Taxing (or Not Taxing) Services is Wrong Focus - How to Improve Sales Tax

The sales tax, used by almost all states, is a consumption tax. Generally, consumption is what the final consumer does.  For example, a company manufactures paper, a greeting card company purchases some of that paper to make greeting cards and sells them to the final consumer or to a distributor who sells them to the final consumer. As the paper or cards move through this supply chain, a sales tax exemption for items purchased for resale prevents sales tax from being charged. The final consumer is the only one who pays sales tax when the card is purchased (reaches the end of the supply chain).

Supply chains and tax systems are not always this "simple" though because not everything a business buys is directly for resale.  A recent case in Kansas found that electricity purchased by Southwestern Bell Telephone, Co. LLC (No. 120,167 (2020)) to help in the delivery of telecommunications services was exempt from sales tax because it was used in this production. A lot of time and effort though went into the determination of whether Southwestern Bell owed sales tax.

A simpler approach is possible and is really part of a proper sales tax system. This approach is that businesses should not pay sales tax on any of their purchases; only the final consumer should pay sales tax.

The Kansas case is just one of many decided every year in addition to ones settled on audit and dealt with by sellers in determining if they should be charging sales tax to a customer. This is a lot of wasted time given that the sales tax should be just on the final consumer. This required element of a sales tax avoids "pyramiding" in the system which occurs when a business pays sales tax and factors that into the price it charges customers leading to tax charged on tax.

There are annual discussions in many state legislatures and by taxpayers and industry associations about not imposing sales tax on services. I think the better focus is on changing the law to tax a broad base of consumption (including services except perhaps for some medical services) and only charging the tax to the final consumer.

This is how a value-added tax (VAT) works. In a pure VAT system (one without lots of exemptions or special rates), everyone pays VAT on all purchases. If that buyer is a business, they get their VAT back. This helps ensure collection by collecting the tax throughout the supply chain. It also prevents the need for a seller to accept an exemption certification from a business buyer and then be liable for the sales tax if it turns out the certificate is invalid.

Will this system work? In theory. In reality, states rely on sales tax paid by businesses so it is hard to replace. But I think a gradual shift to broaden the base, such as to include digital goods that are equivalent of taxable tangible goods (such as iTunes and digital books), entertainment, and personal services will help. Also, not including business purchases in the expansion of the sales tax base. AND, it is important to lower the rate so this is not a tax increase but a tax system improvement effort to make it function better today and in the future. It will also avoid the eroding sales tax base that affects many states today, such as technology allows us to buy non-taxable digital versions of what was previously a taxable tangible purchase (books is a good example).

So, let's eliminate time spent arguing for sales tax exemptions for businesses and expanding tax bases to include more services and instead pursue:

• Prohibiting any sales tax base expansion from applying to items purchased by business (so as not to make the existing pyramiding problem worse).
• Expanding the sales tax base to cover all final consumption with very few exemptions, while lowering the rate. 

What do you think?

Two New Sales Tax Exemptions in California for Two Years

California SB 92 (Chapter 34, 6/27/19) adds two new sales tax exemptions starting 1/1/20 and ending 12/31/21:

1. “diapers designed, manufactured, processed, fabricated, or packaged for use by infants, toddlers, and children” [R&T 6363.9]
2. “menstrual hygiene products” shall only include the following: (1) Tampons. (2) Sanitary napkins primarily designed and labeled for menstrual hygiene use. (3) Menstrual sponges. (4) Menstrual cups.” [R&T 6363.10]

For these new temporary sales tax exemptions, the legislature applies R&T §41 dealing with accountability. Thus, the legislature had to specify the purpose of the exemptions and require a report from the LAO on the effectiveness of these provisions including whether they should be modified, extended, or allowed to expire. For the diaper exemption, the LAO is also to assess “whether more targeted approaches to providing families in need with adequate access to diapers are available.” For the menstrual products, the LAO is also to assess “whether more targeted approaches to providing individuals in need with adequate access to menstrual hygiene products are available.” The specified goals of these exemptions:

·         Diapers: “to promote public health by increasing the affordability of, and expanding access to, diapers.”

