Publication 216, The First 100 Years
The Retail Sales Tax
Of all the provisions of the Riley-Stewart Act (Senate Constitutional Amendment 30), the one which would best serve the state in its quest for revenue was the authorization of “any form of taxation not prohibited by the Constitution.” Out of this provision grew other new forms of taxation, and most of them were delegated to the Board of Equalization. The first and by far the greatest new source of revenue was the Retail Sales Tax.
The concept of a sales tax was not new to the Legislature or the Board. Proposition 9, the forerunner to the Riley-Stewart Act, had provided for both a personal income tax and a sales tax, but opposition to these taxes figured decisively in its defeat. The Board of Equalization suggested several alternative forms of taxation, including a “transactions tax” or “gross receipts” tax which would “apply for property tax relief.” 70 The “Riley Plan”—Iater modified to form the “Riley-Stewart plan”—had called for a gross income or transactions tax, but this, too, met with great opposition and was deleted from the final Riley-Stewart Plan. When Senate Constitutional Amendment 30 was finally enacted, the decision as to what types of taxes to institute was left to the Legislature.
Two factors were instrumental in passing the Riley-Stewart Act: (1) additional revenue was needed to meet the increased demands on the state treasury; and (2) this additional revenue should not come from property taxation. In the course of campaigning for passage of the Riley-Stewart Amendment, many supporters had spoken in favor of a retail sales tax. Even the Joint Legislative Tax Committee had proposed a two percent retail sales tax in its report of April 29, 1933.71 It is not surprising therefore, that after the passage of the Riley-Stewart Amendment, a retail sales tax was “expected from the reconvened Legislature.” 72
In the economic upheaval of the Great Depression, it took great courage to propose a sales tax in the early 1930s. Nevertheless, spurred by the state’s growing fiscal crisis, Controller Ray Riley and Board Member Fred Stewart led the Board in advocating the tax. On July 18, 1933, less than one month after passage of the Riley-Stewart Act, a retail sales tax bill, Senate Bill 1211, was introduced into the California Senate by Senator Ralph E. Swing. After extensive debate over the rate, the Senate and Assembly compromised on two-and-one-half percent, and the bill passed both houses of the Legislature by a narrow margin. Governor Rolph waited until the deadline, July 25, 1933, to sign the bill into law. It went into effect August 1, just one week later, with the two-and-one-half percent rate that was to remain effective until July 1, 1935. Thereafter, the rate was to be lowered to two percent. The Board of Equalization was selected to administer the new tax and was authorized to make “such rules and appoint such accountants, auditors, investigators, and assistants as it may deem necessary to enforce its powers and perform its duties . . .” 73. The Board would also hear appeals by taxpayers protesting sales tax decisions by its administrators.
Surprisingly, there was little opposition at first to the sales tax bill. “The very speed with which the sales tax law was passed disarmed its natural opponents.” 74 The Grange and the Farm Bureau, which wanted either an income tax or both an income and sales tax, mounted an ineffective opposition to the bill. Retailers were apparently appeased by the provision that the tax could be passed on to the customer. However, immediately after the retail sales tax went into effect, opposition began mounting. Most people would have preferred an income tax but the Governor vetoed such a measure. When property taxes did not decrease in 1933-34, it was believed that the state had adequate sources of funds. Hence, why impose a sales tax that would be especially burdensome on low-income families, already hard-hit by the depression? However, the sales tax was an excellent source of revenue and because of the continuing need for revenue, all efforts to lower or eliminate the sales tax failed.
The Sales Tax Act authorized the Board to hire staff to administer the new levy, but it exempted them from civil service. Unemployment was rampant during those depression years, and legislators pressured the Board to hire their constituents, many of whom were not qualified for their jobs. The Sales Tax Act designated three percent of the tax collected to defray the cost of administration. However, the Legislature adjourned without appropriating any money for administration, so that there would have been no funding of the program from August to October were it not for the requirement in the Act that every retailer must purchase a sales tax permit for one dollar. All Board employees were assigned to sell those sales tax permits. The proceeds of those permit sales paid the employees’ salaries, but the firms which supplied the office equipment for this new unit had to wait for their money until the Legislature reconvened in the fall.
The sales tax proved enormously difficult to administer at first, both because the staff was inexperienced, and because the public resented the new tax. The phrase, “a penny for Jimmy”, reflected anger at Governor James Rolph for signing the sales tax into law. However, his courage in doing so despite the political unpopularity just prior to the 1934 election year saved the state from financial disaster during that period of severe economic depression.
