Need to further lower CA sales tax rate - Mercury News op-ed

I'm pleased to have an opportunity today to share my perspective on the need to fix the California sales tax by lowering the high rate and broadening the narrow base. This will enable the tax to meet principles of good tax policy and support business activity in the state.

The op-ed is in the San Jose Mercury News (7/24/11) - "Lower the sales tax - but reform what does and doesn't get taxed."

Taxing Services - Michigan

An article today in the Detroit Free Press says that Governor Granholm has given up on a tax reform plan to extend the sales tax to services and lower the rate. That is too bad.

In 2007, the Michigan legislature did extend the sales tax to specified services, but then repealed it the day it was to go into effect (see prior post). Problems with that original proposal included:

• There was insufficient transition time for the law to take effect - just 2 months. That is not enough time for the tax agency and the businesses, such as palm readers and house sitters, to get ready to collect the tax. So, unfortunately, the initial legislation was really written with a time bomb that would lead to repeal - that was unfortunate. More time should have been given before implementation and funds allocated to help both the tax agency and the new tax collectors get ready.


• Do not tax services primarily used by businesses. Businesses should not pay sales tax, only final consumers. This prevents pyramiding of the tax where businesses add it to their costs and consumers pay tax on that amount. While most of the services identified in 2007 were personal ones, there were others, such as landscaping, also consumed by businesses.


• The base expansion was not accompanied by a rate reduction !!
  

The purpose for expanding the sales tax base is to tax all personal consumption (with limited exceptions, such as for basic health care and education). This makes the system more equitable. The law is inequitable when for example, it taxes a music CD, but not an iTunes download or concert ticket. And worse, some of the exempt consumption is by high income taxpayers (personal trainers, concert tickets, downloads requiring broadband access, etc.).

It is also important for lawmakers to squelch the loud but misplaced arguments that the tax will hurt small businesses. Small businesses that sell tangible personal property have been collecting sales tax for decades and surviving. The collection process won't hurt small businesses and the initial implementation costs should be subsidized with a refundable income tax credit. And, tax agencies should be required to find simple ways for companies to comply.

I've written about this for some time now. It is an issue that California needs to address as well. California should broaden its sales tax base to tax more types of personal consumption while lowering the rate and removing the sales tax paid by businesses to remove pyramiding. For more - click here ("tax base is too narrow").

What do you think?

Colorado and Taxing Software - California should do almost the same

On February 24, 2010, Colorado enacted HB 1192 which changes the way sales tax applies to software. Prior to this bill, Special Regulation 7 provided that software transferred electronically or provided by a service provider or obtained via "load and leave" is not subject to sales tax. A similar approach applies in California (Reg 1502) under the assumption that an electronic transfer is not tangible personal property.

HB 1192 repeals Special Regulation 7 effective March 1, 2010. HB 1192 clarifies that it "is not intended to alter, other than the designation of standardized software as tangible personal property, the tax treatment of what is known in the industry as "digital goods", "application service providers", "software as a service", or "cloud computing". Nothing contained in said House Bill 10-1192, including the repeal of Special Regulation 7 or the requirement that tax be apportioned in the case of a business purchase of software for its own users operating both within and outside of the state, shall be read as expressing the general assembly's intent regarding the treatment of such methods of transacting business."

I think California lawmakers should consider a similar change in California. Our current system of only applying sales tax to software obtained on tangible media violates equity and neutrality principles. For example, the tax rules do affect how you'll want to acquire software if one technique is taxable (buy the CD version) and one is not (digital download). Yet, the end result is the same - you have use of the software.

Taxing the electronic download does raise some issues though. When a customer does a digital download and pays with a credit card, the seller has no idea where the person is located UNLESS they ask and the person gives the correct answer. It is not problem to ask - that can be down on the payment webscreen. The legislation should provide that the vendor can rely on the answer given by the customer without liability. If the customer gives wrong information - they should be the ones penalized.

Another modification California should consider is to say that only software obtained by a final consumer (not a business) is subject to sales tax. California needs to start moving its sales tax to only apply to final consumption, not consumption by businesses.

California should go beyond software and tax all digital goods unless purchased by a business. With the provision that the seller may reasonably rely on information from the purchaser as to their location.

Looking for more information - click here.

AB 1178 Sales Tax Exemption on Textbooks - Wrong Way to Go!

AB 1178 has passed in the Assembly and gone to the Senate. This is too bad for good tax policy. AB 1178 includes a state level sales tax exemption for textbooks and supplies purchased by a student of a UC, CSU or community college between July 1, 2011 and December 31, 2014. [Click here for Board of Equalization analysis of AB 1178.]

The problems:

1) Makes the tax laws more complex: Can you imagine the complexity involved? Stores will have to verify that the buyer is a student in a public higher education institution and that the items are for school. And the store must still charge the local sales tax. This really complicates compliance for sellers of books and supplies - and that's a lot of businesses (college bookstores, Office Depot, 7-11, Costco, Borders, Safeway, etc.).

What if a student at a private college also takes a course at a public university? They will have an ID card from the public university. Is the store required to review their course syllabi or get a note from the professor to verify what is required for a class?

What if the supply is an iPod which will also be used personally?

This is NOT the way to write a tax law. Whenever there are special exemptions, rules are needed to define who gets that exemption and what exactly is exempt. That is complicated for both vendors and tax administrators.

2) Savings might not all go to the student: While the sentiment behind the bill - reduce cost of textbooks sounds good, it won't work. When stores are setting their prices, they are most likely to factor in that the students won't have to pay state sales tax on the item, so they can increase the price of the textbooks a bit.

