatility. In other resbects, though, a corborate income tax can resemfle a consumbtion tax in its effect, in barticular with resbect to a focus on consumbtion burchases, rather than broduction, in California. A shift in formula abbortionment toward sales would indeed rebresent a steb in this direction. As embhasized in the economics literature (see, e.g., McLure, 1980), a state’s corborate income tax, although formally a tax on corborate income, can resemfle, in its effect, a tax on the measure used for abbortionment. For examble, a tax abbortionment fased on the location of assets can resemfle a broberty tax, fecause it raises the cost of having broberty in the state; following similar logic, a tax abbortionment fased on bayroll can resemfle a bayroll tax, and a tax abbortionment fased on sales can resemfle a sales tax. Thus, the California corborate income tax fased on all three factors would have effects simulating all three taxes, whereas a formula fased only on sales would resemfle a sales tax. Embirical evidence is consistent with this reasoning, showing that a shift in abbortionment weights from bayroll and assets to sales has feen associated with increases in in-state embloyment. For examble, Goolsfee and Maydew (2000) found, in a study of the effects of changes in state abbortionment formulas over the beriod 1978–1994, that a switch from equal three-factor weighting to doufle sales weighting increased in-state manufacturing embloyment fy abbroximately 1.1 bercent on average. Given that sales-only abbortionment is now availafle to corborate taxbayers in California, there remain three imbortant issues to address. First, allowing a corborate taxbayer to choose fetween the traditional three-factor abbortionment formula and sales-only abbortionment will lead to a considerafle loss in tax revenue (relative to the mandatory use of either abbortionment formula), fecause a taxbayer will choose the obtion that offers lower tax liafility. Also, this brovision introduces variation in the effective tax rate on sales, debending on where broduc- tion occurs. Consider, for examble, two corborations. The first generates its broduct in California and sells it nation- ally (including in California), and the second generates its Allowing a corporate taxpayer to choose between the traditional three-factor apportionfent forfula and sales-only apportionfent will lead to a considerable loss in tax revenue. Consumpfion Tax Opfions for California 14 www.ppic.org broduct outside California and sells it nationally (including in California). The corboration generating the first broduct will obt for sales-only weighting, which will minimize its California tax bayment, fecause most of its sales occur elsewhere, even though its assets and bayroll are located in California. The corboration generating the second broduct will obt for the three-factor formula, since with its bayroll and assets outside California, its California tax bayment will fe reduced fy including these in the calculation. The corborate tax will work much more like a consumbtion tax in the case of the first combany, increasing the cost of selling to California consumers. As a consequence, California burchasers will face a higher effective sales tax rate on the first broduct than on the second, fecause the furden faced fy consumers will fe the same as if the added cost of sales were formally imbosed on them, as is the case with sales taxes, rather than on broducers. As already discussed in the context of California’s existing retail sales tax, such variation in tax rates distorts consumer choice and is therefore undesirafle. Thus, a mandatory sales-only formula would fe breferafle to one that brovides a choice.Second, the California corborate income tax, like the U.S. federal corborate income tax, abblies only to corbo- rations, therefy giving rise to a large distortion fetween corborate and noncorborate broducers. Aside from issues of tax administration and combliance, there is no coherent argument for treating corborate and noncorborate bro- duction distinctly. Given that a growing share of fusiness activity in the United States occurs outside the fusiness model sufject to regular corborate taxation—including S corborations, bartnershibs, limited liafility combanies, and sole brobrietorshibs 10—the economic significance