Leonard Letter Articles on Sales and Use Taxes – 2004-2007

 

“Data for 2003 Looking Strong” – March 8, 2004

The data have been crunched for the first quarter of 2003. Taxable sales in California rose 3.5% during the first quarter last year from the same period.  Retail stores posted taxable sales of $72.1 billion, a 5.5% increase.  Last year most people viewed the economy as anemic, at best.  Given how things seem better now, I am confident that the revenue side is going to continue to improve.

 

“Do You Owe Use Tax?” – March 29, 2004

As the April 15^th filing deadline approaches for personal income taxes, consider that you may also owe use tax on items you purchases from out-of-state sellers in 2003 for which you did not pay California sales tax.  The use tax applies to an out-of-state purchase when you use, store, give away, or otherwise consume the purchased product in California. This is true whether you buy the item in person in another state (or country), over the Internet, or by mail or phone.  Generally, if sales tax applies to the sale of an item in California, use tax applies to the purchase of a similar item from an out-of-state seller.  This is an awful tax and at the very least the first several thousand dollars of out of state purchases ought to be exempt just to keep the paperwork and blood pressure down.

 

Beginning this year, all California income tax returns include a line on which you can report any use tax you owe.   While the income tax return provides an option for use tax payment, you can choose instead to file the use tax return in the BOE publication 79-B, California Use Tax.  If you have a seller’s permit, you must continue to report your purchases subject to use tax on your sales and use tax return.

 

The use tax has been on the books since 1933.  Few people know about it and even fewer pay it.  I believe we should set a threshold that requires payment of the use tax only when out-of-state purchases exceed a large amount or just repeal it.  But until we can convince the legislature to make that change, we owe use tax on anything and everything that qualifies.

 

“Second Quarter Results Look Good” – May 10, 2004

Taxable sales in California rose during the second quarter of 2003, marking the fourth consecutive increase in quarterly growth. Transactions subject to the sales and use tax totaled $114.5 billion during the second quarter of 2003, an increase of $3.5 billion or 3.1 percent from the second quarter of 2002.

 

“Merit in MIC” – February 22, 2005

You have read much about the controversial Manufacturers Investment Tax Credit in this newsletter. The idea is sound: let manufacturers have a tax break on equipment they purchase so that they are willing to move to or stay in California.  Too many other states offer manufacturers much better tax situations than California, which means the jobs go elsewhere. However, the previous version of the MIC had manufacturers pay the sales tax on items and then apply for a refund of that amount.  The Board was criticized for granting these refunds even though that is what the law required of us.  Senators Abel Maldonado (R-) and Elaine Alquist (D-) have come together to sponsor a new, more straightforward version of MIC. Their measure will simply reimburse the sales tax paid for qualified equipment.  I commend their willingness to step into the fray and recognize that something must be done to encourage job creators to be in California. Combined with workers’ comp reform, a renewed improved MIC will help them do so.

 

“What’s in a Tax Credit” – February 28, 2005
In the debate over the Manufacturers Investment Tax Credit many criticize the concept of giving sales tax rebates to companies that stay in California.  The media has portrayed these rebates as taxpayer subsidy of corporate profit.  What you do not read about in the media are the other state tax credits that companies can use in California. Like the MIC, these credits represent a fraction of the total amount spent by the company on that particular purpose so that the state’s money is leveraged.  I counted nearly 20 such tax credits. For example, we give a 20% credit for money investment into a community development financial institution; 50% of the costs incurred for transporting agricultural products donated to nonprofit charitable organizations; 30% of employer contributions to child care plans or construction of a child care facility; 50% of costs to rehabilitation farmworker housing; 10% of the cost of property and a percentage of wages related to building the Joint Strike Fighter aircraft; incentives to do business in a military base recovery area; credit for building low-income housing; a percentage of research activities conducted in the state; 55% of the fair market value of donations under the Natural Heritage Preservation program; and a percentage of the cost of purchasing and installing a solar or wind energy system that produced electricity.  Most of these credits encourage companies to do things they otherwise would not do (e.g., invest in enterprise zones, child care, or farmworker housing) and other credits that help the company's bottom line by encouraging them to stay in CA (e.g., the research credit).

