Leonard Letter Articles on Sales and Use Taxes – 2004-2008
“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 15th 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
“Bee & Chronicle Readers Call “Baloney” on Use Tax” – December 3, 2007
Due to outreach efforts by BoE staff, the Sacramento Bee and San Francisco Chronicle newspapers ran articles reminding Californians they are supposed to keep every receipt from holiday internet shopping in order to accurately report and pay the use tax due on items that they purchase from out-of-state.
This is a law that makes millions of Californians criminals. We at the BoE have no way of enforcing this law without creating a police state. Somehow these facts just fly right over the heads of the media. Or do they? Perhaps it is more accurate to say that the liberal newspaper establishment just likes taxes. My advice is that when it looks like one’s business is going to blow away like dust, considering the opinions of customers is pretty important. But I digress….
Our media staff got back to me with the reader responses to the newspaper stories on the use tax. I am happy to report the readers of these papers do not seem inclined to swallow what they are fed. Lawmakers and my colleagues on the Board need to pay attention. Silly laws breed disrespect for all law. Some sample comments taken from the web sites of the two papers:
“My use tax check is in the mail. Ha Ha Ha Ha! That was the
funniest article I read all day.”
“You can intellectualize this one all you want, but here's the gist: If it is
that wide open to reliance on the honor system where auditing nearly
impossible. . . Well, it is just a dumb, useless law!”
“If you don't want out-of-state merchants to have an advantage over CA
merchants, instead of making people pay the tax difference, here's a novel
idea. Lower or eliminate the CA sales tax. It doesn't take a rocket scientist
to figure that out. Then there's no reason to shop out of state. And the
retailer pays tax on his profits, so the loss of sales tax revenue will be made
up by the tax on the retailers' profits. So there's no loss. Duhhhh!”
“Phase Out the Destructive Sales Tax” – December 31, 2007
The sales tax has become a destructive, unfair tax. Economists have been telling us for more than two decades that America is becoming a service oriented economy. This now is true to such a degree that our high sales tax no longer makes sense.
When people pay for a service, they are consuming it. Transactions between consumers and service providers grow the economy and create jobs and new service products. But these transactions are not taxed. The sales tax was intended to tax consumption, but because of the shift toward services, less and less consumption is being captured by the sales tax.
This is exacerbating an unfair situation for retailers. While lawyers and stockbrokers and pool cleaners can provide their services and not bother with sales tax, those who sell a tangible product are required to extract from their customers a surcharge between 7.25 and 8.75% on each transaction. Some would argue the way to bring fairness into this equation is to start taxing services too. I find it a dubious idea that making others feel the same pain others feel makes anybody’s pain better. I take some comfort that it would be politically hard to tax services. Once people find out that lawmakers want them to pay sales tax on car repair, construction, transportation, medical services, banking services, accounting, architects, etc., the idea will generate severe pushback, and rightly so.
Along with the fact that people will not accept a service tax, like the Use Tax, it would be virtually impossible to enforce. Say we decide to tax attorney services. How do we capture the tax from an attorney living in Las Vegas who provides his or her services via email? There is no way of enforcing this outside of letting the government track our lives in minute detail, including to whom we write checks, and to whom we send emails. This would require a virtual police state where a much higher percentage of the population would need to work for the government to spy on everybody else. This is crazy. Rather than make services taxable, we should instead dramatically reduce the sales tax.
In 2000 when the Internet was still in its infancy, it was obvious that technology would dramatically alter the delivery of products to consumers and that this would have a negative impact on the state’s sale tax program. Moreover, it was clear that this would bring about an unfair playing field for California retailers.
That year I introduced AB 2367, which would have reduced the state sales tax rate by .25% per year until the state sales tax hit zero, while leaving the local portion of the sales tax to fund public safety services and other state mandates.
The current state portion of the sales tax is officially 7.25%, but 2% is going to local jurisdictions. So it is more accurate to say the state’s portion of the sales tax is 5.25%. By phasing out this chunk of the sales tax, leaving a more modest 2% for locals, the final cost of retail goods would then be closer or even cheaper than the cost of goods that need to be shipped. This would restore parity between Internet sellers and our retailers.
Locals are also allowed, by a vote of the people, to raise the sales tax rate further. This is why you may pay more than 7.25% in your city or county. Some cities are charging a whopping 8.75%. Phasing out the state portion would have the additional benefit of making local governments more accountable for both the sales tax rate, and how it is collected and spent. By making this a community level decision, it would give voters an enhanced ability to keep the rates low.
