CALTAX COMMENTARY:
Sales Tax on Services Raises Many Issues That Must Be
Thoroughly Vetted
By CalTax Fiscal Policy Director Therese Twomey
Every few years, there are discussions of imposing a sales tax on
services in California, often proposed in the name of “modernizing the
economy,” closing California’s state budget gap, or stabilizing cyclical
fluctuations in tax revenue. This year, the discussion is precipitated by
talk of “tax reform” and options to increase revenue in light of the
approaching sunset of Proposition 30’s temporary sales/use and personal
income tax increases.
The idea of taxing services is not new. Proposals to tax a broad array of services have
been bandied about in a number of different states looking to erase budget deficits. In
California, there have been numerous proposals dating back several decades, and recently
there have been about half a dozen measures proposed since the burst of the dot-com
bubble. None have been approved.
The latest proposal, SB 8 by Senator Robert Hertzberg, was introduced at the beginning
of the current legislative session. The bill seeks to impose a broad-based sales and excise
tax on services estimated to raise $10 billion a year, with tax exemptions only for
healthcare services, education services, and small businesses with gross sales of less than
$100,000. The measure also intends to reduce the personal income tax for low-income
earners, while “evaluating” the current corporate tax rate and a possible increase in the
state’s minimum wage.
As with many ideas, what may appear appealing at first often can go awry. A number of
states that have attempted a broad-based sales tax on services have either scaled back
on the number of services taxed, or have repealed the tax altogether because the tax put
in-state businesses at a competitive disadvantage, threatened jobs, or was difficult for tax
agencies to administer. Florida, Maryland, Massachusetts and Michigan all repealed their
service taxes shortly after they were enacted.
While many states tax some services, there is no apparent trend toward expanding the
sales tax base to include more services. According to the Federation of Tax
Administrators, states have been reluctant to undertake a broad-based expansion of the
sales tax base because of the possibility of repeal. Only two states – Hawaii and New
Mexico – have broad-based sales taxes on services, while South Dakota and West Virginia
are the only other states to tax more than 100 services.
In addition to problems related to competitive disadvantages, job loss and tax
administration, taxes on services raise a host of other concerns, including increasing costs
for government, disproportionately impacting small businesses, tax pyramiding, etc.
As the debate on taxing services continues, it is important that these problems and
concerns be fully vetted by policymakers. To that end, CalTax will discuss the more
detailed issues individually in future publications – and until a service tax is imposed in
California, this service will be provided tax-free!
February 13, 2015
2
CALTAX COMMENTARY:
Taxing Business Inputs Would Put California Companies at a
Competitive Disadvantage
By CalTax Fiscal Policy Director Therese Twomey
In our previous piece on the topic of taxing services, we discussed some
of the problems faced by states that have attempted a broad-based
services tax, and we enumerated several concerns that require careful
consideration by policymakers. Chief among those concerns is the
taxation of business inputs.
Business inputs are raw materials, resources, information, people and
services that are placed in a process to support or produce a desired outcome or product.
Within the context of a sales tax on services, business inputs generally refer to the myriad
different types of services that are purchased by one business from another to produce a
product or service. Architectural design services purchased by a construction company, for
example. Since these types of service purchases often occur between businesses, these
transactions often are referred to as “business-to-business” sales (or, in legislative jargon,
“B2B”).
When it comes to taxing services, economists and tax experts generally recommend
against taxing business-to-business sales, because such a tax puts in-state businesses at
a competitive disadvantage, is difficult and costly to administer, and results in tax
pyramiding.
Competitive Disadvantage
If California were to impose a sales tax on services, California businesses would be placed
at a competitive disadvantage, because the tax would make it more expensive for
California companies to produce and provide goods and services relative to businesses in
other states. Keep in mind, California already is a higher-cost state because of our
regulatory requirements, real estate prices, environmental policies, etc. Moreover, certain
types of labor related to manufacturing and fabrication of tangible goods already are
taxed.
For some businesses, a service tax may lead to higher prices – and all other factors being
equivalent, higher-priced California products or services will be less in demand than their
lower-cost, out-of-state counterparts. Lower demand for a product or service often forces
businesses to cut operational costs through layoffs and reduced investments.