 

“Streamlined Sales Tax  Project Needs Attention” – March 14, 2005

Some states have created a coalition called the Streamlined Sales Tax Project.  Their idea is to standardize the sales tax system nationally so there is a legal way for states to collect sales tax from remote retailers, which is now illegal under a Supreme Court decision.  By 2002, 30 states had ratified the Agreement.  California has not, but our state is a voting participant of the coalition.  As such, the next step is to decide whether to conform our sales and use tax system to the Agreement. 

 

For California to conform, we would need to completely overhaul our sales tax system, by changing the way cities receive their share of sales tax and by eliminating locally- enacted sales tax measures that support transportation and other projects.  Plus, even though we are the seventh biggest economy in the world, California would have only one vote on the permanent governing board.  This governing board will tell our Legislature what laws they must change or else California would be denied membership in the system.

 

According to the California Research Bureau, there is no sign that the Agreement would result in California collecting more tax revenue.  Plus, it is not clear how big a problem they are trying to resolve.  As a proportion of total tax revenues, the sales tax is of declining importance as our economy shifts from producing tangible goods to providing more services.  Even without this sales tax collection system in place, there are already fewer retailers who operate solely via the Internet or by catalog sales. According to Forrester Research, these multi-option retailers constituted 75 percent of total on-line sales in 2003, up from 67 percent in 2001.  Thus, that problem appears to be self-correcting.  Most importantly, do we really want to give up our state sovereignty?

 

“Sales Taxation: A Clouded Future” – March 21, 2005

There is a re-energized debate at the federal level about a national consumption tax.  With numerous bills pending, an open mind on the President's part, and now an endorsement from Federal Reserve Chair Alan Greenspan, the likelihood of some new system of taxation grows, and there are strong reasons for it.  Consumption taxes, unlike the income tax, do not punish savings and investments.  That is important because Americans have such a low savings rate.  Consumption taxes are also generally cheaper to collect and less invasive to taxpayers’ privacy than the income tax system. Consider that with a consumption tax, you could pay cash at the register and be done with it, whereas with the income tax, the IRS can conduct an audit of your lifestyle and decide whether you are paying enough tax based on how you live.

 

If the federal government chooses a national sales tax to replace the income tax, it would need to be set at 22%.  What would happen to the 45 states, plus the District of Columbia, that have their own sales taxes?  The impact would be particularly dramatic in high sales tax states like California.  Would we be able to continue charging our average rate of 8% on top of the federal 22%?  Think about adding another fifth to the cost of everything you buy in California.  Since there are good arguments for imposing a national sales tax and repealing the income tax, there is good reason for state policymakers to begin discussing the ramifications on their own systems of taxation.

 

“Terrorism and Taxes” – March 21, 2005
In last week’s issue, I mentioned that the sale of legal cigarettes is falling in California. The problem is that we are seeing an explosion in illegal cigarettes from those trying to avoid our high tobacco tax.  Although we cannot keep up with the black market in cigarettes, legislators with an environmental agenda are proposing a new law to push the price even higher despite the warnings of federal law enforcement officials that the proceeds from this black market benefit terrorists.  The U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives and the U.S. General Accounting Office say that illegal tobacco sales may surpass drug sales as a prime source of funds for terrorists in the United States.

 

Democrat Assemblymembers Fran Pavley and Paul Koretz are backing the bill to tack on a fee to cigarette sales that will fund litter clean-up.  Their reaction to the concerns of law enforcement?  Koretz says, “I don’t think there’s a lack of illegal opportunities for terrorists and others that want to engage in that kind of activity to make their money.  One way or another they will find a way to engage in illegal activities and to raise money for what they are trying to do.”  Pavley explains, “This is a legitimate fee. I don’t think a minor fee on cigarettes is unreasonable.”  Senator Chesbro adds, “We’re not going to stop addressing public health and the environment in California because of terrorists.”