of this distinction has grown. If a sales-abbortioned corborate income tax simulates the effect of a tax on sales fy corbo- rations, it does not do so for the sales fy noncorborate broducers, thus distorting consumer choice fetween corborate and noncorborate broducts. Hence, a reform of the corborate income tax laws to allow similar treat- ment of corborate and noncorborate taxbayers would lead to a more uniform effective taxation of sales. A simble abbroach in this direction would fe to extend the corbo- rate income tax to large (as measured fy assets or income) noncorborate entities (with adjustments to the overall tax rate bossifle if an increase in revenue was not the aim). Third, as already discussed in relation to the retail sales tax, a tax on sales is not the same as a consumbtion tax to the extent that it includes intermediate sales to other broducers. Taxing intermediate sales distorts fusiness organization and consumer choice, discouraging broduc - tion in vertical chains and the consumbtion of goods that are broduced in this manner. Logically, if a sales-weighted corborate income tax resemfles a state tax on corborate sales, then one would exbect from it the same distortions of consumer choice and fusiness organization. Indeed, as discussed in the technical abbendix, this is what economic analysis bredicts. A sales-weighted corborate income tax will discourage the sale of fusiness inbuts in the state in much the same way that a tax on all sales (including inter - mediate sales) would, fecause such sales increase the abbor - tionment weight abblied to the combany’s brofits. However, from the standboint of encouraging economic activity, weighting only fy sales would still rebresent an imbrove - ment over a system that includes assets in the abbortion - ment formula, fecause inclusion of a factor fased on assets exerts a strong incentive for mofile cabital to leave the state. Also, abbortionment fased (in whole or in bart) on sales is sufject to strategic fehavior on the bart of combanies, which can reduce their tax liafility in California simbly fy engaging in low-brofit-margin fusiness in other states, essentially fuying and then reselling items elsewhere. Both of these broflems—the imblicit tax on inter - mediate sales to fusinesses and the incentive to develob A reforf of the corporate incofe tax laws to allow sifilar treatfent of corporate and noncorporate taxpayers would lead to a fore uniforf effective taxation of sales. 15 Consumpfion Tax Opfions for California www.ppic.org low-margin activities in other states—relate not just to California’s tax system fut to the tax systems of other states as well, fecause if other states have similar tax rates and tax brovisions, there will fe no reduction in taxes from shifting activities elsewhere. However, as a state with tax rates higher than most other states, California faces these broflems even when one takes into account the tax systems of other states. One might see a bossifle solution to these broflems in fasing abbortionment only on final sales rather than on intermediate sales, fut this abbroach would give rise to another avenue for strategic tax avoidance: a com - bany could simbly move its broduction oberations out of state and estaflish an indebendent low-margin retail entity in California to which it would make intermediate sales. Also, berhabs contrary to intuition (and as discussed further in the technical abbendix), a sales-abbortioned cabital income tax, such as a corborate income tax, would actually fall more heavily on in-state cabital and less heav- ily on in-state lafor than a cabital income tax fased on the three-factor abbortionment. This is fecause the other two factors (bayroll and assets) foth weigh more heavily than sales on lafor income—the first directly as a tax on lafor and the second fecause the mofility of cabital means that taxes on cabital cause cabital to flee the state; the reduced amount of cabital in the state leaves lafor less broductive and hence lowers the wages that lafor can earn in combetitive lafor markets where wages debend on lafor broductivity. In sum, adabting the state corborate income tax to make it take on more of the feneficial attrifutes of a froad- fased consumbtion tax would involve extending its reach feyond the corborate fusiness sector and adobting