California Lawmakers Miss Opportunity to Help Low-income Parents

Despite better ideas on how to truly help low-income parents of infants, California lawmakers took a route this July that spends a lot of money but doesn't sufficiently help the group in need of assistance. Why does this happen? There is plenty of data and a 2019 report from the Legislative Analysts Office pointing out that their law change won't provide as much help as it could have if better designed.

I'm talking about what started out in 2019 (SB 92, Chapter 34 (6/27/19)) as a two-year exemption (2020 and 2021) from sales tax for infant diapers and menstrual products. The state was required to transfer the lost revenue to local governments. SB 92 also required application of the accountability provision at Revenue & Taxation Code section 41 for the LAO to measure the effectiveness of the exemption in meeting the stated goal of promoting public health by increasing the affordability of and expanding access to diapers.

Prior to its expiration and before the LAO could complete its analysis, lawmakers extended the exemptions until July 1, 2023 and extended the due date for the LAO report to 7/1/22. (AB 85 (Chapter 8, 6/29/20)). Now, with AB 150 (Chapter 82 (7/16/21)), lawmakers have made the diaper and menstrual product exemptions permanent and cancelled the LAO report on the effectiveness of these exemptions.

I wrote about the weaknesses of the infant diaper sales tax exemption in 2019 (8/3/19 post), but repeat the highlights due to this recent example of missed opportunity to really help individuals in need which would end up benefitting us all via healthier babies, greater funds for low-income individuals, and less missed work.

While it may sound good to say you are helping public health and helping to make infant diapers more affordable, we need to ask more questions and apply critical thinking. In my earlier post, I noted that diapers cost between 11 cents per diaper up to 49 cents per diaper. Likely, the more expensive diapers are purchased by parents with more funds who don't need the sales tax savings (roughly 9 - 10% of the purchase price) and likely don't even notice the savings.* 

How much does this cost the state in lost revenue? Per the 2021-2021 tax expenditure report of the California Dept. of Finance, $76 million per year!

Prior to original enactment of the diaper exemption, the LAO told lawmakers that if they really wanted to help low-income families, providing greater subsidies to child care would be better. Per this 2019 report:

"the state can expand a program that addresses one of the biggest expenses parents face: child care. The state funds various types of subsidized child care for low-income families, but the number of eligible children typically exceeds the number of “slots” funded by the state. Due to this shortfall, the state fails to assist part of the targeted population and creates an inequity between those who receive slots and those who do not."

So, why isn't the $72 million per year used to really help low-income parents of infants? 

I think it is because we aren't asking enough questions such as: 

Which income group of parents gets the biggest savings from this tax break? It is the higher income taxpayers who spend more money on diapers and don't need the assistance (wasted spending).* Why are we subsidizing folks who don't need a subsidy?

Will reducing the cost of diapers by the 9 to 10.5 cents of sales tax per dollar help low-income individuals? Of course it offers some assistance, but we still have diaper banks in California and many struggle to pay the sticker price, not just the sales tax. 

What would provide better, more targeted help? Use the $72 million to help those who need it rather than those who do not. Provide diapers to child care centers who serve low-income workers.  I read a report last year on diaper banks for a Tax Notes State article on the need to fix the sales tax base. I learned that some parents get turned away from the child care center if they did not bring diapers for their child so then have to miss work to stay home with the child. Why not use $72 million to prevent this?

Why make the exemption permanent before its expiration date and before getting the analysis from the LAO on the effectiveness of the exemption?  Again, we all need to demand greater accountability from lawmakers regarding spending.

*I recently learned from reading an excellent book that I highly recommend reading (and hope all lawmakers read it) - Broke in America: Seeing, Understanding, and Ending US Poverty (2021), that some low-income individuals do end up spending more on diapers than would be charged if buying them in bulk from a big box retailer because they might not live near such a retailer and/or they don't have a lot of funds at once so buy the smaller package where the cost per diaper is higher.  Again, this calls out for doing better with taxpayer dollars than occurs with the now permanent California sales tax exemption on infant diapers.