·         Menstrual hygiene products: “to promote public health by increasing the affordability of, and expanding access to, menstrual hygiene products.”

Observation: Often, bills that provide a new credit or exemption state that R&T §41 does not apply. Then there is no need for accountability as to whether the provision meets its purpose or even that a purpose be articulated. Important to this assessment though is whether the LAO will have the information needed for a strong assessment. The legislation should have included a provision and funding to have the LAO identify information it will need the CDTFA to collect.

Other states provide similar exemptions with the sales tax on menstrual products sometimes referred to as the pink tax or the tampon tax. States with an exemption include Connecticut, Florida, Illinois, Minnesota, New Jersey and New York.

Do these exemptions reflect good tax policy? NO. The biggest issue is equity and fairness in that they give the largest break to higher income buyers because they are likely to spend more on diapers. I see that on Amazon, diapers range from 11 cents/diaper up to at least 49 cents/diaper. Someone already buying the more expensive diapers doesn't need a sales tax break to make diapers more affordable as they have already opted to not buy a less expensive diaper that would be more affordable. If the exemption were only given to individuals who need it and who may need even more assistance in paying the price without the sales tax, this exemption is poorly targeted.  A similar argument can be made for the menstrual products.

There are better ways to target relief to taxpayers needing relief rather than also giving relief to those who don't need it. This sales tax break results in reduced revenue for state and local governments. How will they make it up?

More targeted relief would be to provide diaper coupons to individuals already receiving state or local aid, or just giving them diapers which the state would buy in bulk at a reduced cost. Same with menstrual products.

Another concern with these products is that there are added environmental costs of these disposable items. Thus, removing the tax on them means that the costs of disposal and filling up landfills needs to come from elsewhere.

What about the argument that only females need menstrual products so taxing them is a gender disparity. That same argument can be made for other products such as razors, shaving cream, jock straps, football helmets, and I'm sure other items. Exempting these items makes the system more complex, less equitable, and requires that the rate be higher on other items.

The California Legislative Analysts Office issued a report (5/12/19) on these exemptions before enactment of S 92. It notes a few additional issues including the difficulty of defining a "necessity" and whether an income tax credit for the menstrual products would present greater tax relief.

What do you think?

Taxing Candy and Snacks - That's a Good Start

Many states exempt food from sales tax (see list from Federation of Tax Administrators). The rationale is that food is a necessity of life so should not be taxed. But this is a flawed rationale because many food items are not necessities of life, such as:

• Candy

• Soda

• Chips

• Expensive food versus its less expensive counterpart (high income individuals spend more on food so they get the biggest tax savings from the exemption)

Many years ago, the California legislature expanded the sales tax to cover snacks but it was so confusing and unpopular that in 1992 the voters passed Prop 163 to change the state constitution to forbid taxation of food. That means if California ever wants to tax food, a constitutional amendment is needed. Assemblymember Cristina Garcia (58th District) announced this month that she plans to introduce legislation to make this change so that candy and snacks can be subject to sales tax (3/11/16 press release). Per this press release, it seems that she wants to earmark the estimated $900 million per year that can be generated from the tax for health issues, such as fighting diabetes. Per Rep. Garcia:

"Removing the snack food tax exemption will generate close to $900 million per year, funding health services and programs to promote healthy eating & lifestyles, particularly for children and families living in poverty."

In 2010, the State of Washington started taxing bottled water, candy and gum. A few months later, the tax was repealed (see Special Notice of 11/17/10). See my blog post of 5/15/10 on the challenges of defining "candy" under Washington law. Unfortunately, I did not save a copy of the Dept. of Revenue's lengthy chart listing all type of candy and what was taxable and what was not (such as a KitKat because it includes flour).