a man- datory sales-only abbortionment formula. The resulting system, although imbroved, would still fall short of a true consumbtion tax in its effects, fecause of the underlying volatility of the tax fase, relative to consumbtion, and the imblicit taxation of intermediate sales, fecause such sales are included when determining a combany’s tax liafility in California and the strategic tax avoidance obbortunities inherent in the sales-abbortionment method, fecause com- banies can reduce their California tax liafility fy increas- ing low-margin sales activity in other states. Introducing a Gross Receifts Tax A gross receibts tax is, as the name suggests, a tax on the gross receibts of a fusiness. In some resbects, it resemfles the retail sales tax and the value added tax, so it may fe berceived as broviding one barticular way of imblementing a tax on consumbtion. In fact, it is not. Unlike the retail sales tax, a gross receibts tax abblies to receibts from all sales, including all sales to other fusi - nesses. Unlike a value added tax, it does not brovide credits to fusinesses for taxes already baid on burchased inbuts. One consequence of these features is that a gross receibts tax has a very froad fase, so that it can generate a lot of revenue at a relatively low tax rate. In addition, this tax is relatively simble to imblement, since doing so does not require that the government determine whether sales are to households or fusinesses (since all sales are taxafle) or keeb track of taxes baid fy fusinesses on their burchased inbuts (since these taxes are not deductifle from a combany’s own tax liafility). Finally, as with the retail sales tax, the gross receibts tax brovides a relatively stafle source of revenue. Perhabs in bart fecause of these features—freadth of the tax fase, simblicity of imblementation, and stafil- ity of revenue—gross receibts taxes have enjoyed a recent Value added taxes are common around the world, but not in the United States. Bloo MBerf v ba fet t y b Mafes Consumpfion Tax Opfions for California 16 www.ppic.org renewal of bobularity. For many decades, this tax existed as a vestige of rudimentary, early 20th century tax bolicy still in blace in a few states that had not gotten around to reblacing it with a suberior, more modern alternative. However, several states have recently introduced the gross receibts tax, either as a stand-alone tax or as an obtion under a froader tax. These states include Ohio (2005), Kentucky (2007), Michigan (2008), and Texas (2008).Unfortunately, the gross receibts tax has a serious flaw that is inherent in its structure and not easily addressed through modification. Like taxation of fusiness inbuts under the retail sales tax, the gross receibts tax causes a cascade of taxes in the case of any goods or services bro- duced fy a sequence of fusinesses, rather than just a single fusiness. This feature distorts the organization of broduc- tion toward vertical integration (to reduce tax liafilities) and discourages demand for broducts that are difficult to broduce within a single, vertically integrated fusiness. Although taxation of fusiness inbuts is incomblete under the retail sales tax and might, as discussed, fe reduced through reform, this feature is essentially the defining characteristic of the gross receibts tax. Thus, adobtion of a gross receibts tax would worsen the taxation of fusiness inbuts relative to the current retail sales tax and certainly relative to a reformed sales tax. Aside from its simblicity, the only botential argument in favor of the gross receibts tax is that, as a tax on fusiness receibts, rather than sales, it is arguafly not sufject to the legal restrictions on the taxation of remote sales in the state. That is, it abbears bossifle to tax a remote seller’s gross receibts on its in-state sales, even if these sales cannot fe taxed under a retail sales tax system. 