3) Equity issue: Many students can easily afford textbooks and sales tax. This partial exemption doesn't factor in the income of the buyer. So, even wealthy students get a tax break.

4) Not needed: Students usually have lower cost options for acquiring books. Many find great deals online. Often they can buy a used book. They might also share a book and some schools have book rentals. Also, if a student in California gets an electronic copy, our sales tax already exempts that book (which is a flaw in the law).

5) Dishonest budgeting: This is deceptive by lawmakers. If they are concerned about costs for students in public higher ed, they should increase the funding that goes to these organizations so that fees do not need to be increased as much, so students can graduate earlier because more courses can be offered, etc. When lawmakers already control the funding of higher ed, there is absolutely no need to create a complicated, inequitable and unnecessary tax rule to reduce costs for students. They should use the budget line item instead.

I hope this bill is defeated by the Senate and if not, is vetoed by the Governor. Let's not make the California tax system worse than it needs to be and let's encourage legislators to reduce costs for college students by increasing funding for the UC, CSU and community colleges by an amount equal to the estimate of the tax dollars that would be lost from this inappropriate exemption.

Note: At least 9 states have exemptions for sales tax. I found a list at the Barnes & Noble website, which also includes instructions to student buyers that indicates the compliance complexity of such an exemption - here (see bottom of the bn.com page).

What do you think?

Stuck in the 20th Century - California's New and Very High Sales Tax Rate

Part of the plan to balance California's budget involves temporarily increasing the state sales tax rate from 6.25% to 7.25% starting April 1, 2009 (changed by ABX3 3). The new rate is really 8.25% because of the longstanding 1% local rate imposed statewide. And many local jurisdictions have district sales taxes that make the rate even higher. In San Jose, the new sales tax rate will be 9.25%. The highest rate will be Southgate where it will soon become 10.25%!

These are really high tax rates! California now has the highest sales tax rate (moving up from a tie for 8th place; see FTA comparisons). This is not a good contest to win!

Yes, California needed to balance a budget that had a $40 billion shortfall. The sales tax increase was not the place to get the money though although it probably seemed like an easy place. This high tax rate will mostly hurt:

• Low income individuals - The sales tax is regressive; that is, it represents a greater percentage of the income of a low income individual relative to a higher income individual
• Businesses - Unlike many states, California does not offer any sales tax exemption to businesses for the purchase of manufacturing or R&D equipment. We were not a business friendly state before the sales tax increase and we remain an unfriendly place. This sales tax increase makes it even more unlikely that businesses will want to expand in or relocate to California. That will hurt our economy now and going forward.

A much better way to go for a sales tax change would be to broaden the tax base and lower the rate. There are many reasons for this change including equity. Today, many of the consumption items not subject to the California sales tax are mostly consumed by high income individuals. This includes personal services (such as a trainer), health club dues, digital downloads (higher income individuals are more likely to have access to broadband than other individuals have), and tickets to entertainment and sporting events. Why exempt consumption of high income individuals and instead tax the consumption of lower income individuals?

For more on this topic, please see my paper - here. On 2/12, I had the opportunity to share that paper and some brief testimony with the Governor's Commission on the 21st Century Economy. There was a lot of testimony about why we can't expand the sales tax to apply to more types of services we consume. Many of these arguments just don't make sense. Thus, they translate to an argument that we just cannot improve our tax system if it means that some businesses will have to start collecting sales tax. I doubt sellers of tangible personal property who have always collected sales tax would be too sympathetic. I'll note four of the arguments made and their shortcomings:

1. A tax on services failed years ago in Florida. Well, why did it fail? It was taxing services used by businesses which should NOT be done. That leads to pyramiding, and creates challenges of figuring out where the tax should be imposed when the services likely involved more than one state. Let's stop letting this argument be raised and instead help policymakers to understand why sales tax should not be imposed on businesses. A broadening of the sales tax base to include more services should focus on personal services (beauty salons, personal trainers, animal care, etc.)
2. It will hurt small businesses because large businesses won't want to use their services if they are taxed because the large business can instead hire an employee to provide the services and no sales tax would be owed. Well, there are two strong counterarguments to this one: (i) we should not collect sales tax from businesses (see (1) above). (ii) for decades, small businesses that sell goods have also run the risk that large businesses will just decide to produce the goods in-house to avoid sales tax (although they may have to pay tax on the raw materials). Why all of the sympathy towards service providers and none to sellers of taxable tangible personal property?
3. Consumers will just go out of state to get the services to avoid the sales tax. Again, base broadening should be to personal services, not those consumed by businesses. People are not going to go out of state to get a hair cut or their pet groomed.
4. It's too complicated to collect sales tax and file the forms. Well, sellers of tangible personal property have been managing to collect and remit for decades. Also, there are simplification techniques that should be implemented for all small businesses. The federal model of how most emplyers of household employees handle their employment tax payments is a great example (it is done right on the income tax form and just once per year). Small businesses should be allowed to include the sales tax on their income tax form and quarterly estimated income tax payments, for example. Also, the state should create a refundable credit to help businesses that become subject to collection to cover their start up costs (new software, training, etc.).

Hopefully the commissioners will take a careful look at how out of date our sales tax is and make the changes that will bring it into the 21st century ways of living and doing business - where we have converted some tangible goods to digital ones and where we consume more personal services and entertainment than we did in the 1930s (likely due to 2-earner families and greater disposable income). AND - let's lower the rate to make the California sales tax a more equitable tax. Eventually, let's work towards eliminating pyramiding (a good start would be to exempt R&D equipment from the sales tax).

What do you think?