While taxing non-essential food items sounds like a good idea, it has problems:

• It is difficult to define "snack." This is what led to voter frustration with California's law decades ago. A box of donuts was not taxed but the pack with six small donuts was. M&Ms were taxed, but chocolate chips were not. An issue arose over Matzo crackers versus Matzo bread.  See this 7/23/91 article from the Deseret News for more.
• The definitional challenge is frustrating for both vendors and consumers. For vendors, errors can be costly.
• Why single out only candy and snacks? Many food items are non-essential. But any exemption makes a law difficult because it is not easy to define the taxed versus exempt items.  
• It is regressive (hurts low-income taxpayers more than higher income ones).

Generating $900 million annually from taxing candy and snacks is a lot of money. Per the California Dept. of Finance's tax expenditure report that includes both the state and local government share of tax. If all food were taxed, over $10 billion could be generated annually (+ the candy/snack tax). 

Why not tax all food to make it easier? Easier in that no definitions are needed.  If it is a consumable, it is subject to tax. The revenue should not be earmarked though. It should go into the general fund. With the additional revenue, lawmakers should:

• Create a refundable income tax credit for low-income individuals to offset the sales tax on food.
• Lower the sales tax rate.

That would be a start. There are other ways that the sales tax should be broadened with revenue used to lower the rate. A tax with few exemptions and a lower rate is much better at meeting principles of good taxation. For more on this, please see my papers on broadening the sales tax base and principles of good tax policy.

What do you think?

Designing sales tax exemptions - what is necessary?

Several sales tax exemptions fall under the "necessity of life" category - or at least that is typically how a state might describe them. For example, see page 1 of California Board of Equalization Pub 61 which lists food, health and housing under this category. One that caught my attention recently is Idaho's addition of  “eyeglasses and eyeglass component parts” as a sales tax exemption effective July 1, 2015.

While the lens are health related, the frames are often fashion related. Frames range in price from $50 including the lens (!) to over $250 for just the frames. If I'd been asked, I would have suggested that Idaho just exempt the cost of the lens and the cost of a basic frame (perhaps $20). The rest should be subject to sales tax. That helps the system be more equitable as expensive frames are not a necessity of life and more likely to be purchased by individuals who can afford the more expensive frame AND the sales tax.

For a bit more and the links, see a short post originally posted to Sales Tax Support.

Idaho recently amended its list of sales tax exemptions to include "eyeglasses and eyeglass component parts" (HB 75, 3/24/15, effective 7/1/15).  There were already exemptions for drugs, hemodialysis supplies, braces and orthopedic appliances, dental prostheses and other medical related items. While eyeglasses seem to fit the list, there is a significant difference between eyeglasses and most medical supplies and devices. Eyeglasses are also a designer item where the cost can be quite high due to the choice of frame. Also, for most medical items, the doctor prescribes the item and the patient has no choice of style or manufacturer. In contrast, patients have a lot of choice in eyeglass frame.

So, the exemption helps any one in need of corrective lenses, but provides a bonus to individuals who want the $300 (or higher) frame rather than a $40 frame. This could be alleviated by only providing the sales tax exemption for the glass and then only the first $50 of the cost of the frame. It would not be difficult to compute. It also sends the message to consumers that the exemption is only for the medical aspect of the purchase, not the designer element of it.

What do you think?

Textbook sales tax exemptions

New York and a few other states allow a sales tax exemption for college textbooks.  That may be too broad of a statement - the exemption is for a college student buying a textbook noted on his/her course syllabus or a list from the college.  It is not simple for the buyer or seller due to definitions, restrictions and recordkeeping.  I've got more on this, originally posted at SalesTaxSupport.

Special tax rules tend to violate principles of good tax policy, such as simplicity, neutrality and equity. For example, a sales tax exemption for certain types of manufacturing equipment will require specific definitions of the eligible equipment. We have seen these types of issues litigated which is a good indicator of the complexity involved. Also, such an exemption benefits one industry over another.

The start of the school year brings attention to a few special education provisions in sales tax rules. I address one of these here - sales tax exemptions for college textbooks.

