The California sales tax begain in 1933 and applied to tangible personal property, with some exceptions. It was a Depression-era tax to help preserve government revenues. It was before we had digital downloads, lots of types of entertainment and personal services, such as personal trainers, tanning and tatoo saloons, etc.
In the past few decades, consumption of intangibles and services has increased while consumption of tangible personal property have decreased. This has eroded the California sales tax base. The Legislative Analyst’s Office (LAO) noted that in 1981, 48% of consumption represented items subject to the California sales tax, but that amount dropped to 38% by 2005. In April 2008, Apple announced that iTunes had become the largest music retailer in the US. In 2007, eMarketer estimates that individuals in the US spent $1.1 billion for music to be listened to on their mobile phones. The research firm estimates that this amount will be $2.8 billion in 2011 (3/28/08 Business Journal article). This digital music is treated as intangible in California and is therefore not part of the sales tax base (other states may treat it as the equivalent of tangible personal property or have expressly stated that it is taxable).
Also, access to broadband that enables larger files to be downloaded is skewed in favor of higher income households. Thus, it is likely that higher income individuals are purchasing digitizable goods in that non-taxable form rather than the taxable tangible form that lower income individuals may be using. This makes the sales tax even more regressive. A 2004 press release by Nielsen//NetRatings was entitled, “Affluent Americans Power Internet Growth.” The report noted that at the income level of $150,000 or more, 69% of Internet users used broadband while 31% used narrowband. In contrast, in households with income under $25,000, broadband use was 25% which narrowband use was 75%.
In recent years, some other states have expanded their sales tax, such as New Jersey, that now taxes more types of personal services as well as digital property.
Should California broaden its sales tax base to include the digital equivalent of items that would be taxed if in tangible form? Your professor advocates modernizing the tax base and lowering the tax rate, as well as broadening it to include items more likely to be purchased by consumers rather than businesses so as to not make the pyramding in the sales tax base any worse. What do you think and why?
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Effective April 1st 2009, California recently increased its sales tax rates by approximately 1% to approximately 9%, making it one of the highest in the country. Before this increase in taxes, California had the 8th highest sales tax rate in the country. The purpose for this tax increase, is an effort to solve the budget deficit. The question which arises here is, does an increase in sales tax improve state tax collections, or does it actually hurt the state government revenues? As we can clearly see from California budget deficit, having one of the higest rates in the country does not help raise the required revenue needed. I therefore agree that California needs to take a look at its current tax base and maybe try a new approach. California's sales tax was first created in 1933 and was imposed on retailers for selling personal tangible property. Back then, sales of tangible personal property was more common. With the change in technology, as well as a change in consumer demands, there has been a great shift in consumer spending. In this new era, as more taxpayers move to two-earner families, there has been an increase demand for personal services, such as child care, gardening and cleaning services. Also, there has been a change in the type of entertainment service required, such as Televisions, sporting events, online gaming etc. Furthermore over the last few years there has been a change in technology as the use of broadband has increased, thereby causing an increase in demand for music, software, ringtones and game downloads. These intangible items as well as some personal services are not taxed by the current California sales tax. There is therefore a call to periodically review and update the California sales tax so as to meet the shift in consumer demand. According to a report by the Center on Budget and Policy, there has been a 13.4% drop in sales subject to sales tax between 1990 and 2003. Furthermore, there has been a drop from 48% to 38% in consumption of items subject to sales tax. This change in consumer behavior supports that there is a need to broaden the California sales tax base. This change will help improve tax collections and make the system more stable.
Why broaden the base? There are several benefits to broadening the base;
1) Broadening the base will lead to an increase in government revenue by imposing taxes on intangibles and other services not surrently being taxed. This will therefore enable the tax rate to be lowered, since a broader base will generate more revenues as more consumption is shifting towards services and intangible assets, taxing only tangible generates less revenue for the state.
2) If the sales tax gets lowered, it will improve California's ability to compete with other states in attracting more businesses into the state. These business will further help to generate more sales tax income for the state.
3) Statistics show that higher income taxpayers are more likely to purchase more digital items and services, as well as have more access to broadband connections than lower income taxpayers. As a result, the current California sales tax law imposes a higher tax on lower income taxpayers than it does on higher income taxpayers. For example, lower income taxpayers may tend to rent a movie to watch, which is taxable, while higher income taxpayers will just go to the movies and not be taxed. Lower income taxpayers may purchase cleaning supplies which are taxable, while higher income taxpayers would hire a cleaning service and not be taxed. The downfall to the current tax law is that tax expenditures are benefiting more high income taxpayers that low income taxe payers. A better way to ensure that the benefits are enjoyed most by those who need it would be broadening the base and even imposing a tax on items such as food, then latter providing a refundable tax credit for lower income taxpayers to offset the costs.