Let’s look at one example. Company A is a California-based consulting services provider
that would have to add a sales tax on top of its normal fees. The tax increases the overall
cost of Company A’s service, putting it at a pricing disadvantage. Purchasers of these
services can go to an out-of-state consulting firm to avoid the tax, or scale back on use of
the service. Due to decreased sales, many businesses faced with situations similar to
Company A would be inclined to reduce their workforce, cut operations or relocate to a
lower-cost state.
Some businesses may be unable to pass along the cost because they compete in national
and international markets. These businesses may be forced to move their operations to
lower-cost states to remain competitive. In this example, Company B is a California-based
purchaser of taxed product-design services.
The service tax increases the cost of doing business for Company B, but since the
company produces goods that are similar to others that are sold in the national market,
Company B cannot raise its prices without losing market share. To remain competitive,
businesses like Company B tend to reduce or eliminate investment in the taxing state and
relocate out of state.
It is because of the competitive disadvantages created by a service tax on business-tobusiness sales – and the resulting threat to jobs and economic growth – that states like
Florida, Maryland, Michigan and Massachusetts repealed their sales tax on services.
Costly and Difficult Administration
Taxing business inputs also poses significant and costly administrative, auditing and
compliance challenges for both the state and taxpayers. It would be difficult, if not
impossible (especially for multi-state businesses), to determine where a particular service
is consumed.
For example, at what point would the service be taxed if computer software
development/consulting services are contracted in one state, performed in a second state,
delivered to clients in a third state, and distributed by the client to business locations in
additional states? I posed this question to Senator Bob Hertzberg, author of this year’s
sales tax on services measure (SB 8), and he half-jokingly announced to the informal
group of stakeholders that I was not allowed to ask any more questions!
From a cost perspective, the State Board of Equalization indicated that it would cost
upward of several hundred million dollars a year to administer taxes for just a few dozen
services – and that doesn’t include collection and remittance costs borne by sellers.
Tax Pyramiding Effect
Finally, from a tax policy perspective, a tax on services leads to “tax pyramiding” – taxing
an input as it moves through the various stages of production, and taxing it again when
purchased by a consumer. This not only reduces tax transparency, but also causes
distortion, making it impossible for policymakers to determine the final effects of the tax
on the consumer.
February 27, 2015
2
Impact on the Economy
As California lawmakers revisit the idea of taxing services, it is important to keep in mind
the experiences from other states that have been there and done that – only to
subsequently undo it. Imposing taxes on business-to-business services increases costs for
in-state businesses, making them less competitive and more inclined to cut costs by
reducing their workforce, decreasing investments or relocating to lower-cost states – all of
which hurt our state’s economy.
February 27, 2015
3
March 13, 2015
CALTAX COMMENTARY:
Other Competitive Disadvantages Caused by a Tax on Services
By CalTax Fiscal Policy Director Therese Twomey
A couple of weeks ago, we discussed concerns over imposing a sales tax
on business inputs and business-to-business sales (B2B), and how such
a tax would be costly to administer and would result in tax distortion. We
also looked at the different ways in which a tax on services would put
California businesses at a competitive disadvantage relative to out-ofstate companies. This week, we’ll look at how a service tax also creates
competitive disadvantages between in-state businesses that contract for
services vs. those with in-house staff; between businesses of different
sizes; and between private service providers vs. federal providers.
Contracted vs. In-House Services
A sales tax generally is triggered at the point of sale. This means a business that procures
product design/consulting services, for example, would be subject to a service tax
because a “sale” has occurred, while a competitor with in-house staff would not be taxed.
Obviously, this would create cost disadvantages between the two businesses.
For example, Company A is a manufacturer that employs in-house engineers because it
produces only one product. Company B manufactures a product that competes with
Company A’s product, but also manufactures other cutting-edge products that involve
highly specialized and changing product designs. Company B, like other similarly situated
companies, tends to outsource its engineering work because specialized engineering firms
may be better suited to serve its business needs. A service tax would increase overall
production costs for Company B, but not for Company A, putting Company B’s product at
a pricing disadvantage.
Some argue that a service tax would increase employment by incentivizing businesses to
hire in-house staff. While this may be true in limited situations, this approach does not
work for all business models, and may eliminate cost efficiencies associated with
outsourcing specialized services. Also, some businesses can’t afford to hire additional
staff. Small businesses, especially, would be least able to afford hiring in-house
employees for functions such as accounting, repair, maintenance, payroll, and legal
representation. Moreover, when a business hires in-house staff to perform previously
outsourced work, this usually causes a shift in employment, and not necessarily
employment growth.
