The Value of Sales Tax in Raising Revenue

The toll of the Great Recession on working families is severe. We are seeing the highest rates in poverty on record, the highest unemployment for decades, and falling incomes.

In these times of economic uncertainty, there is only the certainty that our need for clean and safe neighborhoods and accessible public amenities will be evermore pressing. The structural problem is how we can continue to support these services that maintain the quality of life for our working families, as well as strengthen the foundation for a robust recovery.

You get what you pay for. The most determining factor in the city’s ability to provide general services is the need for adequate resources, as evidenced by the funding of general revenue. This is how the city funds services that benefit all residents, like police, fire, road-repair and parks.

According to the State Controller, the city of San Diego raised about $870 million in General Revenue in FY2008. (This is the latest report compiled by the controller based on financial reports submitted by the city.)

I recognize that this amount is quite less than what we consider to be the “general fund” which includes substantial Transient Occupancy Tax. However, given that the determination of the revenue categories is standardized across the state, and that revenues in other cities would be similarly treated, I rely on the California Controller’s figures for this comparative analysis. I also exclude San Francisco among the 10 largest cities, as the same entity also performs county functions; the state controller also excludes San Francisco in the statewide cities analysis.

The results show that the city of San Diego is underfunded. The city raises $650 per San Diegan in General Revenue. This is 2% of the per capita personal income, one of the lowest among large cities in California. Compare this with 2.2% raised statewide, and 2.6% for the largest cities in California. If the city were to raise general revenue at the same proportion (between per capita revenue and per capita income) as the average of the largest cities, the city would be raising $113 million more every year.

Source: Author’s calculation based on the 98th Cities’ Annual Report, California State Controller, data for fiscal year 2007-2008.

So we have a revenue problem, which is making it unsustainable to provide essential services. Why sales tax? Sales taxes are more diffuse in their impact throughout the economy, and have the least impact on growth, among other alternatives.

According to the Organization for Economic Co-Operation and Development, between revenue-neutral options, taxes on consumption (such as sales tax) are better for economic growth than taxes on income, because they are more efficient.

The sales tax rate in the city of San Diego is currently 8.75% with a possibility that it will fall by a cent on April 1, 2011, depending on the state budget. If Proposition D passes and the state sales hike expires, San Diegans will see a fall in sales tax rate to 8.25% on that date. If the repeal does not occur, and Proposition D passes, the sales tax rate will be 9.25%.

A simple (unweighted) average of the sales tax rate in the ten largest cities comes to about 9.2%. San Jose charges 9.25%, Los Angeles, Long Beach and Oakland charge 9.5%.

In the county, the cities of El Cajon, La Mesa, National City and Vista charge higher taxes than San Diego.

So how would a half-cent sales tax income a middle-income family? The median income of a household in the city of San Diego was $62,668 in 2008. I have listed some of the expenditure categories that may be subject to the tax.

Sales taxable expenditure categories for middle-income household:

Source: Based on a consumer expenditure survey, 2008, by the Bureau of Labor Statistics for a consumer unit with income $50,000-$69,999 before taxes. The actual taxable sales on certain categories (like medicine) will be lower than the upper estimate, since in many cases the entire expenditure category was included.

The proposed half-cent tax increase would result in a maximum sales tax increase of $107.71 a year (30 cents a day) for a median income household in San Diego. This is in comparison to an upper limit of $1,884 currently paid by a median household in sales tax, and assumes that the state hike of 1% does not expire. Assuming that all the expenses listed ($21,542) are taxable, and that the entire category is taxable, gives us the upper limit on expenditures subject to sales tax. The sales tax increase represents 0.18% of income for a middle-class family.

Finally, the increased investment could be a factor in turning around the local economy. In fact, the region has been significantly buffered from the impacts of the Great Recession due to government spending. For example, the economic multiplier effect of $100 million spending on infrastructure could yield $159 million additionally in terms of contracts, suppliers and respending.

According to Nobel Laureate economist Joseph Stiglitz, raising taxes is preferable to cutting spending in a recession:

“The reasoning is straightforward: in a recession, you want to raise (or not decrease) the level of total spending — by households, businesses and government — in the economy. That keeps people employed and buying things, and makes it more likely that businesses will want to invest to serve that consumer demand. Budget cuts reduce the level of total spending … By contrast, every dollar of state and local government spending enters the local economy right away, generating a greater economic impact.”

Murtaza Baxamusa is the Deputy Director with the Center on Policy Initiatives. He lives in La Jolla.