What do you think?

Would Broader Sales Tax Base Deliver Simplification? Yes!

I've got a tax policy post originally posted on SalesTaxSupport.com on complexities of numerous exemptions to sales tax bases. I just pull a few recent rulings from New York as illustration of the complexity, but it exists in all states.  .

A broader base will also allow for a lower tax rate.

A review of a few recent sales tax advisory opinions issued by the New York State Department of Taxation and Finance, remind us of the complexities of sales tax exemptions and special definitions of taxed items. This is an issue in most states with a sales tax. For example, you likely have heard of recent issues as to whether hot coffee to go is subject to sale tax, and litigation on this issue in some states. New York makes its advisory opinions easily accessible on its website which makes it easy to "pick" on New York as an example of sales tax complexity. New York also taxes more than tangible personal property which increases the likelihood of tax base questions. For example, New York taxes furnishing of information and some services.

Following are brief summaries of four rulings issued in April and May 2016.

·         TSB-A-16(13)S (4/26/16) - Sales tax applies to taxpayer's fees charged for high intensity interval training fitness classes, as well as fees to enter weight loss challenges, offered at facilities in NYC. While the taxpayer is not selling taxable dues or membership fees to an athletic club or taxable personal training servicfes, it is selling services of a weight control or health salon which is taxable in NYC.

·         TSB-A-16(14)S (4/27/16) - Sales tax applies to cookies sold in any of three ways: (1) for immediate consumption, (2) in to-go boxes holding rout to a few dozen cookies, and (3) cookies to be delivered. "Whether Petitioner sells cookies in small quantities in its stores, in larger quantities in to-go boxes or delivers cookies to customers, the cookies are always sold in a heated state. Thus, pursuant to Tax Law § 1105(d) and 20 NYCRR § 527.8, Petitioner’s receipts from the sales of cookies are taxable, whether sold for on-premises or off-premises consumption."

·         TSB-A-16(19)S (5/20/16) - Data storage services found not subject to sales tax. This is not the sale of software or an information service or storage of tangible personal property. Thus, it doesn't fall under the taxing statute.

·         TSB-A-16(17)S (5/2/16) - This involves an uncommon fact pattern. A Florida LLC entered a purchase agreement with a New York art dealer to purchase a sculpture being created in Germany. Taxpayer also entered an agreement with a NYC museum, an exempt taxpayer, to display the sculpture and arrange for its transportation from Germany. The museum would cover transportation and insurance. While that constitutes consideration to the taxpayer, no sales tax was owed becuase the taxpayer is a nonresident and the museum has an exempt organization certificate. Also, taxpayer took possession of the sculpture in Germany so there was no transfer in New York.

This is just a few of the rulings released in April and May involving sales tax. These rulings indicate that the New York sales tax law does not meet the certainty or simplity principles of good tax policy. Clearly, the taxpayers asked for rulings because the law was not clear. Each ruling involved a few statutory definitional provisions where it was not obvious how they applied.

A possible solution to the certainty and complexity issues is to follow an approach more common to VAT. Apply sales tax to every transaction where some type of compensation is received from a customer for the acquisition of goods or services, as broadly defined. If the buyer is a business, when they file their sales tax form, they also list the sales tax they paid and it offsets the sales tax the business collected. The difference is submitted to the government. If the business paid more sales tax than it collected, the government sends a refund of the difference.

The law would be easier to apply because no definitions would be needed for the sales tax base because everything sold would be taxed. Rules would be needed to define business and business use, sourcing (to determine, for example, where the sale of the sculpture took place), and administrative/compliance procedures. Also, the base would be broader than we have today enabling states to lower their sales tax rate making the tax less regressive.

What do you think?

Narrow exemptions cause inefficiency, inequity and complexity - HR 867 and S. 1179

H.R. 867 and S. 1179 (114th Congress) propose to modify IRC Section 263A(f) on interest capitalization to add an exemption to the rule. It would read:

“(5) EXEMPTION OF NATURAL AGING PROCESS IN DETERMINATION OF PRODUCTION PERIOD FOR DISTILLED SPIRITS.—For purposes of this subsection, the production period for distilled spirits shall be determined without regard to any period allocated to the natural aging process.”