The state’s reliance on the archaic sales tax has spawned whole industries devoted to lobbying politicians to make more exceptions, distinctions, and complications. The result of all this activity is confusion to everybody. This complex law has outlived its usefulness and should be repealed. I find it very hard to defend a program with the following inconsistencies:
* Carrots to be consumed by horses are taxed, but if the same carrots will be consumed by humans, they are not.
* It is possible that the same cup of Starbucks coffee may be taxed at different rates depending what kind of store is hosting the Starbucks outlet.
* If an animal is raised to be consumed as food by humans, it is not subject to the sales tax; if an animal is raised for a purpose other than that, it is subject to the sales tax.
* The BoE ruled that health facilities should charge sales tax for insulin syringes and supplies used to treat diabetic patients, despite state law that says that items applied directly to the patient are exempt from sales tax.
There are many more examples of how ludicrous the sales tax has become. It is time to end the silliness, restore fairness and bring relief to Californians: phase out the state sales tax now.
“The Fair Tax?” – January 28, 2008
I was recently asked by a Leonard Letter reader for some background on the idea of replacing the federal income tax with something like a federal sales tax. That concept in its most recent incarnation is called the “fair tax” and you can learn more at this site:
http://www.fairtax.org/site/PageServer
As appealing and common sense as the “fair tax” sounds at first brush, the issue really is much more complex and the political realities do not lend themselves to implementing the idea. To understand more about the pressures working against the plan, review this article:
http://www.smartmoneydaily.com/general/the-fair-tax-is-the-end-of-income-tax-on-its-way.aspx
I am convinced that a 23% Federal sales tax rate will have unforeseen consequences which need to be further explored, although abolishing the IRS is certainly appealing. The bigger question for all tax reformers is on the spending side: do we really need to turn over this much of the national wealth to the Federal government each year?
“Beware City Taxes” – January 28, 2008
In these challenging budget times, it is no wonder that cities are seeking to maximize their legitimate revenue sources and it is equally unsurprising that an industry of municipal auditors exists to help cities find ways to increase their take. A businessperson in northern California wrote to me to share his concern with his city’s attempt to impose business taxes on even more people. In particular, cities are now being advised by these auditors to exact business license fees from anyone and everyone doing any sort of business in town: the crafter who comes in for a weekend art fair, Coca-Cola, Frito Lay, etc. Imagine if Coca-Cola did have to pay a business license fee in every single city in which it distributes its soda. It would decide not to provide inventory to individual stores or independent restaurants in those cities, but instead would only do business with large chains that have their own distribution systems. I also have read of cities that charge the same amount of business license tax to a one-person, home-based business as to a large retail chain. I understand local officials’ need to make sure that companies in their boundaries are paying local taxes, but taking this to an absurd level will not result in more revenue, will actually damage many local businesses, and will generate more ill will than satisfied residents.
From the Flash Report: State’s Retailers Will Get Clobbered by Perata’s Tax Hike—March 17, 2008
Senate President Don Perata (D – Oakland) has thrown down
the gauntlet in saying he will hold up the state budget rather than accept the
across-the-board cuts the Governor has proposed. It is disheartening to
see Perata’s solution is a one-cent increase in the state portion of the sales
tax, which by the way is a 16% increase in the tax (6.25% to 7.25%).
Remember, this is a tax that must be paid by retailers only -- not lawyers,
therapists, web designers, political consultants, gardeners, etc. The sales tax
was meant to tax consumption, but the amount of consumption being captured by
it is decreasing every year relative to the whole economy.
In 1990 the state had roughly 900,000 retailers. 18 years later, we have
roughly 1 million. This is an 11% increase, which might sound good except
for the fact the state’s population went up 44% in the same period. Yet,
the Democrats are looking to this diminishing class of businesses for more revenue.
Our retailers are under siege already. The vacancies in the strip malls
will get even worse if this tax increase becomes law.
George Skelton’s column earlier in the week credited Pete Wilson for a $7
billion tax hike in the early 90s. What Skelton left out is that less
than $5 billion of what was promised actually came in, and one of the worst
recessions in memory was exacerbated. Although it is common sense that
people change their behavior in response to changes in the price of goods, the
taxpayers’ response to new taxes is not factored in when revenue forecasts are
made. These static estimates assume people are like cattle. The
tax-hike proponents just whip out a calculator and multiply the tax hike by the
number of people, and voila, that is their revenue number. This utterly
ignores reality. In fact, the revenues from the Wilson tax hike came in
20 percent short of expectations, or $800 million short, the first year after
the hike. Even as the economy recovered, revenues still came in short of
forecasts by half a billion per year for several years.