Different-Sized Businesses
The downsides associated with a service tax tend to be more pronounced and
disproportionate for smaller businesses.
Take, for example, two competing grocery stores, both located in California. Business A
has a single store, and contracts with a local accountant for its bookkeeping and tax-filing
functions. Business B has multiple locations and, due to higher bookkeeping and taxreporting volume, employs an in-house accountant. A tax on accounting services
increases costs for Business A, but not B, and exacerbates the competitive disparity
between the two (Business A already operates at a different price point due to B’s ability
to purchase merchandise at volume discount prices).
The gap could be even greater, depending on the structure of the competitors. Just
imagine the disparity that would be created between a local mom-and-pop grocer that
would have to pay taxes for all kinds of outsourced services, and a larger competitor that
would not be subjected to these cost increases because it employs in-house workers and
benefits from other economies of scale.
Federal vs. Other Service Providers
In some instances, a service tax also favors federal service providers over other service
providers. Take, for example, the repair and maintenance of California’s levee system,
which sometimes is performed by the U.S. Army Corps of Engineers and sometimes is
contracted out to private companies. Who would have the upper hand if the private
contractor’s cost is 7.5 percent to 10 percent higher (based on the current sales tax rates
in various California localities) because the private contractor is subject to a service tax
while the federal agency is not, due to the U.S. Constitution’s Supremacy Clause, which
prohibits states from imposing taxes on the federal government?
This competitive disadvantage also would extend to shipping and delivery services
provided by FedEx, UPS, DHL, etc., vs. those provided by the U.S. Postal Service;
admission prices for parks owned and operated by the state or non-profit concessionaires
vs. national parks; and others.
Who Loses?
Good public policy dictates that taxes be imposed in a manner that promotes market
neutrality, and does not competitively disadvantage one industry or group of taxpayers to
the benefit of another. A service tax runs counter to the principles of sound tax policy. It
exacerbates competitive disadvantages among in-state businesses, puts California
businesses at a competitive disadvantage relative to out-of-state businesses, and
sometimes tips the scale in favor of the federal government over California companies.
Who loses the competition if a service tax is imposed? California residents, because they
will end up paying higher taxes … California businesses, because of increased operational
costs … and California workers, because of lost jobs and opportunities.
March 13, 2015
2
April 10, 2015
CALTAX COMMENTARY:
Disadvantaged Families and Communities Would Bear
Brunt of Tax on Services
By CalTax Fiscal Policy Director Therese Twomey
“Tax reform” was the topic of one of the featured panels at this
year’s CalTax Annual Meeting, and of course, the topic of taxing
services was discussed. While the panelists had differing
perspectives on the issue, they and other policymakers, scholars
and tax experts tend to agree on a number of overarching principles
that constitute sound tax policy. Among those tenets is tax equity.
Tax equity refers to the idea that taxes should be neutral. An equitable tax should
neither be regressive – imposing a greater burden on lower-income taxpayers – nor
steeply progressive, imposing a far greater burden on higher-income taxpayers
simply because they are deemed to have the ability to pay excessive rates.
In general, higher-income households tend to spend a smaller portion of their
income on goods and services than do lower-income households. When a tax is
imposed on purchases of everyday goods like clothing, shoes and household
supplies – as is the case with California’s retail sales and use tax – it is considered
to be a regressive tax, because working families and disadvantaged communities
tend to pay a larger portion of their income for these taxes than do higher-income
taxpayers.
Expanding the retail sales and use tax to services, as some lawmakers have
proposed, would make it even more regressive.
The California Budget Project (which recently changed its name to the California
Budget & Policy Center) concluded its analysis of a service tax by saying, “Absent a
reduction in the state’s sales tax rate or other efforts to minimize the regressive
impact of taxing services, extension of the tax would increase the share of taxes
paid by low- to middle-income Californians, who already pay the largest share of
their income toward taxes, relative to high-income households.” (California Budget
Project, “Should California Extend the Sales Tax to Services?” 2011.)
To put this into perspective, a tax on repair and maintenance services, for example,
would raise the cost for working families who need to fix their appliances, cars and
homes by 7.5 to 10 percent, while having no effect on those who can afford to buy
new appliances, cars, homes, etc. Basically, such a tax would harm those who use
these services the most, and who likely are least able to afford them.