The current interest capitalization rule was added as part of the Tax Reform Act of 1986. The logic is that if a taxpayer is producing a tangible item, such as inventory or a building, it must identify all of the costs incurred that relate to that item. Those costs are to be capitalized rather than currently expensed. These costs include direct materials and labor and many types of indirect costs. If the producer borrowed money to aid the production process, the interest expense incurred during the production time period is yet one more indirect cost to capitalize. The rules to compute the interest are complex because the producer must identify both traced debt and avoided cost debt.

The rule at Section 263A(f) does not apply to all production though. The rule only applies to property produced that has:

1. a long useful life, or
2. an estimated production period exceeding 2 years, or
3. an estimated production period exceeding 1 year and a cost exceeding $1,000,000.

In TAM 9327007, the IRS ruled that the time that wine was aging in the bottle was considered part of the production period such that if it took over two years, interest capitalization was required. 

S. 1179 is sponsored by Kentucky Senator Mitch McConnell. In a 5/4/15 press release, he notes some interesting statistics about bourbon production and his state:

“Kentucky produces 95 percent of the world’s Bourbon supply. Over 15,000 jobs in Kentucky are attributed to the Bourbon industry and it brings in billions of dollars to our state’s economy. This legislation will not only put Kentucky’s Bourbon industry on a level playing field with its competitors, but it is a pro-growth measure that will also help provide a boost to our economy and help create jobs in Kentucky.”

If interest capitalization has such an adverse affect on the bourbon production industry, it would seem that it has a worse affect on the much larger U.S. wine production industry (particularly red wine that requires longer aging).

So, why only pull bourbon from the interest capitalization rule?  Why not just repeal the rule if it is that burdensome?

When one item is singled out for different treatment, problems result:

1. Inefficiencies - one industry is favored over others; the law violates the principle of neutrality and support of economic growth.
2. Inequity - why should a bourbon producer not have to capitalize interest expense but a red wine producer (and likely other producers of alcoholic beverages) have to, even if they are the same size business?
3. Complexity - it can be difficult and take many words and sometimes litigation to determine exactly what falls under the exemption. When a rule applies to all transactions, it is easier to apply.  If the rule itself is complex for everyone, it should be redesigned or repealed.

No doubt, our Senator Majority Leader is well-intentioned in his effort to help a key industry in his state. But why be so narrow and violate principles of good tax policy?  While his proposed change will score as a revenue loser over ten years, it is really just about timing - when is the interest expense deducted (when incurred or only when the bourbon is sold).  And, the rest of Section 263A should be reviewed as part of comprehensive tax reform, particularly regarding its application to inventory. Inventory practices have changed since 1986 and the provision likely isn't needed today as companies use just-in-time inventory practices.

What do you think?

Boundless Sales Tax Exemptions

I noticed that a law enacted recently in Utah created their 75th sales tax exemption.  That is quite a lot of exemptions. Not to pick on Utah though because most states likely have that many or more. Exemptions usually mean the need for detailed guidance on what exactly that exemption is. Utah's 75th one is for fuel cells, which they have defined in another statute and use that same definition for the exemption (which is better than creating a new definition).

I have a post at SalesTaxSupport.com with more about the exemption and policy considerations for exemptions. I also note that it was not clear why the exemption was added. I was unable to find anything from the sponsor or in the legislative record (another common problem with exemptions - there should be a reason given for why something that was subject to sales tax should no longer be subject to sales tax).

A reader offered the possible explanation that eBay planned to build a fuel cell powered data center in Utah (BloombergBusinessWeek, "EBay's Bet on Fuel Cells Will Influence Data Centers," by Adam Lesser, 10/31/12). Not sure if the timing of that with the new exemption that started April 1, 2013 is right, but it seems likely that to further encourage use of fuel cells that reduce emissions and air pollution, the sales tax exemption was added.