4) With changes in the economy, people may reduce spending on certain intangible property such as cars, boats etc. However, broadening the tax base to tax certain services that don't change as often, may provide more stable tax collections.
5) Reducing the amount of exemption from California's tax system, will make the system more simple and efficient which will improve compliance and administration as well as fairness in the system.
In recent years, other states have seen the need to tax didgital property. States such as, Tennessee, New Jersey and Nebraska, have imposed a tax on digital downloads, as they realize that with a shift in consumer spending, the same benefits are gained from music or software purchased online as those purchased in the store. Several other states have also agreed to join in the collection of taxes on these internet sales.
With regards to the increased pyramidng effect of a broader base, an exemption could be made for services or digital download purchases by business, that way more of the taxes are imposed on the consumers of the goods. This will also help to reduce the fear of increased costs buinesses will face.
Following is a policy analysis of a broader California sales tax base.
1) Equity and Fairness - A broader base will make the system more fair as all taxpayers will be taxed on consumption without regards to if the property is tangible or intangible.
2) Transparency/Visibility - A broader base will have no effect on the transparency of the tax system.
3) Certainty - Since a broader base will reduce the amount of exemptions, it will make the tax system easier to understand and improve certainty on whether an item was subject to tax or not.
4) Convenience of Payment - There will be no effect.
5) Economy of collection - the broader base might increase the cost of businesses to collect sales taxes, however, there should be systems in places to keep the collection cost at a minimum such that any increase in cost will not be significant.
6) Simplcity - removing most exemptions from the California sales tax should make the system simpler to understand.
7) Minimum Tax Gap - A broader base will cause more taxes to be collected by businesses. As such, will help raise goverment revenues to minimize the tax gap. However, in the beginning, some of the taxes might not be collected due to confusion by taxpayers.
8) Appropriate Government Revenues - Since the government already has data on consumption by individuals, a broader tax base will therefore not present any problems for the government to determine how much revenue will likely be collected.
9) Neutrality - With a broader tax base on digital items, neutrality will be increased as it will not make a difference if a taxpayer purchased and item online or from a store, as they both will be assessed a tax. However, when it comes to personal services, businesses may decide to hire an employee to perform several duties other than contracting it out.
10) Economic Growth and Efficience - Broadening the tax base and reducing the tax rate will help spread the impact of sales tax amount various types of comsumption and will therefore make the system more efficient. It may also have a negative effect on certain businesses as an increase in transfered costs might have an effect on business activity.
Based on the anaylsis above, I believe the California sales tax needs to therefore have a broader base and lower rate as the benefits appear to outweigh the effects.
Sources:
California's Tax System - Sales and Use Tax Wakness & Possible Remedies: The Tax Base is Too Narrow and Should Be Broadened, Report #2a, Annette Nellen, http://www.cob.sjsu.edu/nellen_a/TaxReform/Report2a_21stCenturyTaxation_SUTBase.htm
California Commission on Tax Policy in the New Economy, Final Report (Dec 2003), Page 132, http://library.ca.gov/crb/catax/
Revenue Review, Tennessee Department of Revenue, Jan 2009m page 3 http://tennessee.gov/revenue/hottopics/revreview-jan2009.pdf
States Move Forward on Internet Sales Tax, Brian Krebs, 07/01/05, http://washingtonpost.com/wp-dyn/content/article/2005/07/01/AR2005070101475.html
The California sales tax structure was established during the Great Depression of the 1930’s when the California economy was dominated by the sale of tangible personal property from the manufacturing and agriculture industries. In the last seventy years, technology and the forces of globalization have led to a drastic change in the California economy. The current California sales tax structure is flawed in three distinct ways:
- California has one of the highest sales tax rates in the United States
- Over time the sales tax base has been diminished
- The sales tax may result in double taxation on consumer products
For these reasons, the California sales tax structure should be altered. One solution would be to reduce the sales tax rate and expand the sales tax to sales of intangibles and services.
Already one of the highest sales tax rates in the nation, California recently raised the sales tax rate by an additional 1% until June 30, 2011. Currently businesses with a presence in California are required to collect sales tax from their customers on certain sales of tangible personal property. A high sales tax rate discourages economic growth in California as businesses are hesitant to set up operations in the state as this would be require them to collect sales tax on sales to California customers. Having a high sales tax rate also results in an increase to the minimum tax gap for state tax revenues. To avoid paying sales tax California taxpayers often buy products online from businesses not required to collect California sales taxes or will cross state lines where the sales tax rate is 0% (e.g. Oregon). California taxpayers are required to pay California use tax on such purchases, however it is widely known that there is a large amount unreported sales. This taxpayer avoidance of California sales tax causes California businesses to have a competitive disadvantage compared to out of state businesses.