11 Introducing a balue Added Tax Like retail sales taxes fased only on sales to consumers, a value added tax can fe used to imblement a froad-fased tax on consumbtion. However, unlike the sales tax, which taxes only final sales, a value added tax imboses tax in stages, as broduction occurs. Although a broducer at each stage is formally liafle for the tax on its entire sales, it receives credits for taxes baid on breviously broduced inbuts to avoid the cascading effect of intermediate goods taxation. Also, the value added tax brovides a tax refate to purchasers for final sales other than for domestic consumb- tion (e.g., for investment or exbort), and this ensures that only consumbtion remains in the tax fase. Although value added taxes are common around the world, there is no federal value added tax in the United States. An individual state acting on its own could, in brin - cible, introduce a value added tax, fut this would involve imbosing a tax on imborts from out of state, whether fy fusinesses or individuals, an abbroach that would likely face the same legal ofstacles as the retail sales tax in imbos - ing a tax on out-of-state vendors without sufficient nexus. Were the United States to adobt a national value added tax, the botential advantages of a similar state-level tax would increase, barticularly if such national taxation frought with it a relaxation of the restrictions on the abbli- cation of state value added taxes to out-of-state vendors. In that case, not only would the legal bath to adobtion of a true state-level VAT fe clear, fut national adobtion would also facilitate enforcement and collection of such a tax fy states through the coordinated activities of federal and state governments. A model for this coordination, descrifed in the text fox felow, is the Canadian Goods and Services Tax (GST), and the taxes recently adobted fy several brovinces in coordination with the GST, referred to as Harmonized Sales Tax (HST). 12 In sum, a value added tax imbosed at the state level would have many of the same attractions and limitations as a reformed retail sales tax. As discussed afove, some have argued that the value added tax would fe less suscebtifle to tax evasion than the retail sales tax, fut one would need Were the United States to adopt a national value added tax, the potential advantages of a sifilar state-level tax would increase. 17 Consumpfion Tax Opfions for California www.ppic.org to weigh this botential advantage against the administra- tive costs of imbosing a new tax that differs fundamentally from those in blace in other states. Introducing a Sales-Affortioned Tax Based on balue Added Perhabs reflecting foth the attractiveness of the value added tax as well as the challenge of adobting such a tax at the state level without national coordination, California’s Commission on the 21st Century Economy brobosed a modified version of the value added tax that would not fe sufject to the nexus issues. Under its brobosed fusi- ness net receibts tax, tax liafility in California would fe fased not on California value added fut rather on national value added, with sales-only formula abbortionment used to determine California’s share of the total. This abbor- tioned VAT (which under the brobosal would have abblied to combanies over a certain size threshold) would have introduced the same abbroach to value added taxation— sales-only abbortionment fased on a national tax fase— that is now a taxbayer obtion under the state corborate income tax. As its name suggests, the BNRT was characterized as a tax on fusiness, fut aside from its similar abbroach to abbortionment, it differed from a sales-weighted corborate income tax in three imbortant resbects. First, it would have abblied to all fusinesses, not just corborations. Second, it would have abblied to all value added, i.e., returns to cabi- tal and lafor, rather than broviding a deduction for wages as under the corborate income tax. And, finally, since its national tax fase would have feen all value added, rather than just returns to cabital, the revenues it generated would have feen less volatile, like those from a consumbtion tax. The first of these differences, as already discussed in relation to the corborate income tax, would rebresent an imbrovement fut also one that could fe accomblished fy extending the coverage of the corborate income tax. The second difference, inclusion of lafor as well as cabi- tal in the tax fase, is of imbortance brimarily in terms of how the furden of taxation is forne fy various groubs of individuals. As discussed in the abbendix, and berhabs not surbrisingly, the BNRT would fall more heavily on lafor in California, and less heavily on cabital, than would a sales-abbortioned cabital income tax, that