Former Chief Counsel Traynor had written the sales tax law. Upon its enactment, he requested a leave of absence from the University to accept a temporary assignment as Director of the Sales Tax. Keesling and Say were appointed assistant directors. Wahrhaftig joined the legal staff and was assigned to work on sales tax matters.
Executive Secretary Pierce enlisted the aid of public utility companies who loaned three efficiency experts to the Board to help overcome the initial confusion generated by the sudden imposition of this new tax. The three utility employees assisted in organizing a staff and developed a system of administration. Traynor later praised these men for their outstanding work, emphasizing that the utility companies provided these experts to the state at no charge.
Traynor, Keesling, and Wahrhaftig drafted many basic regulations to implement the new sales tax law, most of them still in effect. Among these were the fabrication rule, the motion picture rule, and the contractors’ rule.
Earlier, during 1933 and 1934, there was substantial avoidance of the new sales tax, as Californians ordered merchandise directly from sellers in other states. To forestall such evasion, Traynor, Keesling, and Wahrhaftig drafted a use tax bill, which was enacted into law in 1935. This type of tax was later adopted by the other states which imposed a retail sales tax. In 1937, the same trio of attorneys drafted a bill which was enacted, permitting other states to use California courts to collect taxes on a reciprocal basis. All states subsequently enacted similar legislation.
At the end of 1933, Traynor relinquished his position as Director of the Sales Tax and returned to the University to teach full time. From 1933 until his appointment to the State Supreme Court in 1940, he served as a consultant to the Board on tax matters.
Although the sales tax was proving to be a good source of much needed revenue, the Board viewed with growing concern the revenue losses the state would sustain with the return of utilities to the local tax rolls on January 1, 1935. The Board encouraged the Governor to adjust the sales tax rate to avoid the scheduled one-half of one percent reduction in the sales tax rate in July of 1935. The Board went so far as to say:
“Even if the sales tax is retained at its present rate, there will be no revenue from it which may be used to replace the $30,000,000 of annual utility taxes transferred to the counties, cities, and districts. The difference between anticipated income from existing sources and the corresponding expenditures for which the state is obligated shows an alarming ‘red ink’ figure. There will be no core of the sales tax apple to take the place of the utility tax revenues.” 75
The state recouped this loss through the newly enacted taxes on business and personal income, which yielded approximately $40,000,000 per year.
Governor Frank F. Merriam responded with a request for a three percent tax in his proposed 1935 budget. After a heated debate in both houses the joint Legislative Committee on Revenue and Taxation recommended a three percent sales tax, the exemption of food for home consumption, a use and storage tax and the application of sales tax to some leases and rentals.76 The Legislature followed these recommendations with the passage of three bills: the Hunt Bill raised the tax rate to three percent and exempted foodstuffs; a second bill added leases and rentals made in lieu of sales to the list of taxable transactions; a third, the use tax bill, imposed a sales tax counterpart to purchases brought in from outside the state. All three bills became effective July 1, 1935.
The Board’s reaction was generally favorable, particularly to the use tax which it had recommended. Its biennial report declared:
“The Use Tax Act has accomplished its purpose of placing California retailers on equal terms with their out-of-state competitors.” 77
This affirmation did not, however, reflect the sentiment of the Board regarding the foodstuffs exemption. Foodstuffs had actually accounted for twenty-five percent of the sales tax receipts in the first twenty-three months and, understandably concerned, the Board admonished, somewhat emotionally:
“Exemptions, reasonable enough when considered individually, will form a vicious cycle destroying the usefulness of the measure, and will plunge the state back into the ‘tax crisis’ from which it was rescued with the adoption of the Sales Tax Act.” 78
At the height of the depression, the state relieved the counties of their responsibility for financing education, assuming costs that totaled $40,000,000 annually. In its first year, the newly enacted sales tax raised $46,200,000 to meets its new obligation. In 1933-34, the state contributed $30 per pupil in average daily attendance at elementary schools, $60 per pupil in secondary schools. It was the sales tax that saved the schools, and kept them open throughout the depression.
70 Report of the State Board of Equalization 1931-1932. p. 11
71 Report of the Joint Legislative Tax Committee (Senate Journal 1933) p. 2113.
72 Ibid., pp. 3379 and 3465
73 Cal Stats. (1933), ch. 1020, p. 2609
74 Stockwell, op. cit.
75 Report of the State Board of Equalization, 1933-1934. p. 11
76 Report of the Special Joint Legislative Committee on Revenue and Taxation, Senate Daily Journal (May 15, 1935), p. 2026
77 Report of the State Board of Equalization, 1935-1936, p. 3