Estimating revenue for next year’s budget used to be considerably easier, according to a new report released by the Legislative Analyst’s Office last week.
Prior to 1980, local governments could count on a trend in consumer spending: the growth in sales tax dollars would parallel the growth in the economy. Since then consumers have been spending substantially less on taxable goods; an upsetting trend for public agencies who rely on sales tax for a significant chunk of their revenue.
The collection of sales taxes peaked in 1979, when 53 cents of every dollar was spent on taxable items. Fast forward three decades and only 33 cents of each dollar are spent on taxable items.
Where has this money gone? The LAO finds that since 1980, consumers have been spending increasing amounts on nontaxable services—like housing and healthcare—and less on taxable goods like cars, clothes, and household appliances.
Chas Alamo, the author of the study, reports: “Over time, the share of consumer income spent on taxable items has declined, causing taxable sales to grow less quickly than the state economy.”
Meanwhile, demand for services has steadily increased. And this increase in demand has been accompanied by a rapid inflation in prices for those services. Accordingly, these market forces leave consumers with less cash to spend on taxable products.
The LAO report attributes this increase in demand for nontaxable services to three factors: 1) the growing number of Californians entering retirement cause a substantial increase in the demand for healthcare services; 2) rising incomes often lead to an increase in spending on leisure, recreation and entertainment; and 3) state and federal policies that lower the cost of services—as in the mortgage interest deduction for homes and grants for college—cause consumers to spend more money on these services than they would have without the intervention of these policies.
Any hope that this trend will turn around? According to Alamo, the answer is no: “Absent further increases in the sales tax rate or expansion of its base, sales tax revenue for the state and local governments are likely to grow slower than the economy for at least the near future.”
Increasing the sales tax rate is a tactic a number of cities have employed to combat falling sales tax revenue. At 7.5%, California’s base rate for state sales tax is the highest in the nation and California state law caps cities and counties from raising local sales tax by more than 2.5%. However as of 2013, the LA County cities of La Mirada, Pico Rivera, and South Gate have all instituted 10% tax rates.
Any unique or innovative ways your local government agency has adapted to and accommodated the trend of declining sales tax revenues? Send them to the editor here.
Read the full LAO report here.