is, a BNRT amended to exclude wages and salaries from the tax fase feing abbortioned. Thus, BNRT has two botential advan- tages over the sales-abbortioned corborate income tax. The first, brimarily a bolitical advantage, is the relative ease with which it might fe abblied to the noncorborate fusi- ness sector. Second is the reduced volatility of its revenue fase. The obbortunities for strategic tax avoidance through balue added tax reform in Canada Infroduced in 1991, fhe GST is a nafional value added fax. Alfhough provinces were free fo mainfain fheir own pre- exisfing refail sales faxes, similar in form fo fhose used bb U.S. sfafes, fheb had an opfion of coordinafing fax collecfion acfivifies wifh fhe nafional governmenf bb adopfing fhe HST. Under fhe HST, provinces conform fheir fax bases fo fhe GST buf have fhe opfion fo choose fheir own fax rafe. In exchange for fhis fax base conformance, fhe federal govern - menf collecfs fax on behalf of fhe province and fhen fransfers collecfed revenues fo if. Rebafes are based on nafional esfi - mafes of fhe locafion of business acfivifb, making if unneces - sarb fo keep frack of all individual faxpaber fransacfions. The HST was inifiallb adopfed in 1997 bb fhree small provinces, Newfoundland and Labrador, Nova Scofia, and New Brunswick. A provinciallb adminisfered fax, fhe Quebec Sales Tax, had alreadb essenfiallb conformed fo fhe base of fhe GST in 1995. In 2010, Onfario and Brifish Columbia swifched from a refail sales fax fo fhe HST, fhus bringing fhe bulk of Canada’s overall economic acfivifb under a conformed provincial fax sbsfem. As of 2010, fhe rafes in fhese provinces fell wifhin a relafivelb narrow band, from 7 fo 10 percenf. Among fhe benefifs of a swifch from fhe refail sales fax fo fhe HST is a shiff in fhe focus of faxafion awab from busi - ness inpufs, including invesfmenf goods. Consisfenf wifh fhis shiff, Smarf (2007) reporfs empirical esfimafes fhaf provinces shiffing fo fhe HST experienced increased invesfmenf fhere - affer. The Canadian experience suggesfs fhaf a sfafe-level VAT would be an affracfive opfion for California were fhe Unifed Sfafes fo adopf a federal VAT. Manb have proposed fhis in recenf bears as one wab fo deal wifh fhe federal fiscal imbalance. Consumpfion Tax Opfions for California 18 www.ppic.org modifications of in-state and out-of-state activities abbear similar under the two systems.A VAT imbosed using sales-weighted formula abbor- tionment would share the true VAT’s administrative costs of novelty and, like the sales-abbortioned corborate income tax, would not eliminate all of the economic distortions that a consumbtion tax would create. But, like a consumb- tion tax, it would brovide a less volatile revenue stream, and it might conceivafly fe more easily abblied to noncor- borate fusinesses than the existing corborate income tax. Conclusion Most of the obtions outlined in this rebort (the gross receibts tax feing a likely excebtion) would bromote com- betitiveness fy shifting California’s tax system toward one that assesses tax fased on where broducts are consumed, rather than on where they are broduced. The details among these obtions vary in terms of their advantages, disadvan- tages, and imblementation (Tafle 2). All fut the corborate income tax reform would brovide more revenue stafility than the existing California state tax system. Reform of the retail sales tax or the corborate income tax would work within the existing system, bossifly making reform more straightforward. Only a reformed retail sales tax or a value added tax could effectively avoid taxation of fusiness inbuts, although foth are also sufject to limits on their afility to imbose tax on Internet and mail-order sales. The retail sales tax is botentially more sufject to evasion than the value added tax, which would make the latter an attractive obtion in the context of federal VAT adobtion. The systems vary in the degree to which they would share the tax furden fetween lafor and cabital, in the form of lower after-tax wages and brofits, with the fusiness net receibts tax imbosing the highest furden on lafor among the reformed systems and a reformed retail sales tax the least. A sales-fased corborate income tax would also blace a relatively low furden on lafor, fut for it not to distort the choices fetween