College textbooks are usually expensive.  As an undergrad many years ago in the California state university system, my books were always more than the cost of my tuition.  I see that my alma mater, CSU Northridge, currently tells students that books will cost almost $1,800 per year! In California, students pay sales tax on the textbooks, unless they buy an electronic book.

A few states, such as New York, offer a sales tax exemption on tangible textbooks. However, it might be "taxing" to the student (and the sellers) to get that exemption. In early August, the New York State Department of Taxation and Finance issued Tax Bulletin ST-126 (TB-ST-126; 8/7/14). Per this bulletin, "the student may have to complete Form ST-121.4, Textbook Exemption Certificate, and give it to the seller." Then over 600 words follow to explain how to get the exemption. The requirements to get the exemption include that the student must be full-time or part-time (that is odd as there is no other type of student) at "an institution of higher education,"  the book must be required for course work, and the student must show the seller a "valid student identification card or other evidence of enrollment at the time of purchase."

It's not easy for sellers either. They have to verify all of this and keep copies of the required book list from the instructor or university, or the "properly completed certificate" of exemption from the student.

There are penalties for misuse of the exemption.

So, is the textbook exemption worth it? Is this good tax policy? No. If the exemption is there to help reduce costs of going to college, there are much higher costs than sales tax where many college students could use assistance.  From an equity perspective, the exemption benefits all students, even those who can easily afford to pay the sales tax. A scholarship or grant to help students in need of financial aid would be more targeted. There would be more funds to help those with a financial need if the exemption did not exist. Also, the recordkeeping burden for the seller is too costly and not appropriate. If legislators want to reduce costs for college students, why not find a way that won't put the burden on third parties.

Information from the National Association of College Stores notes that a slight majority of states that impose sales tax have some type of textbook exemption, most of them with restrictions. The restrictions add to the complexity in that special definitions are needed. Also, sellers are at risk of making an error and being on the hook for the uncollected sales tax. Amazon only lists ten states that exempt textbooks from sales tax.

The NACS also notes there are proposals from some states for exemptions. I know California periodically has such a proposal (such as AB 479). [I've blogged on an earlier version from 2010.]

Another problem with the exemption beyond the complexity is that it sends a message that the state doesn't need the revenue. Yet, states do need the revenue. Also, it can lead to ideas for even more exemptions, such as on the computers and supplies purchased by college students.

Better to have a broader base and a lower rate. This better ensures that the sales tax can meet the principles of simplicity, neutrality, and equity.

While the exemption might sound like a great thing for students, and California often introduces proposals for such an exemption, it is not. There are better ways for legislatures to help college students including targeting relief to those who need it and not imposing extra work on third parties (booksellers) to handle the program.

What do you think?

http://www.tax.ny.gov/pdf/current_forms/st/st121_4_fill_in.pdf

Should schools and students pay sales tax (or VAT)?

http://www.boe.ca.gov/legdiv/legresearch.htm

It might seem odd for a state school or any government agency to pay taxes. Generally, they are exempt from income and property taxes, but likely pay sales tax (or VAT if outside the US) on purchases. Students of the state schools also pay sales tax on taxable items they purchase from the school bookstore or for their education (such as books).

Isn't this just a roundabout way for the state to be paying tax to itself?  Would it be more efficient to exempt purchases of state schools and agencies from sales tax?

What reminded me of this issue was an article about a bill (HB 4165) introduced in Singapore to create a VAT exemption for goods and services purchased from schools. ["Bill filed to exempt goods sold in schools from VAT," by Miranda, Business World Online, 5/23/14] The logic is also to keep school costs down. The bill sponsor suggests that when the school pays VAT, it must increase what it charges students.

California has had proposals to exempt textbooks and school supplies from sales tax. That is not easy to administer though because it is not clear that a book is a textbook (such as a novel) and some people buy textbooks or supplies that are not for school. See my 2/2/10 blog post. I note a few problems with such an exemption including complexity of defining the exemption and the reality that the seller might increase the cost of the items due to the exemption.