 

So, first these legislators call our federal law enforcement and anti-terror experts liars.  Then they argue that even if the anti-terror experts are correct, their concerns should be dismissed in favor of environmental concerns.  I could not disagree more strongly with their bill and their rhetoric. We need to reign in the black market for many reasons, the foremost of which is disabling terrorists.  That these legislators are not willing to see and support that goal is disturbing.

 

“Higher Sales Taxes Coming to a District Near You” – March 28, 2005
Let me share with you why you sometimes pay as much as 8.75% sales tax on your purchases in California.  The combined state and local sales tax rate of 7.25% is made up of a state component (6.25%) and the city/county component of 1%.  However, way back in 1969, the Legislature enacted the district tax where local jurisdictions (Special Tax Jurisdictions) may impose an additional sales and use tax.  STJ taxes can add an additional .125 to .5 percent tax on top of the statewide rate. But STJs are stackable in an area. Depending where you buy goods, you may be paying 2 or 3 STJ rates on top of the statewide rate.  At the end of the last fiscal year, there were 41 STJs in California.  There will be 65 by April 1.  Staff informs me that another 15 localities have contacted the Board about implementing new ones.  So it appears possible that in relatively short order, you may find it difficult to find a place in California where the sales tax is less than 8% of your purchase.

 

“Where Not to Stop” – April 4, 2005

Last week I mentioned that there are some places in California where you are charged 8.75% sales tax.  Some Leonard Letter readers wanted to know where that was so that they could avoid shopping there. Below is the list of those areas that charge the highest sales tax rate in the state.  Almost every one of these is in Alameda County.  An asterisk indicates an incorporated city:

Alameda*, Albany*, Army Terminal (Alameda County), Ashland, Avalon*, Berkeley*, Bradford, Castro Valley, Cresta Blanca, Dublin*, Elmwood, Emeryville*, Fremont*, Government Island, Hayward*, Landscape, Naval Air Station (Alameda*), Naval Hospital (Oakland*), Newark*, Oakland*, Piedmont*, Pleasanton*, Richmond*, San Leandro*, San Lorenzo, Sunol, and Union City*.

 

“Honor the Truth” – April 11, 2005

I put out a release last week in opposition to the Democrats’ proposal to raise the state’s sales tax in order to eliminate the sales tax on gasoline.  The Democrats are acknowledging that the sales tax on gasoline is not going to transportation projects, as promised, and they are admitting that the state is profiteering from spiking gas prices.  Since the truth is now out there, the honorable thing for them to do is to simply repeal the sales tax on gasoline.  The Democrats finally acknowledged that the sales tax on gasoline is doing nothing to improve roads or benefit drivers. It is merely generating a windfall for the General Fund.

 

“Taxing Tribes” – May 23, 2005

California’s sales tax law is complicated and it is even more complicated when Indian tribes or tribal members are involved.  I have recently requested that the Board create a Tax Information Bulletin to clarify this matter for businesses who makes sales to Indians.  The challenge for those businesses is that the California sales tax does not apply to sales made to Indians if the property is delivered to the purchaser and the property ownership transfer takes place on the reservation.  Indians know this, but the businesses often do not.  The business’s invoice to the Indians must state this exemption for their records to be accepted by the Board and reconciled to what the auditors would otherwise think that businesses owed to the state.  I want to get this message to everyone who does business with tribes so that they do not get caught in the web of red tape for taxes they legitimately did not collect.  You can read the full regulation at http://www.boe.ca.gov/pdf/reg1616.pdf and soon there will be new publication that explains this situation in plain English.

 

“An Inconvenient Fee” – August 15, 2005

The good news is that you can now pay your sales and use taxes with Visa.  (MasterCard, Discover/Novus and American Express were already accepted.  In the last year the BoE has received 16,762 credit card payments totaling more than $53 million.)  The bad news is that you will pay a “convenience fee totaling 2.5 percent of the transaction amount by the processing vendor.”  It is un-American to have to pay an extra fee for the privilege of paying your taxes, and calling it a “convenience fee” is just government jargon for “ripping you off.”  We need to move to a better system soon, and I am pushing the bureaucracy to get us there quickly.  In the meantime, read your credit card agreements carefully. Perhaps the rebate points, airline miles or thank you gifts you receive will counterbalance the inconvenient fee you will have to pay along with your tax bill.