This tax imbalance also would apply to public agencies in disadvantaged
communities. A service tax would disproportionately hit older public facilities and
infrastructure located in lower-income areas that are in greater need of repair and
renovation. There would be much less impact on newer buildings and infrastructure
in developing neighborhoods.
A 7.5 percent tax on a facilities renovation project could mean a $1,075,000 bond
on the ballot instead of a $1 million bond measure. In lower-income communities, a
7.5 percent difference in a parcel tax could mean the difference between passage or
failure of the ballot measure. If the funding measure is not approved, the facility
will fall into further disrepair, and maintenance costs will be even higher down the
line. If the tax is approved, taxpayers will pay more – not only for the repair itself,
but also for the debt service on an additional $75,000, which totals more than
$113,000 (including $38,800 in interest costs) over a 30-year period at the current
3 percent interest rate.
As different proposals to expand the retail sales and use tax to services have been
introduced in California, there have been no apparent solutions to the myriad
problems and challenges associated with the tax, as discussed in our prior
commentaries. What is more apparent is that a service tax would run counter to
sound tax policy principles relative to tax equity, worsen California’s already
regressive sales tax, and disproportionately hurt those families and communities
that are least able to afford it.
April 10, 2015
2
April 17, 2015
CALTAX COMMENTARY:
Consumers’ Wallets Would Take a Big Hit From New Tax on
Services
By CalTax Fiscal Policy Director Therese Twomey
Expanding the retail sales and use tax to all services that currently are
non-taxable would cost California families and businesses close to
$123 billion a year, according to the State Board of Equalization, which
is responsible for administering the sales and use tax. Yes, that’s “B”
for billion, and that’s based on the average statewide tax rate of 8.42
percent, not the 10 percent tax rate that is actually charged in several
of the state’s larger counties. What is your share of the $123 billion in
new taxes?
To get a better idea of just how much a sales tax on services would cost, some of my
colleagues and I decided to keep track of all of our service expenses in March, and tally
them up. Our self-reported data is not meant to be an economic model, but serves as a
hypothetical example for a four-member, two-member or single-member household with
similar expenses. Of course, some households may have more of one type of expense,
and less of another.
The table below shows what we spent for various types of services for the month of
March, and the amounts relative to each category. We also differentiated between
households of different sizes. As you can see from the table, based on the average
statewide tax rate of 8.42 percent, a family of four could pay approximately $270 a
month, or $3,230 a year, in higher taxes if the retail sales tax were expanded to services.
A two-member household with no dependents could pay almost $318 a year ($26
monthly), and a single-member working individual could pay $2,043 a year in additional
taxes, or the equivalent of $170 a month.
Your monthly expenses undoubtedly are different – for example, a friend who recently
went through a divorce just about fainted when he considered the prospect of having to
pay an additional 8.42 percent for all of the legal services – so plug in your own numbers
to the table on the next page to see how much of a bite a sales tax on services would
have on you and your family’s budget.
Household
Two-member
Single-member
Service Type
Four-member
(Two adults and
two children)
(Two adults aged
20-35 with no
dependents)
(landscaping, pool cleaning,
house cleaning, pest control, etc.)
$525
--
$210
(child care, after-school care,
elderly care, etc.)
$975
--
--
(tax preparation, legal, delivery,
etc.)
$279
$78
$1,200
(haircut, manicure, dry cleaning,
gym membership, etc.)
$274
$69
$144
$478
--
--
(home and cell phone service,
cable or satellite TV, etc.)
$486
$125
$440
(movies, golf, restaurant tips,
etc.)
$180
$42
$28
$3,197
$314
$2,022
$269.19
$26.44
$170.25
$3,230.25
$317.26
$2,043.03
Home
Dependent care
Professional services
Personal
Repairs
(car, appliances, flooring, etc.)
Phone and television
Entertainment
Total Amount Spent on
Services
Additional Tax Per
Month*
Additional Tax Per Year*
(One adult,
professional
occupation)
You
*Using the average statewide tax rate of 8.42 percent.