The California sales tax structure has changed very little from inception in 1933. However from 1980 to 2008 the percent of personal income being spent on taxable property dropped from 55.4%to 34.6%. One of the reasons for this decline is the growing service industry and from online sales. Downloading of software and most services performed in California are not subject to sales tax. The current California sales tax structure violates the tax policy principle of neutrality as taxpayers are encouraged to engage in transactions which will avoid the sales tax such as downloading software online rather than buying in a retail store. In time this tax structure has had the economic effect of encouraging some businesses such as software companies and discouraging others such as manufacturers.
California charges sales tax for almost all sales of tangible personal property for use in the state provided the sale is not for resale. Therefore this tax could result in multiple layers of taxation on the sale of a consumer product. The application of multiple layers of tax unfairly burdens certain industries such as retail stores and manufacturers as opposed to service providers.
See Next Comment for Conclusion
Because of the above, the California sales tax structure is flawed. The solution is to reduce the sales tax rate and expand the tax to the sale of intangible software downloads and services performed in the state. Lowering the California sales tax rate will reduce the tax gap as taxpayers will have a smaller incentive to look for ways to avoid the high sales tax rate. Reducing the sales tax will make California businesses more competitive as out of state businesses will have a smaller advantage of not having to collect California sales tax. The application of sales tax to intangibles and services supports the tax policy principle of fairness as the tax base will be spread over a larger number of businesses not just those producing tangible property.
The California sales tax structure is outdated and needs to be corrected. Until then California businesses will be at a competitive disadvantage and the California government will continue to struggle with non-collection and an ever narrowing tax base.
http://ftp.aicpa.org/public/download/members/div/tax/3-01.pdf
http://www.cotce.ca.gov/documents/reports/documents/Commission_on_the_21st_Century_Economy-Final_Report.pdf
California can no longer ignore its dwindling sales tax base and further rate increases will only make matters worse. As consumption patterns have moved away from goods to services, a large portion of personal consumption is exempt from California sales tax which further narrows the tax base and makes it less responsive to economic growth. At 8.75% California already has the highest sales tax rate in the country, which can total up to 10.75% with local sales tax included. Further increases in rate could threaten California’s competitive position with other states for attracting new business. In addition, because a sales tax is a tax on consumption of goods, it has the effect of being “regressive,” impacting low-income taxpayers more severely since low income taxpayers spend a greater portion on taxable consumption in a given year. Services and intangible digital goods that are tax free tend to be consumed by higher-income taxpayers making the sales tax even more regressive on lower-income taxpayers. Broadening the tax base is an obvious next step to increase tax revenue, lower the tax rate, and address equity and fairness.
Services and intangible goods, including digital items, are exempt from California sales tax. But there is no reason to tax some but exempt others. For example, pet supplies are taxable but dog sitting is exempt. Pool equipment is taxable but pool maintenance is exempt. In these examples, the taxpayer has already made the decision to own a pet and a pool. Why does the tax code subsidize the cost of ownership by exempting related services from tax? There is no reason for it. And in fact, most taxpayers aren’t even aware of the distinction. The tax base should be broadened to not only include digital items, but to include all services. Broadening the base to tax services would make California’s tax system more equitable, more stable, and more responsive to changing consumption patterns.
Surprisingly, according to the Federation of Tax Administrators, a majority of states applied their sales tax to less than one-third of 168 potentially-taxable services in 2007. But the economic downturn is forcing many states to reconsider. A July 2009 report by The Center on Budget and Policy Priorities was entitled, “Expanding Sales Taxation of Services: Options and Issues.” The report estimates California could increase its tax revenue by as much as 41% by expanding its tax base to include services. Maybe this is too much change to undertake all at once? But certainly it needs to be seriously considered given California’s budget crisis.
Collecting sales tax from online retailers is an area that California and other states are already considering. The largest online retailer, Amazon.com Inc., is pushing back on proposed legislation in California and several other states. But the increase in tax revenue is worth the fight. In New York, its 2008 law to require online retailers to collect sales tax, brought an additional $34 million in 2009, and $70 million is expected in 2010. For California, it is time to follow the lead of other states and at least tax digital items. I would advocate for more - taxing all services and using the increased revenue to fund rate reductions for both sales tax and personal income tax. But until California is willing to undertake major reform, taxing online retailers is a good first step.
http://www.boe.ca.gov/news/sp111500att.htm
http://www.boe.ca.gov/pdf/pub61.pdf
http://www.taxadmin.org/fta/pub/services/btn/0708.html#table
http://www.cbpp.org/files/8-10-09sfp.pdf
http://online.wsj.com/article/SB124579383785943841.html
http://online.wsj.com/article/SB10001424052748704059004575128003135531516.html
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