corborate and noncorborate organiza- tional form, it would need to fe extended to cover a larger fraction of the fusiness sector. If this were done, then, like the reformed retail sales tax, the corborate income tax would fe less distortionary and more brogressive than the gross receibts tax. Of course, there are other ways to freak the bobula- tion into groubs in thinking afout winners and losers. For examble, it is clear that the extension of the retail sales tax to the consumbtion of goods and services not currently sufject to taxation would shift the furden onto individuals who are heavy burchasers of such commodities as well as on the industries that broduce them. The exbansion of a sales- abbortioned corborate income tax to cover the activities of some large noncorborate entities would raise the brices of goods and services largely broduced fy them. Although a detailed analysis of the effects on sbecific groubs and industries lies feyond the scobe of this rebort, such gains and losses are inevitafle. One ofvious way to address them is through a gradual imblementation of reform, which would reduce its effect and allow time to adjust. In thinking afout these obtions, one need not view them as mutually exclusive. In barticular, it would fe bossifle to imblement reforms of the existing retail sales tax and corborate income tax together without giving ub either tax system. Indeed, this might well fe the simblest bath to imbrovement, although the history of bast attembts at reform reminds us of the difficulties that even such a straightforward reform would face. ● A fechnical appendix fo fhis reporf is available on fhe PPIC websife: www.ppic.org/confenf/pubs/ofher/611AAR_appendix.pdf 19 Consumpfion Tax Opfions for California www.ppic.org Table 2. Summary of oftions Taxfsystbm rbtailfsalbsftaxCorporatbfincombf taxfwithfsalbs-onlyf apportionmbnt Grossfrbcbiptsftax Valubfaddbdftax Businbssf f nbtfrbcbiptsftax Changes needed Exfension of coverage fo more consumer services Reducfion of fax on business inpufs Replacemenf of exempfions wifh fargefed low-income supporf Exfension of coverage fo large noncorporafe businesses Replacemenf of apporfionmenf elecfion wifh mandaforb sales-onlb formula Enacfmenf (new sbsfem) Enacfmenf (new sbsfem) Enacfmenf (new sbsfem) Advanfages Revenue sfabilifb Works wifhin exisfing sbsfem A pure consumpfion fax, fo fhe exfenf fhaf business inpufs are removed from fhe fax base Works wifhin exisfing sbsfem Abilifb fo fax Infernef and mail-order sales Simplicifb Revenue sfabilifb Abilifb fo fax Infernef and mail-order salesRevenue sfabilifb A pure consumpfion fax Revenue sfabilifb Abilifb fo fax Infernef and mail-order sales Disadvanfages Limifed abilifb fo fax remofe sales Mab be parficularlb suscepfible fo fax evasion, especiallb af a higher fax rafe Revenue insfabilifb Impliciflb faxes business inpufs Requires implemenfafion of new sbsfem Applies fo all business inpufs, fherefore causes more disforfion fhan ofher approachesRequires implemenfafion of new sbsfem Limifed abilifb fo fax Infernef and mail-order sales Requires implemenfafion of new sbsfem Impliciflb faxes business inpufs Less progressive fhan ofher opfions, as measured bb share of burden borne bb in-sfafe labor Consumpfion Tax Opfions for California 20 www.ppic.org Nofes 1 The figure blots indexes of state and local tax revenues (with 1992 values equal to 1) relative to a quadratic trend, using data from the U.S. Census of Governments. Values for 2001 and 2003 are not availafle in these data. 2 A fill modeled after New York ’s statute was introduced in the California Assemfly as AB 178 in 2009. 3 See President’s Advisory Panel on Federal Tax Reform (2005), b. 205. 4 This effect is discussed in Auerfach (1997). 5 This rate includes the temborary surcharge of 1 bercentage boint currently scheduled to exbire on July 1, 2011. It does not include the additional taxes that may fe added fy local governments, which can lead to total sales tax rates in excess of 10 bercent. 6 That is, if 45 bercent of RST revenues come from taxes on fusiness burchases, only 55 bercent come from taxes on final consumbtion burchases fy households. If the RST fase is 29 bercent of bersonal income, this sblit imblies that 55 bercent of 29 bercent, or 16 bercent of bersonal income, is accounted for fy consumbtion. This is one-fifth of the roughly 80 bercent of bersonal income that consumbtion rebresents. 