There are other ways to reduce costs for students, such by increasing government support through other spending cuts and efficiencies. But, that doesn't address the odd flow of funds when the state schools pay sales tax (such as a grade school buying textbooks), with the funds going to the state. Why not just exempt the direct purchase by the school.  I think the exemption for student purchases is the problematic one. For example, how does the seller know the buyer is buying the book or supply for school use?

What do you think?

How sales tax exemptions can waste one's time

Recent litigation in Missouri over whether converting frozen dough into baked goods is "processing," such that the electricity used is exempt from sales tax, shows the time and money that can be wasted with pointless rules.  The solution is to not have businesses pay sales tax - instead, only have it paid by the final consumer (the same was a VAT works).  Please see my summary of the case and issues in this SalesTaxSupport.com post.

Marijuana and the Tax Law

It's unlikely anyone missed the news stories about marijuana sales becoming legal in Colorado on 1/1/14. The Huffington Post reported on 1/8/14  that sales in the first week were about $5 million. That also generated a lot of tax revenue for the state because Proposition AA* that Colorado voters passed in November 2013 allows for a 15% excise tax when unprocessed retail marijuana is sold by a cultivation facility to a retailer AND a 10% sales tax (on top of the normal Colorado sales tax of 2.9%) when the retailer sells the marijuana. That proposition suggested that $70 million would be generated annually with the first $40 million to be used for public school capital construction. Additional revenues would be used to enforce regulations on the retail marijuana industry and the balance for other needs (apparently at the discretion of the legislators).

Recent guidance from the Colorado Department of Revenue (Sales 93) notes that there is a Retail Marijuana Sales Tax Return. Also, there is apparently just one possible exemption, described in "Sales 93" as follows:

"Medical marijuana is exempt from state sales tax for patients that are issued a registry card that has a tax-exempt status notation from the Colorado Department of Public Health and Environment (CDPHE). A person qualifies for the tax-exempt status if, depending on the number of people in the patient's family, their income is below a certain level. The tax-exempt patient must provide the tax-exempt registry card to the retailer at the time of purchase in order to be exempt from sales tax."  [This appears to be something new because a 2009 opinion from the Colorado Attorney General said it was subject to sales tax.] "Excise 23" explains the 15% excise tax. Medical marijuana is not subject to this tax.

Some observations:

• These are high sales tax rates on top of the normal sales tax. Depending on what additional costs the state incurs from the sales, it seems to be a significant source of revenue. A 1/9/14 story in the Wall Street Journal - "Pot Legalization Crimps Funding of Drug Task Forces," notes that states that legalize marijuana lose funding because some of the seized assets are used by law enforcement.
• Are there other items consumers are willing to pay an additional 10% sales tax on?  Perhaps the Colorado state sales tax of 2.9% is too low?
• Registry card - This card used by a low income patient to obtain a sales tax exemption on medical marijuana is interesting. Generally, it is difficult to target sales tax relief because a vendor doesn't know if a person is low-income and eligible for tax relief. This is why states typically deliver sales tax relief in overbroad ways, such as by exempting food purchases. Such broad exemptions provide significant relief to high income taxpayers who spend more on food than do lower-income individuals, and likely don't need a sales tax break. Perhaps this approach works for medicinal marijuana sales as other documentation might exist and these sales are far fewer than food.  I think the system would not work for other types of sales, such as food, due to possible abuse and added administrative costs. I think that food should be subject to sales tax with relief provided to low-income individuals via a refundable income tax credit.
• Income taxes - Since 1982, federal income tax law has denied operating deductions for a business of selling controlled substances (IRC Section 280E). The business can subtract cost of sales from its revenues, but not operating expenses such as utilities. While most businesses aim to treat expenditures as period costs rather than inventory costs, marijuana retailers would be incentivized to treat as many expenditures as possible as inventory costs so they can include them in cost of sales under the IRC Section 263A ("unicap") rules. [For more on this topic, see (1) IRC Section 280E, (2) Olive, 139 TC No. 2 (2012), and (3) "Federal Income Taxation of Medical Marijuana Businesses," by Professor Roche at the University of Denver law school, August 2013.]
  
