BILL ANALYSIS AB 9 Page 1 Date of Hearing: April 25, 2005 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Johan Klehs, Chair AB 9 (Coto) - As Amended: April 18, 2005 2/3 Vote. Fiscal Committee SUBJECT : Education Finance: Sales and use taxes: Services SUMMARY : Requires the Legislature and the Governor to ensure that the current per pupil level of funding for California's K-12 public schools grows by at least 20% annually, beginning in fiscal year (FY) 2006-07, until it reaches a level of at least $10,200 per pupil in current dollars. Requires that additional funding first be used to reduce teacher-pupil ratios so that they are equal to or less than the average teacher-pupil ratio of the 10 states with the lowest ratios for public elementary and high schools. Requires that per pupil funding equals or exceeds the average of the top 10 states by FY 2011-12, and that it remain among the top 10 each year thereafter. Establishes a sales tax on specialized services to increase funding for K-12 education, and specifies the services that fall within that category. Specifically, this bill : 1)States legislative findings and declaration as follows: a) Section 8.5 of Article XVI of the State Constitution clearly expresses the will of the people of California to support public elementary and high schools at a level that is equal to or greater than the average annual per pupil expenditure of the 10 states with the highest annual expenditures, and to reduce the average class size so that it is equal to or less than the average class size of the 10 states with the lowest class size. b) The average current expenditures per pupil for 2004 of the 10 highest spending states is $10,300 compared with $7,100 in California. c) The average teacher-pupil ratio for the 10 states with the lowest class sizes is 14 pupils compared with 20 pupils per classroom in California. AB 9 Page 2 d) To achieve the constitutional goals for raising per pupil spending and lowering class size in California, it is the intent of the Legislature to commit additional state resources annually in order to achieve these goals by 2011. 2)Requires the Legislature and the Governor to ensure that the average per pupil level of funding for California's public elementary and high schools increases annually, beginning in FY 2006-07, by at least 20% of the difference between the average annual expenditure per pupil in 2004 of California school districts and the average annual expenditure per pupil in 2004 of the 10 states with the highest current expenditures per pupil, reaching a level of no less than $10,200 per pupil in 2004 dollars by FY 2010-11. 3)Requires that increased per pupil funding provided pursuant to this act shall first be used to reduce teacher-pupil ratios so that they are equal to or less than the average teacher-pupil ratios of the 10 states with the lowest teacher-pupil ratios for public elementary and high schools. 4)Requires the Legislature to ensure that, for FY 2011-12 and each FY thereafter, the average per pupil level of funding for California's public elementary and high schools remains equal to or greater than the average of the 10 states with the highest current expenditures per pupil. 5)Extends the state sales tax to specified services, effective January 1, 2006, either separately or as part of a retail sale, as follows: a) Includes the total amount for which a specialized service is provided, valued in money, in the definition of "sales price". b) Includes the provision of a specialized service by a retailer, valued in money, in the definition of "gross receipts". c) Includes every person providing a specialized service of a kind of which the gross receipts are required to be included in the measure of sales tax in the definition of "seller". d) Includes every seller who furnishes or provides a AB 9 Page 3 specialized service in the definition of "retailer". e) Defines "specialized services" to include: i) Cost of membership to any private club. ii) Information-access services provided through any prefixed telephone, including telephone numbers with the prefix 900 or 976. iii) Marina services, including boat slips and docking services, fuel for watercraft, and watercraft rentals. iv) Custom computer program services. v) Cost to charter an aircraft or limousine to transport passengers in this state. vi) Accounting or bookkeeping services. vii) Legal services. viii) Security and detective services. ix) Telephone services, other than residential telephone services. x) Engineering, architectural, or surveying services. xi) Management, scientific, or technical consulting services. f) Specifies that all tangible personal property (TPP) physically transferred to the customer in connection with the furnishing or provision of the specified services that is not incidental is a sale separate from the service and is subject to sales tax. g) Requires every person desiring to engage in or conduct business providing specialized services within the state to file an application with the Board of Equalization (BOE) for a permit for each place of business. h) Provides that any person who engages as a provider of a specialized service in California without a permit or after AB 9 Page 4 a permit has been suspended or revoked, and each officer of any corporation which so engages is business, is guilty of a misdemeanor. i) Authorizes BOE to revoke the permit of a person found to be not actively engaged in or conducting business as a provider of a specialized service. j) Provides that any person who knowingly issues a resale certificate while the person is not actively engaged in business as a provider of a specialized service, for personal gain or to evade the payment of taxes, is liable for the taxes that would otherwise have been due on the transaction, plus a penalty of 10% or $500, whichever is greater. 6)Requires that all revenues derived from the sales tax imposed on specialized services be deposited in the Education Finance Account, established for that purpose. 