 

“Fuel Shock Yet to Register at the Pump” – August 22, 2005

Contrary to what some might expect, we have yet to detect a serious slow-down at the gas pumps in reaction to soaring oil prices.   While second quarter data is still coming in, in the first quarter of this year, taxable gas sales in California were 3.82 billion gallons compared to 3.89 billion gallons in the first quarter of 2004 -- about a 2% decrease.   Diesel sales were actually up this year from the first quarter of last year --  676 million gallons in the first quarter this year compared to about 654 million gallons in the first quarter of 2004 -- about a 3% increase.  These hot prices, however, benefit the state to the detriment of taxpayers who continue to be double-taxed on every purchase of gas.   If the state had a conscience, it would lower the gas tax so that the rise in gas prices is revenue-neutral instead of brazen profiteering.

 

“Certified Pre-Owned Tax Problem” – August 29, 2005

Used car dealers are the number one source of assessed dollar amounts for tax penalties in California.  More than 13% of all the penalty dollars the BoE brings in come from these dealers. The average dollar recovery, per hour of staff time, is almost three times the state average for the 2004-05 fiscal year.  Used car dealers are the seventh highest type of business audited, representing 3.37% of all field audits, and more than 6% of the total net tax liability.  All of these numbers indicate that a fair number of used car dealers have a pattern of substantially understating their sales and use tax liability.

 

“Addicted to Taxes” – September 19, 2005

In yet another example of imposing taxes that you do not have to pay yourself, the California Hospital Association is promoting an initiative for next year’s ballot to increase the tax on a pack of cigarettes by $1.50. The group estimates that $1.4 billion could be raised each year and 65% of that money would go to a fund to support trauma centers and emergency rooms.  Ostensibly, health care workers are encouraging people to stop smoking; they say that hiking the price would be an incentive to quit the deadly habit.  However, it is also possible that recipients of the taxes become addicted to the tobacco tax revenue, and their supply is dwindling.  Prop. 99 of the late 1980s applied a 25-cents-per-pack tax with the money going to health education against tobacco and health care for poor families. About a decade ago, that measure brought in $575 million, but last year it totaled only $321 million. In 1998, voters added a 50-cents-per-pack tax to fund early childhood education.  That brought in $686 million in its first year, but dropped down to $593 million in the current year.  Advocates of the measure believe they will have voter support because most voters do not smoke and many are critical of smokers.  Perhaps voters should be more concerned with weaning special interest groups off of their addiction to tax dollars.

 

“Tax Gap” – January 9, 2006

The 2005 state budget's supplemental report requires the Board of Equalization to report the Sales and Use Tax Gap.  This is the amount of uncollected revenue for sales and use transactions.  This is mostly underreporting by registered businesses, or nonfilers who should be registered, or use tax liabilities that could be owed by anybody.  The Board's research section estimates that the total amount of state sales and use tax that was owed during fiscal year 2004-05 amounted to $28.2 billion.  Of this amount, $26.9 billion, or 95.2%, was paid.  Therefore, BoE is reporting the sales and use tax gap is $1.4 billion, or 4.8% of the total amount due for that time period.  This is not an insignificant number.  However, I would be willing to bet that the major credit card companies would be delighted with a collection number above 95%.   While we need to continue to make it easier to comply with our tax laws and do a better job of catching the tax cheaters, the tax gap number is not so high that new draconian measures that trample taxpayer rights need to be passed into law.