  Query: Do the states that have legalized marijuana sales conform to this federal rule?
  
  Query: Will federal legislation pass to change 280E, such as H.R. 2240 that would make IRC 280E non-applicable in a state where sale of marijuana is legal? A problem with such legislation is that it would cause federal law to not treat all federal offenses the same given that the marijuana is a controlled substance under federal law.
  
  Query: How much will federal and Colorado income tax revenues increase due to sales by Colorado marijuana retailers?
• Practitioners - There seems to be an open question of whether a tax practitioner (particularly a licensed CPA or attorney) can assist a marijuana retailer with their tax compliance and planning, given that it is an illegal business, at least under federal law. Is there any ethical violation?

What do you think?

*For more on Prop AA, see Ballotpedia and Project Vote Smart.

Sales tax simplicity, equity and economic efficiency

The Texas Comptroller of Public Accounts publishes an interesting and informative monthly Tax Policy News. The March 2012 issue includes an article - "Spring is in the Air." It explains how Texas sales tax applies (or does not apply) to seeds, bulbs, trees, landscaping, stepping stones, pool cleaning and more.  The article is almost 2,500 words long. There are a variety of special rules depending on who is selling, the income derived, etc.

Here is an excerpt from the article:

"Dirt and Stepping Stones

Purchases of stone or rock that is cut, crushed or mixed with other products (such as processed soil, dirt, sand or gravel) are taxable as processed materials. But, purchases of unprocessed dirt, sand, gravel, stone, rock or similar materials are not taxable.

Dirt, sand, rocks and gravel that are merely sorted, sized, screened, washed or dried are not considered processed materials.

A person performing a taxable real property service, such as landscaping, may issue a resale certificate instead of paying tax on the purchase of processed materials that will be incorporated into a customer’s real property as part of the taxable service. See Rule 3.356 for more information about real property services. A person performing a nontaxable service must pay tax on processed materials.

A charge to a customer for unprocessed materials that are incorporated into the customer’s real property as part of a taxable real property service, such as landscaping, becomes taxable as part of the total charge for the taxable service. A charge to a customer for unprocessed materials that are incorporated into the customer’s real property as part of new construction (under either a lump-sum or separated contract), such as a rock wall, is not taxable. See Rule 3.291 for more information about contractors who add new improvements to real property."

Special rules, rules that are not intuitive (such as washed, dried and sorted gravel is not considered processed), and the need for long explanations of the rules, indicates a complex tax system. Special rules usually often create inequities where similarly situation taxpayers (or items) are not taxed similarly. Also, the exemptions do not seem to be aimed to serve the only two good purposes - a sale to a business or a necessity of life.  (Note - as I've often noted in this blog, a problem with exempting necessities of life, such as food, is that it provides a tremendous savings to higher income individuals who spend more on necessities.  Taxing them with some type of relief to low-income taxpayers, such as a refundable income tax credit or monthly subsidy would be better.)

How could these rules be simplified?  How about this for a statute:

Texas sales tax is imposed on all items sold to non-business customers. Such tax is to be collected and remitted by the seller.  Sellers must register with the state and will receive a tax identification number. Such number must be provided to sellers in order to receive a sales tax exemption. The only sales transactions not subject to sales tax are non-elective medical care and school tuition. Sellers with less than $10,000 of sales in the prior year may elect to remit sales tax on an annual basis either on a special sales tax reporting form or with their business income tax return.

With a broad base (although all business purchases would be exempt), the sales tax rate could be lowered. The above language could apply to any state, not just Texas.

What do you think?

Tax oddities and challenges of compliance

An article in BloombergBusinessweek - "Yoga Gets Off the Mat to Fight New York's Tax Man" by Caroline Winter (4/4/12), is a reminder that when tax rules are odd, such as having narrow exemptions or complicated definitions of what is taxable and what is not, it can lead to compliance problems. For example, when some narrow category of items becomes subject to sales tax, those providing the service might not know and when a rule is odd, people would not logically think that the transaction is taxable.

