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California Proposed Tax on Services Rears Its Head Once Again

This article is reproduced with permission from Spidell Publishing, Inc.

For the fourth time in the last five years, legislation has been introduced to impose a sales tax on services. However, while the other bills were legislative intent bills, SB 993 actually provides specifics. It would:

  • phase in a 3% sales tax on business-to-business services starting on January 1, 2020;
  • provide a corresponding 2% decrease on the sales tax on goods (making the bill revenue neutral);
  • provide numerous exemptions, such as for small businesses (gross receipts under $100,000), health care, education, residential construction, day care, etc.; and
  • require sellers of the services to collect the tax at the time of sale if the benefit of the service is received in California.

The author of the bill, Senator Hertzberg, has been advocating this broadening of the sales tax base for years, arguing that this is the only way to prevent the volatility that arises from California’s reliance on the personal income tax, while providing a taxing system that more closely reflects our service-based economy.

Strong Opposition

The Senate Governance and Finance Committee held its first hearing on the bill on May 16, 2018. This hearing was a “conversation starter” and will be followed by numerous other hearings. However, if this hearing is any indication, this bill, like other bills introduced in previous sessions, could be dead on arrival.

In the bill’s legislative analysis, there are over 100 businesses and associations listed as opposed in contrast to “unknown” supporters. This was also reflected at the hearing, with two unions voicing support, while dozens of business organizations spoke against the bill. (One lobbyist representing the union actually then turned around and voiced opposition on behalf of another business group he was representing.)

The concerns voiced include the following:

  1. Increased costs to consumers: The tax will result in increased costs to consumers as a result of the pyramiding effect. One example included a hospital whose services are exempt, but it would still be required to pay tax on legal, billing, and accounting services, which would increase its costs that would be passed on to patients. Herzberg responded that for many businesses, the tax on services will be offset by the reduced tax on goods.
  2. Pushing jobs outside California: If businesses with low profit margins must pay increased costs, they may be forced to move outside California. Hertzberg countered that it is anticipated that 20% of the tax will be paid by out-of-state businesses.
  3. Compliance nightmares: This will be a compliance nightmare for businesses that have never been previously subjected to the tax, plus they will need to determine where the benefit of the service is received. This will especially impact small businesses that cannot perform many legal, consulting, and design services in-house. Hertzberg argued that these taxpayers can just purchase a $12 software package to perform these functions.
  4. It has not worked in other states: Four other states have enacted a broad-based tax on services, and all of them repealed the tax.
  5. Is this even needed now? With federal tax reform, the new gas tax, the new cannabis tax, the cap and trade program, and the expanded real estate transfer tax, California has more than enough revenues coming in. Hertzberg’s response was that it is better to take advantage of this time of prosperity to develop a reasoned approach to tax reform rather than wait until there is another recession and we are operating in crisis mode.
Is there a ballot initiative coming?

During an exchange between Senator Hertzberg and a committee member, it was hinted that if the Legislature does not adopt the service tax, this may be headed to the ballot. Senator Murdoch noted that this would be an easy sell to the voters, as it could easily be sold as a tax on big business and a corresponding reduction in tax to the people. Hertzberg acknowledged that the concept polled very well.

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