California bill would tax business services, reduce state sales tax rate

Like most states, California taxes some services and exempts the rest. However, it taxes very few — only some service and labor costs that result in the creation of tangible personal property. According to Senator Bob Hertzberg, “49 states tax services, and 43 of those states tax more services than California.”

At its inception, sales tax applied primarily to the transfer of tangible personal property in all states. Back then, in the 1930s, the sale of goods far outpaced the sale of services. But spending habits have shifted over time, and Americans now spend much more on services than goods. States that tax few services feel that change in the weight of their purse.

Over the past few years, several states have made a move to tax more services, with mixed results. Massachusetts imposed a tax on software services in 2013, but then repealed it due to strong opposition by the business community. Missourians were so outraged over the tax on admissions to instructional classes (e.g., dance, yoga) that the state prohibited further taxation of services in 2016. That same year, Pennsylvania Governor Tom Wolf largely abandoned his plan to tax a variety of services, both personal and professional, in the face of persistent opposition.

North Carolina had more success in 2016 with taxing certain repair, maintenance, and installation services, though taxpayers found the new policy so confusing that the state adopted a lengthy grace period (the Sales Tax Base Expansion Protection Act). And despite protest from yoga aficionados, Washington, D.C. successfully imposed a tax on fitness classes and other personal services in 2014.

A bill seeking to broaden sales tax to services was also introduced in California in 2015. Its sponsor, Sen. Hertzberg, pointed out at the time that 80 percent of the state’s economy was related to the sale of services, not goods, “and most of these services are untaxed.” He added that a tax on all services would provide a steadier stream of revenue than the personal income tax, which tends to plummet during recessions.

That measure received little support. A 2016 report on tax reform issued by Controller Betty Yee found that a broader sales tax would be no less regressive than the existing tax, but suggested that excluding basic services and lowering the overall rate could help offset the burden. Hertzberg has taken that advice to heart: Senate Bill 993 (2018) would broaden sales tax to only a handful of services, reduce the state sales tax rate, and be revenue neutral.

Proposed tax on sales of services

Starting January 1, 2020, California would tax the purchase of “high-end business services, such as those provided by lawyers, consultants, and accountants for corporations and other high-income businesses.”

Services related to child care, education, health care, interest, and rent would be exempt from the tax, as would very small businesses. In addition, the tax would not apply to the sale of a service by a California business to an out-of-state location.

The rate would increase incrementally as follows:

• Prior to January 1, 2020: 0%
• January 1, 2020–December 31, 2020: 0.75%
• January 1, 2021–December 31, 2021: 1.5%
• January 1, 2022 and beyond: 3%

Hertzberg says now is the time to move forward with tax reform: “I have been working on this issue for years. The severe impact of the Trump tax on California means now is the time to bring this idea to life.”

Proposed tax on sales of services by certain remote sellers

SB 993 would also tax sales of services by certain out-of-state sellers.

Sales tax would apply when an out-of-state seller enters into an agreement with a person in California to directly or indirectly refer potential purchasers of services to a retailer, whether by internet link or otherwise, provided both of the following conditions are met within the preceding 12 months:

• The retailer’s total cumulative sales price of services sold to referred purchasers in California exceeds $10,000.
• The retailer’s total cumulative sales of services to purchasers in California 
  exceeds $1,000,000.

Proposed state sales tax rate change

To ensure the above changes do not increase tax revenue in California, the sales tax rate on goods would drop incrementally from January 1, 2020, to January 1, 2022, as follows:

• Prior to January 1, 2020: 4.75%
• January 1, 2020–December 31, 2020: 4.25%
• January 1, 2021–December 31, 2021: 3.75%
• January 1, 2022 and beyond: 2.75%

Like Hertzberg’s previous attempt to broaden sales tax, SB 993 isn’t garnering a great deal of support. According to the California Chamber of Commerce, it’s a job killer that would lead to higher prices or even an exodus from the state: “If the new services tax is adopted, any other state in the country will have a more business-friendly tax environment than California and lower prices for the services covered.”

But the senator is undaunted. He’s taking the long view, seeing this as an opportunity to start a conversation about much-needed tax reform.  

Learn more about California sales tax.