The article notes that some yoga studios in New York City were not aware that since last April (2011) they have been subject to the city's sales tax. Per the article New York City decided "that yoga studios be categorized as fitness centers, instead of movement spaces, and thus subject to a sales tax rate of 4.5 percent. (Dance studios aren’t taxed.) The change isn’t very new—it went on the books last April—but New York studio owners say they were never notified. That is, not until auditors started showing up in January and fining studios for back taxes for as much as three years."

An April 2011 Tax Bulletin ST-329 (TB-ST-329) from the New York State Department of Finance and Taxation, is a great example of how peculiar and laughable a poorly designed tax system can be. For example, it states:

"New York State makes a distinction between health and fitness clubs and athletic clubs. New York State and local sales taxes are imposed on dues and membership fees paid to any athletic club in the state. An athletic club is any club or organization whose material purpose or activity is the practice, participation in, or promotion of any sports or athletics (for example, a Judo club or curling club). However, a facility that provides steam baths, saunas, rowing machines, or other exercise equipment, or that promotes exercising solely for health or weight reduction purposes, as contrasted to sports, is not considered to be an athletic club."

It seems a bit odd that both activities are described as a "club" and involve physical activity, yet taxed differently. 


So, it is not the state of New York that is taxing the yoga salons, but New York City.  Some states and their cities do not have the same sales tax base making compliance even more difficult for vendors!  Per the 2011 Tax Bulletin:


"New York City imposes its local sales tax on every sale of services by weight control salons, health salons, gymnasiums, Turkish and sauna baths, and similar facilities, including any charge for the use of these facilities. This tax does not apply to any of these facilities located outside of New York City. Therefore, dues, membership and initiation fees, and any charges paid for the use of these facilities located in New York City are subject to the New York City local sales tax. However, if a facility also provides access to participant sporting activities and facilities, such as a swimming pool or racquetball courts, to its members, the facility is not considered to be a weight control salon, health salon, gymnasium, or other establishment for New York City sales tax purposes"

Wow!

How to simplify?  Apply sales tax to all goods and services consumed by individuals as final consumers and lower the rate.  Perhaps some necessities should be exempt such as non-elective medical services.  I suggest taxing food and finding another way to provide relief to low-income individuals such as through a refundable income tax credit or provision of debit cards for use throughout the year (ideally attached to the cardholder's bank account including accounts paid for by the state). The reason is that higher income taxpayers spend a lot more on food so exempting it provides a big tax break to individuals who do not need it.  With this design changes, we would not have oddities of knowing whether a yoga class or health club dues are subject to tax - they would be because purchased by a consumer.

What do you think?

More - see 21st Century Taxation website - here.

Cloud computing and tax issues

A recent article (3/28/12) in CIO - "Cloud services face taxing dilemma" by Brandon Butler, points out the continuing challenges in determining if sales tax is owed on any variety of transactions that occur in the cloud. This is an area where state tax laws, based on 20th century ways of living and doing business, are mostly inadequate to address cloud computing. I say that with two perspectives in mind: (1) the law is not clear whether the cloud transaction is subject to the state's sales tax, and (2) the law is clear (such as in California) that because the transaction does not involve tangible personal property it is not taxable, but lawmakers need to update their tax laws to prevent their continued erosion as taxable tangible property transactions convert to intangible transactions. And, I want to stress that I believe good tax policy calls for broadening the sales tax base to only cover purchases by consumers, not by businesses.

In Febraury 2012, the Utah Tax Commission issued Ruling 10-011 on "Sales Tax Treatment of Web-Based Remote Access Services."  Under Utah law, which primarily applies sales tax to sales and transfers of tangible personal property also includes these elements:

• ""Sale" includes: . . . . (v) any transaction under which right to possession, operation, or use of any article of tangible personal property is granted under a lease or contract and the transfer of possession would be taxable if an outright sale were made."
• ""Tangible personal property" includes: . . . . (v) prewritten computer software, regardless of the manner in which the prewritten computer software is transferred."
• ""Tangible personal property" does not include a product that is transferred electronically."
• "Notwithstanding any other provision of this section and except as provided in Subsection (12)(b), if a purchaser uses computer software and there is not a transfer of a copy of that software to the purchaser, the location of the transaction is determined in accordance with Subsections (4) and (5)."