7)Requires that funds in the Education Finance Account be used only for the purposes of meeting the funding and pupil-teacher ratio goals set by this bill. EXISTING LAW : 1)The State Constitution requires all of the following: a) Allocates half of revenues received in excess of the state appropriations limit to school districts and community college districts in equal amounts per pupil enrolled; b) Continues this allocation until expenditures per pupil are among the top 10 states with the highest annual expenditures per pupil, and, for K-12 school districts, that the average class size is less than or equal to the average class size of the 10 states with the lowest class size; c) Specifies that these allocated revenues be used solely for the purposes of instructional improvement and accountability; and d) Establishes a minimum level of per pupil support that AB 9 Page 5 must be annually maintained for the support of school districts and community college districts (Proposition 98). 2)Sales and Use Tax Law (SUTL) imposes a tax on the sale or the storage, use, or other consumption in this state of TPP unless the property is exempted or excluded by statute. Services are not subject to SUT as they are not tangible goods. FISCAL EFFECT : At the time this Committee prepared this analysis, an estimate of the additional state revenues resulting from broadening the sales tax to selected services had not been received. However, Committee staff estimate that taxing selected services could generate significant state revenue. Based on the estimated sales receipts for FY 2005-06, sales tax on legal services alone would generate approximately $2.1 billion in total sales tax revenue. Proposition 98 Fiscal Effect : Unknown. COMMENTS : 1)This bill has been referred to both the Assembly Revenue and Taxation Committee and the Assembly Education Committee, and passed out of the Education Committee with a vote of 7 to 4. This analysis focuses on the provisions of the bill related to the Revenue and Taxation Code. 2)According to the author, the purpose of this bill is to provide per pupil funding for education at a level equal to the top 5 states in the nation. 3)According to the Legislative Analyst's Office (LAO), because services are largely exempt from sales tax, the tax base is less reflective of total spending than it once was. This means that: a) Not all consumption is treated the same, creating inequities in the treatment of consumption; b) Tax rates are higher than they would otherwise need to be to raise a given amount of revenue; and c) Taxable sales as a percent of consumption has declined markedly, from 48% in 1981 to about 38% presently. AB 9 Page 6 4)In its survey of sales taxation of services, the Federation of Tax Administrators found that in 1996, California taxed only 13 of the 164 services surveyed. Only four states taxed fewer services. 5)Proponents of taxing selected services argue that there is nothing sacred about services that should immunize them from sales tax. Proponents also argue that broadening the tax base could reduce the regressivity of the sales tax since those in lower income brackets can generally be expected to spend a larger share of their budget on goods and less on services than those in higher income brackets. 6)Opponents of a sales tax on services argue that many service jobs are provided by small independent contractors who do not have extensive accounting and bookkeeping skills. Keeping track of and collecting sales tax would be difficult for them. Sales taxation of retail services might be burdensome enough that small independent contractors and small firms might leave the business or evade the tax. In addition, taxing services might give large firms an incentive to provide these services in-house to avoid taxation. 7)Committee staff note that: a) Extending the state sales tax to specialized services would substantially broaden the sales tax, and a broad tax base with a relative low tax rate is generally thought to represent better tax policy than the alternative. b) The extension of the sales tax to services such as lawyers, accountants, engineers and consultants could change incentives for cities and counties. It would not improve incentives to cities and counties to build housing, but might give the cities greater incentives to build office buildings. c) This bill does not fully define each of the specialized services which would be subject to sales tax, which could cause confusion and implementation issues. For example, it is unclear whether "accounting services" include tax preparation services. Using the North American Industry Classification System (NAICS) industry codes could help clarify which services are subject to sales tax. AB 9 Page 7 d) This bill does not require service providers with a business presence in California to collect sales or use tax on any sales made to California, as retailers of goods are required to under the current SUTL. This may compel service providers to divert their service transactions with California clients through out-of-state offices in order to avoid the tax. e) Expanding the sales tax to specialized services can create an elastic tax effect of state revenue growing with the rate of economic growth. f) "Tax pyramiding" may occur when services are taxed, as businesses "buy" services as inputs into the production of goods and other services that are effectively taxed again when the goods produced are sold at retail. TPP used in the manufacturing of a product sold at retail is not subject to sales tax. g) BOE would incur significant costs to identify and register thousands of new business entities and to process an increased volume of tax returns as a result of extending the state sales tax to selected services. REGISTERED SUPPORT / OPPOSITION : Support Association of California School Administrators California Federation of Teachers California School Boards Association California School Employees Association California Teachers Association Metropolitan Education District Opposition California Family Alliance Consulting Engineers and Land Surveyors of California Analysis Prepared by : Sabrina Landreth / REV. & TAX. / (916) 319-2098