While the $123 billion tax increase already is bad enough, it does not take into account
lost opportunity costs or other economic factors, such as higher prices for products and
everyday goods. Additionally, what is the cost to California families if employers are
forced to make job cuts? How much more of a drain will this be on the state’s already
bankrupt unemployment insurance fund? Will this force more families into public
assistance programs like Medi-Cal? How will we pay for this (and other state programs) if
businesses relocate or downsize, and fewer companies and workers are paying income
taxes? And, how do you measure the lost opportunity costs when employers choose to
expand in other states?
These and many other implications need to be carefully examined. We need to be
concerned not just about the checks we would have to write to pay for the tax, but also
the jobs, revenue and economic opportunities that will be lost.
April 17, 2015
2
The Challenge of Taxing Services
Tax & Fiscal Facts • March 2015
At Issue
Every few years, there are renewed discussions of imposing a sales tax on services in
California, often proposed in the name of “modernizing the economy,” closing California’s
budget gap, or stabilizing cyclical fluctuations in tax revenue. This year, the discussion is
precipitated by talk of “tax reform” and options to increase revenue due to the approaching
sunset of Proposition 30’s temporary sales and use and personal income tax increases.
The California Tax Foundation was established by the California
Taxpayers Association in 1980 as a 501(c)3 not-for-profit
organization to promote sound tax policy through objective,
thought-provoking research.
1215 K Street, Suite 1250 • Sacramento, CA 95814 • (916) 441-0490 • www.caltaxfoundation.org
The Challenge of Taxing Services
•
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Tax preparation and advice
Attorney services for divorce proceedings,
child custody and criminal cases
Veterinary services and pet grooming
Car rentals and storage unit rentals
Home alarm/security service
Tips at restaurants
And many more…
Under most proposals to impose a service tax,
services used by businesses would be taxed if they
are out-sourced and not provided in-house. Some
examples:
•
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•
While medical services most likely would be exempt from a sales tax on services, some
health-related costs could be subject to tax.
What services could be subject to tax?
Currently, California individuals and businesses
pay taxes on the purchase or use of various tangible
goods, but do not pay taxes on services. Past
legislative proposals have varied in the specific
services that would be subject to tax; however, most
would tax everyday services including:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
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Accounting and payroll
Legal and attorney services
Research and development
Architectural design and construction
Product design and engineering
Consulting
Manufacturing
Advertising
Procurement, transportation and shipping/
delivery
Equipment installation
Repair and maintenance
Telecommunications and cellular service
Security
And many more…
Would a sales tax on services
“modernize” the tax system and
promote economic growth?
Grooming (haircuts, manicures, spa services)
Child care and babysitting
Dental cleanings, fillings and braces
Home phone and cell phone service
Cable and satellite television
Music lessons, dance lessons and golf
instruction
Admission tickets to movies, sporting events
and amusement parks
Access to golf facilities and ski resorts
Shipping and delivery of packages
Installation services for flooring, windows and
appliances
Repair and maintenance of cars, homes and
appliances
Lawn and pool maintenance and cleaning
Proponents of a sales tax on services often
seek to raise tax revenue and “modernize the
economy,” because, in their opinion, there has
been a shift from the consumption of goods to
a consumption of services. There are several
reasons why this premise is flawed, and why a
sales tax on services would prove harmful to the
state’s long-term economy.
First, while the economy in general has
moved from manufacturing to service industries
from an employment perspective, from a taxable
consumption perspective, there is simply no
2
The Challenge of Taxing Services
What problems are associated with
taxing business-to-business sales?
conclusive evidence that consumption of services
has outpaced the consumption of goods. To
the degree that taxable sales have declined
as a percentage of personal income, it could
be explained by several reasons: (1) greater
consumption of goods that currently are exempt
from taxes, such as food, prescription medicines,
etc.; (2) higher consumption of various services
that the Legislature likely will exempt from a
sales tax, such as medical care and education;
and (3) the decline in prices of goods due to lower
production costs overseas.
Second, taxed activities tend to grow slower
than untaxed activities. If California’s economic
future depends on the production of high valueadded services, taxing those services merely
serves to slow economic growth. A tax on labor,
at a time when California’s unemployment rate
remains high and the state’s recovery is tenuous,
would be a significant setback to regaining the
jobs lost during the last several years.
While broadening the sales tax to services
would bring some amount of new revenue to the
state in the short term, it could stifle long-term
economic development. For example, taxing
services would lead to a migration of not only
service jobs and businesses out of state, but also
the jobs and businesses that either support or
are end-users of those taxed services. A tax on
services also would be a deterrent to business
expansion or relocation in the state. All other
factors being relatively equal, business expansion
and relocation decisions typically are predicated
on factors that maximize returns on investment
– and a sales tax on services would mean lost
investment and employment opportunities.