As I often note in my posts, sales tax should not apply to business purchases in order to avoid pyramiding of the tax. But, since this policy is not followed by the states (and is difficult to flat out implement since about 1/3 of sales tax revenues comes from business purchases), lawmakers occasionally expand the list of sales tax exemptions, as was just done in Utah, to address isolated, perceived needs.

Please check out the post for further policy discussion on sales tax exemptions.

What do you think?  Should exemptions have stated reasons for them included in the legislative proposal? Should they be forbidden? Should states just work toward exempting all business purchases?

Sales Tax Oddities - Food

A recent ruling in Florida is a reminder of the lack of logic and transparency in some of the special rules and exemptions common in sales tax laws. The question asked of the Florida Department of Revenue was when salad bar items and baked goods would and would not be subject to sales tax.

In Florida, as well as several states, if the food item is prepared for consumption on the premises (such as at a restaurant), sales tax applies. So, what about when your grocery store has a salad bar? Does it matter if a customer eats it in store, in the parking lot, at home?  Not really. It depends on whether the person could eat it in the store, such as because there are tables and chairs by the salad bar. Does it matter if the store also gives you a fork?

Well, if you could eat your salad at the store, sales tax must be charged. Per the ruling:

"Taxpayer’s sales of salad bar items are taxable at the two stores that have tables and chairs because these items are prepared foods sold for immediate consumption. Sales of salad bar items at the store that does not have tables and chairs are exempt when packaged without eating utensils."

And here are the rulings regarding deli items prepared on the premises as well as baked goods:

"Deli Salads. Taxpayer’s sale of deli salads (i.e., chicken, tuna, egg, and potato) is taxable because the salads are not prepared off the premises and sold in the original sealed container. The exception for prepared food sliced into smaller portions provided in s. 212.08(1)(c)9., F.S., does not apply because the repackaging of the deli salads by store employees does not involve slicing."

"Bakery Products. Taxpayer’s sales of the bakery products are exempt, since they are packaged in a manner consistent with an intention by the customer to consume the products off the seller’s premises."

It would be much easier and more transparent* to either tax all food or none of it. When there are exceptions and special rules, then the tax agency needs to define the exemptions, issue rulings and publications, and confirm compliance via audits. And, taxpayers are confused because it seems that the end result is the same whether or not there are tables, chairs or a packaged fork - they get to consume the salad.

* transparency - when taxes apply and how they apply should be clear. No hidden taxes.

For the ruling, see FL Technical Assistance Advisement – TAA 12A-021 (9/13/12).

What do you think?

The oddities and complexities of tax exemptions

A simple tax system would define the tax base and not have exemptions. When something(s) get carved out for different treatment, it is usually difficult to define that carved out item. Same thing when something is going to be taxed at a different rate. Two recent examples.

1. On March 6, 2012, the Missouri Supreme Court issued a ruling in Aquila Foreign Qualifications Corporation v. Dept of Revenue, No. SC91784. Aquila is a utility company selling electricity. One of its customers is a convenience store that also prepared food. The store tried to avail itself of a special sales tax exemption for processing so that it did not have to pay sales tax on the electricity used to prepare the food. The court upheld the Department of Revenue's denial of the exemption.  Per the court, the legislature "did not intend the term “processing” to include retail food preparation."

2. An article in the February 2012 Texas Tax Policy News explains the differences in definitions for "tangible personal property" and "motor vehicles" and how the sales tax exemption for "agriculture" equipment and the "motor vehicle tax agriculture exemption." operate.

Treating property, transactions, and activities the same broadens the tax base, allowing for lower tax rates. It also reduces compliance costs. But what about desires to incentive some activities or address spillover costs, such as are associated with R&D? Find the best way to define the activity. For example, if there are existing laws, such as patents, consider that. For example, allow a tax credit for the costs of patenting technology.

What do you think?

