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Wednesday, March 10, 2010

Sales tax exemption complexity

I find it amusing to read explanations of sales tax exemptions in the California Board of Equalization monthly newsletter. The March 2010 newsletter includes a short article reminding readers that "toasted sandwiches are taxable."

Generally, food purchased at the grocery store is non-taxable. The rationale for this exemption is that food is a necessity of life. But, food prepared for on-site consumption, such as at a restaurant, is subject to sales tax. At a grocery store (and other places), issues can arise because you might pick up a prepared sandwich to eat at the tables that some stores have in their deli section or you might be taking it home to eat later, just like the small carton of yogurt you also purchased. But, if the food is given to you at a particular temperature, it is assumed it is for consumption right then and is probably taxable.

The article reminds readers:

"A food product is considered a hot food product if it is heated to a temperature above room temperature (for example, grilling or toasting a sandwich, dipping a sandwich in hot gravy, or using infrared lights, steam tables, or microwave ovens)."

But, we can't judge taxability by temperature alone because, of course, there are exceptions and special rules. For example, the article also notes:

"Sales of hot bakery goods are not taxable when sold to go, unless they are sold as part of a combination package. For example, a combination of hot coffee and a doughnut for a single price is taxable because the combination package includes a hot food or hot beverage."

This is all a reminder that when items are carved out of the tax base, such as food not being subject to sales tax, special definitions are needed, such as to define "food." Also, lawmakers have a tendency to say, "well, we don't want to exempt the whole large category of items" and they write exceptions. This all helps keep tax practitioners employed, but is bad tax policy.

It would be simplest to tax all consumption by individual consumers and provide relief, such as for necessities of life and the regressive nature of the sales tax, via a refundable income tax credit. This makes the law simpler AND more equitable. While food is a necessity of life, higher income individuals buy more of it and at higher prices so the relief is skewed to provide greater tax savings to taxpayers who don't need the relief. For more - click here.

If you read my post of March 8, you might think I'm being inconsistent in my perspective on the value and need for exemptions. In that post (here), I noted that California should create a sales tax exemption for manufacturing and R&D equipment purchased by businesses. But that is due to a different reason. A sales tax should only tax final consumption by consumers; businesses should be exempt. This easily happens with a credit invoice VAT, but no state does it completely for the sales tax. There is no complexity with the sales tax exemption for all business purchases because we know what a business is and they are registered as such with various state agencies. When a business makes a purchase, no sales tax is charged. If the buyer is not a business, sales tax is charged.

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