 

“Independent Distributors and Sales Tax” – February 26, 2007

We all know people who have a home-based business, often just a small venture based on a hobby or to help a stay-at-home mom earn extra income. They sell jewelry or craft products or other small items, all of which are tangible personal property subject to the sales tax.  I heard a story about one such business this week that was disturbing. This independent sales person buys her products at a reduced price from her distributor and pays sales tax to the company for those products.  She then increases the prices for resale to customers and charges them sales tax on the higher price. However, she is not sending that sales tax to the state and says that her accountant told her she does not have to because she earns only a nominal amount from the business.  I would like to remind everyone that every penny of sales tax you collect must be remitted to the state; there is no threshold income level or net sales number or business size requirement.  If you collect any sales tax for the state, you must turn it over to the state.  If you are engaged in a small business of this type and are not sure about how the sales tax on your products gets paid, I urge you to go to this link to learn about obtaining a state seller’s permit and keeping yourself above the law:

http://www.boe.ca.gov/info/reg.htm

 

And, of course, you can always contact me and I can help get detailed tax information for your situation.

 

“Sales Tax on Marijuana” – March 26, 2007

Setting aside the moral, philosophical and legal debate about the use of medical marijuana, consider the practical dilemma that distributors of the product find themselves in.  Anyone who sells a tangible personal product in California is required to obtain a state seller’s permit, collect and then submit sales tax to the Board of Equalization.  Yet, the permit is clearly labeled with this warning: “NOTICE TO PERMITEE: You are required to obey all federal and state laws that regulate or control your business. This permit does not allow you to do otherwise.”  Some medical marijuana dispensers do not obtain a seller’s permit because they worry about confidentiality or self-incrimination. Others obtain the permit but do not disclose the product being sold, which means the Board cannot adequately provide them with tax advice or legal requirements.  Anyone who sells tangible personal property of any type can obtain information about a seller’s permit by calling the Board’s toll-free line at 1-800-400-7115.

 

“New County Taxes on Alcohol?” – April 9, 2007

Despite the record-breaking growth in county revenues in recent years, too much never seems to be enough.  The State Senate is considering a bill to allow counties to tax “the privilege of consuming beer, wine, and distilled spirits.”  SB 297, by Senator Gloria Romero, would allow county boards of supervisors to impose a new tax of up to 5% of the purchase price of such beverages for whatever purpose the supervisors might deem necessary, subject to approval by county voters.

 

Interestingly, the bill limits the new tax to alcohol “purchased in a retail sale for consumption on the premises of the seller,” so bar customers would pay the tax but liquor store customers would not.  I do not drink, so this distinction makes no difference to me, but I wonder about the justification for treating the two kinds of sales so differently. 

 

The Legislative Counsel Bureau has scored SB 297 as a majority vote bill, which means that the legislature's anti-tax Republicans cannot block it.  If it becomes law, I am not looking forward to the county-by-county campaigns to adopt the new taxes.  If history is any guide, we can expect supervisors to make generous promises they can not keep to the special interest groups that will fund the pro-tax campaigns.  The campaigns will be full of deception and wild threats that vital services will be cut unless the new taxes are approved.  Some things never change.

 

The other issue is the vote requirement.  The bill allows a simple majority of voters to impose this tax on a narrow category of the population, those who consume alcohol at a bar or restaurant.  Talk about taxation without representation.  The vote requirement should be a two-thirds vote of the voters to make sure there is a consensus for this new tax.  Should I really be allowed to vote on a new tax that I will never pay?

 

“Free Market Better Than Litigation” – June 4, 2007

The Board is being sued by Santa Clara County because they think flavored beers should be taxed at the distilled spirits tax rate ($3.30 a gallon) instead of the beer tax rate ($.20 a gallon).  The Board’s perspective is that these terms are defined by law.  The law requires the Department of Alcohol Beverage Control to classify alcohols, and that department and the federal government have appropriately chosen to tax flavored beers according to the legal definitions. 
 
A couple weeks ago, the San Francisco Chronicle editorialized against the Board’s position.  However, they made the unfortunate charge that these flavored beers (“alcopops”) contain “distilled spirits.”   This is not correct and I am grateful they printed my letter explaining that these products may contain distilled alcohol, but not distilled spirits.  “Distilled spirits” is a specific legal term that describes hard liquor, such as whiskey and gin.  Distilled alcohol is a generic term that refers to any alcohol that has been boiled.  The term distilled spirits applies only to beverages, but distilled alcohol is included in many other products, including flavorings, colorings, solvents, cough syrup, etc.   For instance, pure vanilla extracts must contain at least 35% alcohol per FDA requirements. Thus, it is fair to say that chocolate chip cookies contain distilled alcohol.
 