Migration of businesses and jobs would not
only hurt workers, but also would lower corporate
tax and personal income tax revenue for the state.
Additionally, fewer higher-paying jobs means
less homeownership, which reduces property tax
values and revenue. And fewer jobs means less
disposable income for purchases of goods that
support the sales tax revenue base. All of these
situations limit economic growth for the state over
the long run.
Economists and tax experts generally
recommend against imposing a service tax on
business-to-business sales, or “business inputs,”
for a variety of reasons.
First, a service tax puts in-state businesses at
a competitive disadvantage, because it increases
the cost to produce or provide a good or service.
For some businesses, this increase may lead to
higher prices, creating pricing disadvantages
for California goods and potentially reducing
demand. This would result in lower product
sales and decreased manufacturing in the state.
Other businesses may be unable to pass along the
cost, because they compete in the national and
international markets. These businesses would be
inclined to reduce investment and employment
in the state to compensate for the higher costs,
resulting in fewer jobs and opportunities for
economic growth.
These competitive disadvantages would extend
to in-state businesses that contract for services
Building, construction, repair and other maintenance or repair services could be subject
to a sales tax on services.
3
The Challenge of Taxing Services
vs. those with in-house staff; between businesses
of different sizes; and between private service
providers vs. federal providers. For example,
businesses that procure services would be subject
to the tax, while competitors with in-house staff
would not. Smaller businesses, which tend to
outsource their accounting, repair, maintenance,
payroll, etc., would be disproportionately
impacted because they would pay taxes on these
services, while larger competitors that employ
in-house staff, and may already benefit from
other economies of scale, would not. Additionally,
a service tax sometimes favors federal service
providers, such as the U.S. Postal Service (which
would not be subject to tax under the U.S.
Constitution’s Supremacy Clause) over private
providers like FedEx or UPS, which would be taxed.
A service tax on business inputs also
poses significant administrative, auditing and
compliance challenges for both the state and
taxpayers, because it would be difficult (especially
for multi-state businesses) to determine where
a service is consumed. Costs for the state to
administer select services have been estimated at
upward of several hundred million dollars a year,
not including compliance costs for taxpayers.
Finally, from an economic and tax policy
perspective, a tax on services leads to “tax
pyramiding” – taxing an input as it moves through
the various stages of production, and taxing it
again when purchased by a consumer. This not only
reduces tax transparency, but also causes distortion,
making it impossible for policymakers to determine
the final effects of the tax on the consumer.
What impact will a service tax have
on California’s businesses, families and
economy?
A broad-based tax on services would expose the state
to numerous adverse economic consequences:
• Puts California businesses at a
competitive disadvantage. California has
the highest state sales tax rate in the nation,
and the highest top personal income tax
rate compared to other states.1 A sales tax
on services would make it even harder for
California companies to compete, on several
levels. For example, California service industries
would have a significant pricing disadvantage
compared to services provided in other states.
Not only would this reduce demand for
California-based services, it also would make it
more costly for California companies that use
taxable services to produce or provide goods
and services. California products/services
would be more expensive and, all other factors
being equivalent, would have less demand
than their out-of-state counterparts. A tax on
services would threaten many of California’s key
industries, including high-tech, manufacturing,
and the financial sector.
• Reduces jobs and investment in
the state. Lower demand for a product
or service often forces businesses to cut
operational costs through layoffs and
reduced investments. Other businesses may
be forced to move their operations to lowercost states to remain competitive. Both
scenarios reduce opportunities for job and
economic growth in California.
Pet grooming and veterinary services could be subject to a sales tax on services.
4
The Challenge of Taxing Services
Business services, such as architectural, interior design, graphic design, printing, accounting, legal, etc., could be subject to a sales tax on services.
• Puts small businesses at risk,
potentially drives them underground.
Higher taxes on certain services could lead to
a do-it-yourself approach. For example, if a
tax were imposed on pool cleaning services,
some taxpayers may opt to do the work
themselves rather than pay the increased cost.
