Record numbers of Californians are struggling with housing affordability. The median home price is at new highs and the state is fighting record homelessness. Housing experts, economists and the state’s editorial pages all agree with Governor Newsom: to solve our housing crisis, we must build millions of more homes.
According to the report by the California Foundation for Commerce and Education (CFCE), imposing a 5% sales tax on services would drive up the cost of the average new single-family home by more than $16,500. This would hurt prospective homebuyers, impede the state’s housing goals and reduce the value of tax dollars spent to create new housing.
A Tax on Services is a Tax on Housing
Numerous services go into building every new home: architects, engineers, environmental consultants, plumbers, electricians, general contractors, laborers, accountants, attorneys and more all provide services essential to producing the finished product. A tax on these services would not just hit a homebuyer once – the cost of the taxes gets passed on and compounded up the production chain, in a process known as “pyramiding.”
Here’s how pyramiding works in the context of housing:
- A 5% sales tax on legal and accounting services would add 5% to the cost of those services when purchased by a technical drafting firm.
- The cost of the drafting firm’s services now includes the 5% tax on attorney and accountant services respectively.
- When an architect hires the drafting firm’s services, it is now paying 1) a tax on the original taxes on legal and accounting services, and 2) a tax on the drafting services.
- The cost of the architect’s services now includes the cost of the 5% tax on the drafting firm’s services and the compounded cost of the tax on legal and accounting services.
- When a contractor purchases the architect’s services, it is now paying: 1) a tax on the tax on the original tax on attorneys and accountants, 2) a tax on the tax on drafting services, and 3) a tax on the architect’s services – on top of the costs of all those services themselves.
- The cost of the contractor’s services now includes the cost of the 5% tax on architect’s services, the twice-compounded cost of the tax on drafting services, and the three-times-compounded tax on the legal and accounting services.
- When a developer purchases the contractor’s services, the developer is now paying: 1) a tax on the tax on the tax on the tax on legal and accounting services, 2) a tax on the tax on the tax on drafting services, 3) a tax on the tax on architect’s services, and 4) a tax on the contractor’s services.
The CFCE report found that the effective tax rate of a 5% sales tax on business services in key economic sectors related to housing can range from 6.1% (construction) to 8.13% (finance) due to pyramiding.