Now Perata is promising $5 billion from a one-cent increase in the state’s
sales tax rate. Unlike a static model, a dynamic revenue model factors in
the response of taxpayers to changes in price. The Department of Finance
has the ability to do dynamic modeling, but rarely makes that information
public. I have a dynamic revenue model from the Department of Finance
that shows an 8% decrease in revenue for every one-cent hike in the sales tax
rate. This means Perata’s tax hike would only bring in maybe $4.2
billion. But wait, this dynamic estimate was done in 2003. Since
2003, people are even more likely to choose the Internet than put up with a 9%
surcharge on tangible goods. I doubt Perata’s plan will even bring in $4
billion and even that assumes that we do not enter a full recession that could
make it even less.
From a supply-side standpoint, it is better to tax consumption rather than
savings and investment. However, the current tax scheme does not
tax consumption as much as it taxes one group of businesses over another.
The solution is not to extend the sales tax to services. That would only
put new pressure on businesses, many of which would choose to provide their
services from comfortable offices in Nevada, deliver their product over the
Internet, and no longer bother with California income tax either. Higher
and more taxes is not a long term solution that makes sense.
What is clear is the Perata tax hike is not worth the cost of increasing
pressure on the state’s retailers at a time when retailers are desperately
fighting for survival. In the Skelton article, former Governor Pete
Wilson was quoted saying the solution to the current crisis is to revisit the
massive spending increases during Davis’ last couple of years.
California had an extraordinary revenue boom in the late 1990s. The
subsequent revenue bust in the early 2000s was the result of the popping
Internet bubble, and the failure to recognize that revenues were in an unsustainable
spike. The personal income tax soared from $28 billion in 1997-98 to a
peak of nearly $45 billion in 2000-01, before plummeting to below $34 billion
in 2001-02. The state’s fiscal problem has its roots in how we treated
this spike in revenue. Had we treated it as one-time money and invested
in capital projects, rather than committing the state to those lofty spending
levels permanently there would not be a budget deficit today.
But instead, as of 2002 the state had a $2 billion deficit that year and
$5 billion more the next. California went from a $5 billion surplus to a $5
billion deficit in just two years, and we have not since closed this gap.
Given this set of facts, Senator Perata, along with the Legislative Democrats,
cannot credibly argue we have a revenue problem. It is obvious how the
state’s finances got off track. To say we have a revenue problem is to
commit to imposing another massive spike in revenue. Rather than have that
revenue come naturally from good economic conditions, the Democrats want to
collect the extra money through more taxation, whether or not the economy can
deliver it.
In this new economy, tax hikes only generate a race to the bottom. We
need to compete for people and businesses. If we do not lower both taxes
and state spending, California is going to lose, and lose big.
Sales Tax on Digital Downloads Still a Terrible Idea – July 7, 2008
Charles Calderon (D-City of Industry) got a lot of attention after introducing a bill that proposed digital content be subject to the sales and use tax. The label, “I-Tunes tax,” stuck, and the bill (AB 1956) was defeated in the Assembly Revenue and Taxation Committee, whose Chairman is the same Charles Calderon. What has not gotten as much attention is that Calderon has used the special session to re-introduce the same bill as a special session bill, so we need to rehash what is so brazen and wrong about the proposal, ABX3 22.
Under the State Constitution a bill to create a new tax or increase an existing tax is the prerogative of the Legislature. Calderon’s bill would bypass this restriction by mandating the Board of Equalization draft a regulation declaring that digital content is tangible personal property subject to tax. I believe Calderon’s argument is that in this bill the Legislature is not enacting a tax increase, but is ordering the BOE to take actions that will result in a tax increase. This transparent gimmick to avoid the Constitutional impediment to higher taxes caused my colleague on the Board, Betty Yee (D-San Francisco), to say at a public meeting that she is offended by Calderon’s proposal. It is a cynical hijacking of our process which exists for the benefit of the public, not legislators who cannot win in the Legislature.
On the policy merits, I say there is simply no way to enforce this law without putting a cop inside everybody’s computer. How else is the BoE going to find out whether I purchased and downloaded something on my laptop here or in Nevada? Computers receive information constantly for virus protection, upgrades for various software, and so on. Much of the time computer users are not even aware this is happening. How is the BoE supposed to know?
Further our sales tax is a tax on tangible property. Calling computer bytes tangible is like asserting the moon is made of green cheese. You can call it that but that does not make it so.