The tax agency concluded that "The Web Services sold for fees to Subscribers located in Utah are subject to Utah sales tax under § 59-12-103(1)-(1)(a), as “retail sales of tangible personal property made within the state.”"  The agency noted that the software is "off-the-shelf" and use of the software is transferred to customers.  The agency found it not to be a non-taxable service because the "Company is not using the proprietary software to sell services."  "Subscribers are paying for the use
of the proprietary software not for services provided by the Company."

And they said: "Our conclusion is not based on your position that the Company does not sell or license software or other tangible personal property to its Subscribers, and that Subscribers cannot access the Company’s internal software for any functional purpose, including modifying code, creating documents, or manipulating files. The Company is still selling the use of the proprietary software even though it is not transferring that software to the Subscribers. Utah Code § 59-12-211 was enacted to address situations such as the one presented for this ruling."

I highlighted the statement above in bold. I think this ruling seems weak, but represents the tax agency doing its best to fit something that appears not to be a transfer of anything.  They call it a transfer of use, but unlike a typical transfer, the customer has nothing that it can transfer to someone else. If I buy a book, I have something I can transfer to someone else.

The sourcing rule above (last bullet) seems to offer support, but that is a sourcing rule. Does the tax base law support that a taxable transfer occurred?

A solution? States should modify their sales tax laws to say that anything - services, use, property (tangible or intangible) acquired by a non-business consumer is subject to sales tax. This would eliminate the need for tax agencies to squeeze modern transactions in and reduce risk of litigation. Lawmakers could carve out any exemptions they think warranted, such as perhaps non-elective medical care.  I would not even suggest they exempt food because it is too big of a benefit to higher income individuals who spend a lot more on food than low income individuals. A refundable income tax credit could be used to provide relief to low-income individuals or to provide the relief on a weekly basis, funds could be deposited into a bank account that has a debit card associated with it, which would also help reduce issues faced by the "unbanked."

What do you think?

Sales Tax Exemptions - outdated and inequitable

An editorial in The State (South Carolina) on March 27, 2011 - "Overhaul broken tax system" points out problems with the numerous sales tax exemptions. These are problems in many states including California. The paper points out that South Carolina has 85 exemptions that end up exempting more items from sales tax than are subject to it. One special rule that I had not heard of before, but is quite inequitable is that the sales tax on cars is capped at $300 of purchase price. So a college student who struggles to buy a used car for $6,000 pays the same amount of sales tax as a high-income individual buying a $73,000 Jaguar (at 5% tax rate, they both pay $300 of sales tax on the purchase).

This seems odd and is something that the South Carolina Tax Realignment Commission proposes phasing out. Per their December 2010 final report, "The cap, entirely appropriate and necessary in 1984, 26 years later, represents one of the most regressive aspects of the State‘s entire sales and use tax code today." The cap was added years ago because neighboring North Carolina had one.

The editorial notes other problems with the South Carolina sales tax: "The tax that was created when we spent nearly all of our money on things hasn’t kept up as we became a service economy. Between the untaxed services and all those product exemptions, a full 72 percent of gross sales in our state go untaxed. The result is a sales tax that doesn’t grow with the economy, that forces poor people (who buy mostly things) to pay a far higher portion of their income than wealthier people and that is much higher than it needs to be. As the Legislature’s own Taxation Realignment Commission found, we could easily reduce the sales tax by a penny or two simply by expanding the reach of the sales tax more in keeping with other states."

This is true for California as well. We could broaden the base and lower the rate and use some of the money to create an exemption for businesses to avoid pyramiding of the tax. For more on this, please see my reports and op eds here.

What do you think?