This could put many small businesses and
their employees out of work. Additionally, it
could drive others to move their operations
into the underground economy, putting
law-abiding service businesses at an unfair
disadvantage. Both of these situations would
reduce tax revenue to the state’s general fund.
more regressive tax base, because the tax
requires working families and disadvantaged
communities to pay a larger portion of their
income than higher-income taxpayers for
service-related taxes. The California Budget
Project notes that “extending the sales tax to
services is unlikely to improve the equity of
the sales tax.”2 Repair services are particularly
integral to budgets of families who cannot
afford to purchase a new appliance, car or
home. Costly taxes would have to be paid on
services to repair leaky pipes, replace a roof,
or perform any other needed maintenance and
repair. This runs counter to the basic policy
principle that taxes should be based on an
individual’s ability to pay.
• Discriminates against small businesses.
Larger businesses that can afford to hire
employees to do the work of an independent
contractor would not pay sales taxes on
services performed by these employees.
Smaller businesses, however, would be forced
to pay sales tax, as they must contract for
these services. This results in higher costs on
small businesses.
• Increases costs to government. Unlike
many states, California taxes sales made
to and by state and local governments.
Government entities, including school
districts, are huge consumers of services, and
would incur cost increases of 7.5 percent to
10 percent on taxed services they purchase.
Moreover, government is a huge seller of
services relating to everything from education
(colleges and universities) to housing (lowincome housing authorities) to medical care
• Hurts working families and
disadvantaged communities. Expanding
the sales and use tax to services creates a
5
The Challenge of Taxing Services
of which are unfamiliar with sales and use
tax reporting and remittance requirements.
The BOE potentially would have to register
teenagers who provide babysitting services,
mow lawns, or tutor students.
The agency also would need to develop a
new method for auditing service providers,
which will prove difficult, because BOE staff
would have to determine where a particular
service was used or consumed, if doing so is
even possible. For example, at what point
would the service be taxed if computer
software development/consulting services are
contracted in one state, performed in a second
state, delivered to clients in a third state, and
distributed by the client to business locations
in additional states?
A BOE analysis of a 2011-12 sales tax on
services proposal (AB 1963 – Huber) estimated
state administrative costs in the neighborhood
of $847 million in the first year and more than
$600 million annually thereafter.3
Transportation and movement of goods could be subject to a sales tax on services.
(public hospitals). Thus, taxing services shifts
a significant portion of the sales tax burden
to government, thereby increasing the cost
of government for taxpayers and those who
consume services sold by the government (i.e.,
increasing tuition on college students).
• Picks winners and losers. Past proposals
have sought to tax some industries, while
exempting others. Good public policy dictates
that taxes be imposed in a manner that
promotes market neutrality, and does not
competitively disadvantage one industry
or group of taxpayers to the benefit of
another. A service tax runs counter to the
principles of sound tax policy. It exacerbates
competitive disadvantages among in-state
businesses, puts California businesses at a
competitive disadvantage relative to outof-state businesses, and sometimes tips the
scale in favor of the federal government
over California companies. These types of
proposals create winners and losers, and
benefit one industry or business to the
detriment of another.
Past and current legislative proposals
to assess sales tax on services
Over the past two decades, there have been
sporadic attempts to impose sales tax on services
in California. In 1995-96, AB 194 (K. Murray)
proposed to tax a number of specified services,
including general repair of tangible personal
property, installation of tangible personal property,
and computer programming. In 2005-06, AB 9
(Coto) proposed to impose a tax on the gross receipts
derived from specialized services, as defined. Both
measures failed in the policy committee.
As part of the 2009-10 budget process, draft
language proposed to enact a sales tax on a number
of specific services, including veterinary care
and admission to sporting events. However, the
proposal never made it into a bill. More recently,
two measures were introduced in 2011-12 proposing
a sales tax on services – the previously mentioned
AB 1963 (Huber), and AB 2540 (Gatto). AB 1963
proposed a broad sales tax on services (with a limited
number of services exempted), along with a reduction
• Creates costly and extensive
administrative problems. Imposing a
sales tax on services would lead to extensive
administrative problems. The State Board of
Equalization (BOE) would have to identify
and register myriad new businesses, many
6
The Challenge of Taxing Services
in the personal income tax and the sales and use
tax rates. AB 2540 proposed to tax specifically
enumerated services. Both measures subsequently
were amended to remove provisions that would enact
a sales tax on services.