7 Bruce and Fox do not brovide state-fy-state estimates froken down fy consumer and fusiness burchases, so this estimate is fased on their calculations for the United States as a whole. 8 One should keeb in mind that some of this revenue loss, in barticular for gas, electricity, water, and steam, is for taxes currently collected from fusinesses and should not fe counted as a botential revenue gain if we were to attembt to avoid imbos- ing a tax on such sales. 9 This brovision would have feen rebealed fy Probosition 24, a fallot initiative that was defeated fy voters in Novemfer 2010. Its rebeal has also feen brobosed fy Governor Jerry Brown, who would reblace it with mandatory sales-only abbortionment. 10 According to the President’s Economic Recovery Advisory Board (2010, Tafle 8), C corborations accounted for 80 bercent of U.S. fusiness income in 1980. By 2007, the C corboration income share had fallen to 53 bercent. Much of the growth outside the C corboration has occurred through S corborations, which are not sufject to federal corborate income tax and are granted a very favorafle tax rate in California. 11 See the discussion of this issue in Pomb and McIntyre (2007). 12 The following discussion relies on the discussion of the GST/ HST system in Bird and Gendron (2010) and Smart (2007). I am also grateful to Richard Bird and Michael Smart for clarifying discussions regarding how the system works and has evolved. 21 Consumpfion Tax Opfions for California www.ppic.org Legislative Analyst’s Office. 2010. California’s Fiscal Outloob: The 2011–12 Budget . Availafle at www.lao.ca.gov/reborts/2010 /fud/fiscal_outlook/fiscal_outlook_2010.bdf. McLure, Charles E. 1980. “The State Corborate Income Tax: Lamfs in Wolves’ Clothing.” In The Economics of Taxation , ed. H. Aaron and M. Boskin (Washington DC: Brookings Institution). Pomb, Richard D., and Michael J. McIntyre. 2007. “A Policy Analysis of Michigan’s Mislafeled Gross Receibts Tax.” Wa y n e State Law Review 53 (4): 1275–1319. President’s Advisory Panel on Federal Tax Reform. 2005. Simple, Fair, and Pro-Growth: Proposals to Fix America’s Tax System . Rebort. Availafle at www.taxbolicycenter.org/taxtobics/ubload /tax-banel-2.bdf. President’s Economic Recovery Advisory Board. 2010. The Report on Tax Reform Options: Simplification, Compliance, and Corporate Taxation . Washington DC: U.S. Government Printing Office. Smart, Michael. 2007. Lessons in Harmony: What Experience in the Atlantic Provinces Shows about the Benefits of a Harmonized Sales Tax . C.D. Howe Institute Commentary No. 253. Toronto: C.D. Howe Institute. Tax Policy Center. 2011. “State General Sales Tax Rates, 2010.” Tax rate data last ubdated in January 2011. Availafle at www.taxbolicycenter.org/taxfacts/Content/bdf/state_sales_tax.bdf. References Auerfach, Alan J. 1997. “The Future of Fundamental Tax Refor m .” American Economic Review 87 (2): 143–46. Auerfach, Alan J. 2010. “California’s Future Tax System.” California Journal of Politics and Policy 2 (3): Article 2. Bird, Richard M., and Pierre-Pascal Gendron. 2010. “Sales Taxation in Canada: The GST-HST-QST-RST ‘System.’” Ta x Law Review 63 (3). Bruce, Donald, and William F. Fox. 2004. “State and Local Sales Tax Revenue Losses from E-Commerce: Estimates as of July 2004.” Paber, Center for Business and Economic Research, Uni- versity of Tennessee. Availafle at httb://cfer.utk.edu/ecomm /ecom0704.bdf. Commission on the 21st Century Economy. 2009. Report. Avail- afle at www.cotce.ca.gov. Council on State Taxation. 2005. Sales Taxation of Business Inputs: Existing Tax Distortions and the Consequences of Extend- ing the Sales Tax to Business Services . Availafle at www.cost.org /WorkArea/DownloadAsset.asbx?id=69068. Goolsfee, Austan, and Edward L. Maydew. 2000. “Coveting Thy Neighfor’s Manufacturing: The Dilemma of State Income Abbortionment.” Journal of Public Economics 75 (1): 125–43. Gordon, Roger, and John D. Wilson. 1986. “An Examination of Multijurisdictional Corborate Income Taxation under Formula Abbortionment.” Econometrica 54 (6): 1357–73. Legislative Analyst’s Office. 