The Bagel Tax

A few stories have been published this week about New York enforcing it sales tax on certain types of food. The food of focus - bagels. When is a bagel subject to sales tax? The answer is that if it is sliced, it is taxable, and if not sliced it is not taxable. The rationale seems to be that if sliced, it is like taxable restaurant food and if not sliced, it is non-taxable food. But, it all sounds "wacky" - see Forbes article, "Wacky Sales Tax Rules Cover More Than New York Bagels," by Janet Novack (8/25/10). Also see Wall Street Journal, "Sliced Bagels, Taxes on Top," by Jacob Gershman, 8/24/10.

Complexities and oddities easily arise when something is going to be excluded from tax or taxed differently. When a subset of items or activities is exempted, it becomes crucial to define what is taxed and what is not and that is not always an easy thing to do. It would generally be better to not have any exemptions, such as by taxing all food, and then providing relief to low income taxpayers with a refundable income tax credit.

What do you think?

Exemptions that are too broad

An article in The Atlanta Journal-Constitution on June 2 - "Tax breaks for seniors: Can counties afford them?" caught my attention. The tax break at issue is not uncommon and exists in California. The exemption is for property taxes and is available to seniors. In California and other states, the assessment that seniors are able to avoid are extra property tax assessments to help fund local schools. One way these voter approved assessments can garner more votes is by including an exemption which allows seniors to apply for an exemption from the new tax so they don't have to pay it (even if they voted for the new tax). A property owner only needs to be a certain age and file the paperwork to get the exemption. Even if the senior is wealthy, he gets the exemption. (Another example in California of an exemption that is too broad is the senior exemption for state income taxes which is based on age rather than income level.)

The Atlanta article notes the high cost to the government of such exemptions: "In Cobb County, where the school system faces a $126.7 million deficit, there have been rumblings of re-evaluating the county’s lenient school tax exemption, which provides a full exemption for all homeowners age 62 and above and costs the county more than $50 million a year. "

Wow! That's a lot of money that would certainly benefit the schools. And, if all taxpayers were subject to the tax equally, the tax could be lower.

Exemptions based solely on age are the wrong way to go. Decades ago, many seniors were in poverty status, but that is not true for most today. So, broadly assuming that all seniors need a tax break is just wrong, and a foolish way to design a tax system.

When exemptions are too broad, several principles of good tax policy are violated, most notably - equity and fairness.

Another issue with the property tax exemption for seniors, when the tax comes into existence via voter approval: Is it right to treat a tax as enacted if some of the people voting for it then file forms to waive application of the tax to themselves? Seems like filing of the application could be viewed as, in effect, really being a "no" vote. In California, that question requires a review of "Prop 218."

Comments?

Washington to Remove Exemptions for Candy and Bottled Water

SB 6143 signed into law by Governor Gregoire on April 23, 2010 includes several provisions that will generate additional revenue for the state including an economic nexus standard for income taxes. [See Washington Legislature site on SB 6143 and Deloitte summary for more information on the entire bill.]

SB 6143 also removes the sales tax exemption for candy and bottled water. Washington, like most states, does not apply sales tax to most food items. Generally, this is done so that the tax doesn't apply to "necessities of life." However, as noted in this blog and 21st Century Taxation reports, this is a poorly targeted exemption because high income individuals spend a lot more on food than do lower income individuals so the exemption provides a greater tax break to higher income individuals. Also, any exemption from the general rule complicates a law because definitions are needed to distinguish between taxable and non-taxable items.

SB 6143 and its change in exemptions is a good example of the complexity of exemptions. Here are some excerpts from this new law:

"Until July 1, 2013, the exemption of "food and food ingredients" provided for in subsection (1) of this section does not apply to prepared food, soft drinks, bottled water, candy, or dietary supplements. Beginning July 1, 2013, the exemption of "food and food ingredients" provided for in subsection (1) of this section does not apply to prepared food, soft drinks, candy, or dietary supplements."