The latest proposal, SB 8 (Hertzberg), introduced
in the 2015-16 legislative session, seeks to impose
a sales and excise tax on services at an unspecified
rate, beginning on January 1 of an unspecified year.
The sales tax is imposed on sellers of taxable services.
The excise tax is imposed on buyers of services. Both
taxes would be imposed independently of each other,
and are expected by proponents to raise taxes by $10
billion a year. The measure also intends to reduce the
personal income tax for low-income earners, while
“evaluating” the current corporate tax rate along with
an increase in the state’s minimum wage. While the
implementing language provides no exemption from
either tax, legislative findings and declaratory language
elsewhere in the bill intend to exclude health care
services, education services, and small businesses with
gross sales of less than $100,000 a year. Since neither
the sales nor excise tax has a stated rate and there is
no implementation date (at the time of publication of
this report), the measure remains a majority-vote bill.
However, if the measure is amended to actually enact/
impose a tax increase, it will require a two-thirds vote.
Experience from other states
Although many states tax some services, there
is no apparent trend toward expanding the sales
tax base to include more services. According to
the Federation of Tax Administrators (FTA), other
states have been reluctant to undertake a broadbased expansion of the sales tax base since several
states have repealed such expansions shortly after
enactment. Only two states – Hawaii and New
Mexico – have broad-based sales taxes on services,
while South Dakota and West Virginia are the only
other states to tax more than 100 services.4
Four states repealed sales taxes on services
shortly after enactment:
• Florida. Hailed as a way to meet the
expanding fiscal needs of this fast-growing
state, the Florida services tax was expected to
After-school programs, tutoring, restaurant tips, and automotive repair services could be
subject to a sales tax on services.
7
The Challenge of Taxing Services
bring in $1.3 billion annually. Florida enacted
its services tax in July 1987 and repealed
it six months later because it put in-state
businesses at a competitive disadvantage with
out-of-state counterparts.
• Massachusetts. With legislation enacted
in 1990, Massachusetts attempted to tax
only services provided to businesses. These
included legal services, accounting, auditing,
bookkeeping, engineering and architectural
services. The tax would have created
competitive disadvantages for service providers
located within Massachusetts, but the state
repealed the tax two days after it took effect.
• Maryland. In 2007, the Maryland
Legislature enacted a computer services tax,
covering web design, facilities management,
custom computer programming, data center
support, systems integration, installation and
maintenance, computer training and data
entry. According to the Maryland Computer
Services Association, the tax would have
been “a serious blow” to Maryland IT
businesses, which at the time employed
68,000 people with an annual payroll of $5.2
billion. The tax was repealed in 2008, before
it went into effect.
• Michigan. The Michigan Legislature enacted
a 6 percent tax on services in October 2007.
This tax was imposed on business service
center services, consulting and investment
advice, janitorial services, landscaping,
warehousing, packaging, procurement, and
personal services. Before the tax became
effective, taxpayers formed a coalition
to repeal it, arguing that it would hurt
Michigan’s economy and force jobs to leave
the state. The tax was repealed just 17 hours
after its effective date.
Conclusion
While imposing a sales tax on services would
bring in some additional short-term revenue to the
state, it would stifle the state’s economic growth in
the long term. California businesses would be put at
a competitive disadvantage, because goods produced
in-state would be less price-competitive compared
to their out-of-state counterparts. Jobs and
investment opportunities would be lost as employers
seek to relocate or expand in lower-cost states.
Small businesses and working families would be
disproportionately affected. And costs to administer
a broad-based proposal are estimated to be in the
hundreds of millions of dollars a year.
Endnotes
1
The Tax Foundation, State and Local Sales Tax Rates, Midyear 2014.
2
California Budget Project, Should California Extend the Sales Tax to Services?, 2011.
3
State Board of Equalization, Draft Staff Legislative Bill Analysis of AB 1963 (Huber), 2012.
4
Federation of Tax Administrators, FTA Survey of Services Taxation – Update, 2008.
The California Tax Foundation was established by the California Taxpayers Association in 1980 as a 501(c)3 not-for-profit organization
to promote sound tax policy through objective, thought-provoking research. More information about the foundation, including access to
recent research, is available online at www.caltaxfoundation.org. For information on ways to make a tax-deductible charitable contribution
in support of the foundation, email [email protected].
1215 K Street, Suite 1250 • Sacramento, CA 95814 • (916) 441-0490 • www.caltaxfoundation.org