Some people are concerned that there is something worse about having boiled (distilled) alcohol in a product instead of alcohol that has not been boiled.  But chemically there is no difference; the ethyl alcohol molecule does not change when it is boiled, then condensed through the distillation process.  This fact explains why the Board of Equalization cannot test a product to find out whether the alcohol in it was distilled or not.  No such test exists.
 
Underage drinking is indeed a serious problem.  I have been told that these flavored beers are easier to drink than other alcohol beverages, so they might be something that teenagers would favor as a gateway to drinking before they are legally permitted.  But I have a problem with those who say it is worse for a product to contain distilled alcohol than non-distilled alcohol. 
 
That leads me to my point.  Two weeks ago Anheuser-Busch announced they would no longer make a flavored malt beverage called Spykes, which has the highest alcohol content I have seen for a flavored beer: 7%.  The reason?  Parents and activists complained that the product is too attractive to underage drinkers and it was not selling very well.  Thus, the market is addressing a problem that some prefer using litigation and nanny government to solve. 

 

I prefer the market solution, and you should too.

 

“High Taxes, High Regulation Are Sweet Music to Criminals” – July 9, 2007

I am pleased to report that the BoE has now reported on the practical effect of AB 71, the Cigarette and Tobacco Products Licensing Act of 2003.  Our staff estimates that compliance improved enough to bring in an extra $88 million per year ($292 million in evasion in 2003, down to $204 million now).  BoE staff faced a lot of challenges in getting this new law into effect and they deserve credit for getting the new system running well. 

 

The new law raised reporting and licensing requirements, record keeping requirements, and mandated a new hologram stamp designed by a contractor to the U.S. Treasury to be affixed to each pack of cigarettes sold.  Cigarettes are subject to both the cigarette tax and the cigarette and tobacco products surtax, and both are paid by distributors through the tax stamps. Currently, each stamp costs 87 cents per pack of 20 cigarettes.  In sum, the tax is close to a whopping 47% per  pack.

 

Looking at what was actually accomplished, the practical effect of AB 71 has been to reduce avoidance by maybe a third.  And this is just looking at the first year of full implementation of the law.  I fear the criminals have not yet had sufficient time to defeat the new security measures, but it is inevitable that many will.

 

We have come as close as I think possible to a police-state level of regulation on the sale of tobacco products.  But we have not had enough of an impact to justify the hyper-regulation.   It is obvious that the taxes are so high that no matter how many tobacco cops we hire, no matter how many mandates we place on retailers, it is too inviting for criminals to figure out ways to sell cigarettes in California without paying tax.   After just a quick search I found a website that claims to sell tax-free cigarettes.

 

The era of government punishing people by taxing their behavior should end.  The Internet and the globalization of the economy are weakening the state’s control over people.  As predicted, high taxes only drive business out of the U.S. and incentivize criminal activity.

 

“Now Taxing Your Portable DVD Player” – July 16, 2007

In January of 2005 the state’s controversial electronic waste and recycling fee program began.  It ranges from $6 to $10, depending on the size of an item’s liquid crystal display (LCD) or  cathode ray tube (CRT) screen.  The e-waste fee is collected by retailers when they sell certain electronic products as determined by the Department of Toxic Substances Control. The money collected by the Board of Equalization is transferred to the Toxics department for various programs.  More than $62 million has been collected, but you would have to ask Toxics how it is spent since I have no idea. The Toxics Department just added portable DVD players with screens that are more than four inches (measured diagonally) to the list of items subject to the fee as of July 1, 2007. For more information about who is required to collect the fee, which items the fee is applied to, how to register to collect and remit the fee, and other frequently asked questions (although no good answer about how it is spent), go to:

 

http://www.boe.ca.gov/sptaxprog/ewfaqs.htm