""Candy" means a preparation of sugar, honey, or other natural or artificial sweeteners in combination with chocolate, fruits, nuts, or other ingredients or flavorings in the form of bars, drops, or pieces. "Candy" does not include any preparation containing flour and does not require refrigeration."

""Bottled water" means water that is placed in a sealed container or package for human consumption. Bottled water is calorie free and does not contain sweeteners or other additives except that it may contain: (i) Antimicrobial agents; (ii) fluoride; (iii) carbonation; (iv) vitamins, minerals, and electrolytes; (v) oxygen;(vi) preservatives; and (vii) only those flavors, extracts, or essences derived from a spice or fruit. "Bottled water" includes water that is delivered to the buyer in a reusable container that is not sold with the water." Tax won't apply though to "sales of bottled water for human use dispensed or to be dispensed to patients, pursuant to a prescription for use in the cure, mitigation, treatment, or prevention of disease or other medical condition."

So, cookies are not taxable, but candy is. A bottle of plain water is taxable, but not one with enough sweet flavoring to add a few calories. This illustrates another issue with exemptions, they can violate the neutrality and equity principles. The law change may lead buyers to prefer sweetened bottled water over plain bottled water. This is also odd because how is sweetened bottled water a necessity of life?

The simplest, more efficient way to go would be to tax all food and provide relief to low-income taxpayers via a refundable income tax credit. This would also raise more revenue than the current system and that revenue could be used to either lower the sales tax rate a bit.

What do you think?

Complexities of Tax Exemptions

The September 2008 Tax Information Bulletin of the CA Board of Equalization has an interesting blurb about the taxation of vitamin enhanced water drinks. I'm including it here because it illustrates so well how special exemptions complicate the law:

"Sales of vitamin enhanced water beverages may be non-taxable

Noncarbonated, vitamin enhanced, water beverages that come in packages similar in size and volume to non enhanced beverages are generally considered food products. Sales of these food products by grocery stores and other retailers on a togo basis are not subject to tax.

However, sales of vitamin enhanced water beverages are taxable when these products’ labels, packaging or product literature make specific medicinal claims, describe the product as a food supplement, food adjunct (additive), or a dietary supplement or come in small packages designed to give a quick, concentrated boost or shot of vitamins and nutrients. The word "vitamin" in the product name or description does not constitute a dietary supplement claim which may render the product subject to tax."

It refers readers to Regulation 1602 on Food Products for more details.

The whole area of how the California sales tax applies to food products is a bit complicated. Generally, food products are not subject to sales tax. But there are various exemptions. One notable one you're probably aware of is that sales tax is added to your restaurant bill. Also, some food establishments ask if your order is "for here or to go" and then only charge you sales tax if it is for "here."

The complication with vitamin water is that the definition of non-taxable food products does not include certain food or dietary supplements. So, per the Bulletin, if the bottle just has the word "vitamin" without making a medicinal or food supplement claim, it is not taxable. This also shows the oddity of some of our tax laws. Here, the contents of the bottle - what the buyer is going to consume, is the same whether just labeled as "vitamin water" or labeled as "water with a health boost from 15 essential vitamins" but the first one is not subject to sales tax but the second one is. YET ... it's the same beverage inside each bottle!

Rules like these are also sometime referred to as being part of the tax practitioner's full employment act!

And more ... If you recall years ago when the state legislature enacted the "snack tax" where snacks became subject to sales tax despite the general exemption for food products, it wasn't popular because it was so difficult to define a snack. For example, chocolate chips were a food product while M&Ms were a snack. The public hated the snack tax so much that not only did they repeal it by the inititative process, but that proposition also made a change to the California constitution that food products could not be taxed (Prop 163 of Nov. 1993). So, any changes to how sales tax applies to food likely can't just be done by the state legislature who should be the ones in charge of tax law design, but needs to go through the process of modifying the state constittution.

I've written on this before - that California's sales tax base is too narrow (and the rate is too high) - please click here.

Do you think any changes are needed to the sales tax base such as to add food products (with a corresponding income tax refundable credit for low-income taxpayers), digital downloads, personal services, and entertainment?