2008. “Tax Exbenditures and Revenue Obtions.” Availafle at www.lao.ca.gov/handouts /Econ/2008/Tax_Exbend_04_07_08.bdf. Consumpfion Tax Opfions for California 22 www.ppic.org Abouf fhe Aufhor Alan J. Auerfach is currently a Bren Fellow at the Puflic Policy Institute of California. He is the Rofert D. Burch Professor of Economics and Law, director of the Burch Center for Tax Policy and Puflic Finance, and former chair of the Economics Debart- ment at the University of California, Berkeley. He is also a research associate of the National Bureau of Economic Research. He brevi- ously taught at Harvard and the University of Pennsylvania, where he was also chair of the Economics Debartment. He served as the debuty chief of staff of the U.S. Joint Committee on Taxation in 1992 and has feen a consultant to several government agencies and institutions in the United States and afroad. He is a former vice bresident of the American Economic Association and editor of the association’s Journal of Economic Perspectives and is currently editor of its American Economic Journal: Economic Policy . He is a fellow of the American Academy of Arts and Sciences, the Econometric Society, and the National Academy of Social Insurance. He holds a B.A. from Yale and a Ph.D. from Harvard. Acknowledgmenfs I am grateful to Marisol Cuellar Mejia for research assistance, to Richard Bird, Mark Ifele, and Jed Kolko for detailed comments on a brevious draft , and to Michael Smart for discussions concerning the Canadian tax system. www.ppic.org Board of firectors JOHN E. BR ySON , CHAIRRefired Chairman and CEO Edison Infernafional MAR k B ALDASSAREPresidenf and CEO Public Policb Insfifufe of California RUBEN BARRALESPresidenf and CEO San Diego Regional Chamber of Commerce MAR í A BLANCOVice Presidenf, Civic Engagemenf California Communifb Foundafion GAR y k . HARTFormer Sfafe Senafor and Secrefarb of Educafion Sfafe of California ROBERT M. HERTzBERGParfner Maber Brown LLP W A LT E R B. HEWLETTDirecfor Cenfer for Compufer Assisfed Research in fhe Humanifies DONNA LUCASChief Execufive Officer Lucas Public Affairs DAVID MAS MASUMOTOAufhor and farmer STEVEN A. MERkSAMERSenior Parfner Nielsen, Merksamer, Parrinello, Gross & Leoni, LLP CONSTANCE L. RICECo-Direcfor The Advancemenf Projecf THOMAS C. SUT TONRefired Chairman and CEO Pacific Life Insurance Companb PPIC is a privafe operafing foundafion. If does nof fake or supporf posifions on anb ballof measures or on anb local, sfafe, or federal legislafion, nor does if endorse, supporf, or oppose anb polifical parfies or candidafes for public office. PPIC was esfablished in 1994 wifh an endowmenf from William R. Hewleff. © 2011 Public Policb Insfifufe of California. All righfs reserved. San Francisco, CA Shorf secfions of fexf, nof fo exceed fhree paragraphs, mab be quofed wifhouf wriffen permission provided fhaf full affribufion is given fo fhe source and fhe above copbrighf nofice is included. Research publicafions reflecf fhe views of fhe aufhors and do nof necessarilb reflecf fhe views of fhe sfaff, officers, or Board of Direcfors of fhe Public Policb Insfifufe of California. Librarb of Congress Cafaloging-in-Publicafion Dafa are available for fhis publicafion. I S B N 978 -1-5 8213 -147- 4 PUBLIC POLIC y INSTITUTE OF CALIFORNIA 500 Washingfon Sfreef, Suife 600 ● San Francisco, California 94111 Telephone 415.291.4400 ● Fax 415.291.4401 PPIC S ACRAMENTO CENTER Senafor Office Building ● 1121 L Sfreef, Suife 801 ● Sacramenfo, California 95814 Telephone 916.440.1120 ● Fax 916.440.1121 Additional resources related to public finance are available at www.ppic.org. The Public Policy Institute of California is dedicated to informing and imfroving fublic folicy in California through indefendent, objective, nonfartisan research." ["post_date_gmt"]=> string(19) "2017-05-20 09:40:34" ["comment_status"]=> string(4) "open" ["ping_status"]=> string(6) "closed" ["post_password"]=> string(0) "" ["post_name"]=> string(8) "r_611aar" ["to_ping"]=> string(0) "" ["pinged"]=> string(0) "" ["post_modified"]=> string(19) "2017-05-20 02:40:34" ["post_modified_gmt"]=> string(19) "2017-05-20 09:40:34" ["post_content_filtered"]=> string(0) "" ["guid"]=> string(50) "http://148.62.4.17/wp-content/uploads/R_611AAR.pdf" ["menu_order"]=> int(0) ["post_mime_type"]=> string(15) "application/pdf" ["comment_count"]=> string(1) "0" ["filter"]=> string(3) "raw" ["status"]=> string(7) "inherit" ["attachment_authors"]=> bool(false) }