BILL ANALYSIS                                                                                                                                                                                                    



                                                                  AB 9
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          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.









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             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  








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               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  








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               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  








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               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.









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          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.









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             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