Sales Tax Hike Analysis Available – July 21, 2008
In remarks last Thursday, the Governor announced that raising the sales and use tax is something he is considering. Since my department collects the tax, I recently asked our chief economist to prepare a dynamic revenue analysis of an increase in the sales and use tax. A dynamic analysis seeks to predict how a tax increase would affect economic activity, and thus provide a more realistic idea of the revenues that will actually come in. A static estimate assumes the policy change will have no economic effect and is a simple calculation.
The state’s static revenue estimate for a one percentage point increase in the sales tax is $6 billion per year. The dynamic estimate I requested takes into account how the increase would affect economic activity over time and concludes the state would actually take in $5.69 billion, which is over $300 million short of the state’s official (static) estimate. This would be an ongoing year over year shortfall once the effect of the tax hike filters through the state’s economy. This is eerily familiar territory for those who remember Governor Wilson’s tax increases came in $1.8 billion short of static estimates over the first three years.
The new estimate concludes the tax hike would also result in more than 50,000 jobs lost in California from the reduction in economic activity. I have posted the revenue analysis here:
http://www.boe.ca.gov/leonard/info/Dynamic%20Sales%20and%20Use%20Tax%20Revenue%20Impacts.pdf
Service Tax – November
10, 2008
Good friends alerted me to rumors that state leaders were dragging out old
ideas on the taxing of services. I was working on an in-depth response showing
the adverse economic impacts of such taxes and the administrative difficulties
in taxing labor or services for the first time in this way. But I am already a
week behind because serious, permanent, billion dollar service tax proposals
are now on the table.
Yes, there are a few other states that tax services in this way. Most of them
have low or no income taxes so the tax burden on families is very different and
usually lower in the other states. Some states like Hawaii add service taxes to
tourist type services and most of those tourist businesses offer discounts to
locals.
A hat tip to LA Times staff writer Martin Zimmerman for good research in a
short time describing the burdens that Californians bear compared to other
states. I concur that if enacted that such a tax is likely to backfire.
http://www.latimes.com/business/la-fi-caltax7-2008nov07,0,4976048.story?track=rss
Another issue related to local government is that none of these taxes on
services will include the local share of the state sales tax. The local sales
tax for all cities and counties, and those special add-on sales taxes, cannot
be levied on services without a separate vote of the people in each
jurisdiction.
If this tax survives a week I will be back with more.
Why Sales Tax is So Complicated – November 24, 2008
A major grocery store chain built a store that literally straddled the dividing line between two cities. Previously, those cities had an agreement about how the local portion of the sales tax revenue would be distributed between them, but now one of the cities is adopting a district tax that makes its overall tax higher than its neighbor’s rate, entitling them to more revenue when goods are sold in their city. However, the neighboring city’s tax was staying the same so the store needed to know how to handle the different tax rates. Under state tax law, it would seem that the clerks would have to ask each customer which city they lived in and charge a different tax rate depending on the answer. However, since this would have been on the honor system, I am guessing that suddenly all the customers would have *lived* in the city with the lower tax rate.
Obviously, that option struck the grocery store as silly so it asked the BoE for advice. And the BoE’s answer was this: since almost all the cash registers were in one city, just move the rest into the same city and only one rate would need to be charged. That way, the actual sale of any item would be in the one city where the cash registers were located even if the customer took the item off the shelf in a part of the store located in the other city.
This was a practical solution for this particular store because it had an open floor plan and could easily move the registers. However, slightly different circumstances could have easily changed the answer. Since there are now more than 100 district taxes in California with possibly many, many more on the way, many taxpayers will have incentive to learn exactly which cities they shop in with more precision than they ever thought worthwhile.
Tax Rates by the Zip Code – November 24, 2008
What was once a level statewide rate of sales tax for state and local government is now a complex group of local sales taxes approved on top of the basic rate. Retailers are under a burden to collect the right tax based on where their store is located and sometimes based on where the buyer lives. Buyers have an interest in the tax rate being charged for their purchases. This has always been difficult to determine. Now the Board of Equalization has posted a geographic tracker web page that will take an address and provide the local total tax rate. You can get to the Board’s resource page here:
http://www.boe.ca.gov/sutax/pam71.htm
From there you can look up by city, or search by county to see how rates vary. For example, scrolling through Los Angeles County, you can either pay the base rate of 8.25% or go to South Gate and pay 9.25%. Clicking elsewhere allows you to look at cities that have special taxes in place. In my hometown of San Bernardino, you can see which addresses pay the tax. For other cities, you can plug in the address of the store and see what the tax rate is. Other cities have posted maps of their boundaries so that you can see whether you are shopping within the city or in an unincorporated area that may have a different rate and not send the local portion of the sales tax back to where you would like it spent. More than ever, it pays to be aware of where you shop and what tax rate you are paying.