BILL ANALYSIS                                                                                                                                                                                                    Ó

                                                                  AB 2540
                                                                  Page  1

          Date of Hearing:  April 23, 2012

                                Henry T. Perea, Chair
                    AB 2540 (Gatto) - As Amended:  April 16, 2012
           2/3 vote.  Fiscal committee.  
          SUBJECT  :  Sales and use taxes:  services:  Veterans' Home of 

           SUMMARY  :  Expands the Sales and Use Tax (SUT) Law to cover 
          "specified services" and annually appropriates $210 million for 
          specified purposes from the revenues collected.  Specifically, 
           this bill  :  

          1)Imposes a tax upon all retailers for the privilege of selling 
            "specified services."  The tax is set at 7.5% of the 
            retailer's gross receipts from the sale of "specified 
            services" sold in California on or after January 1, 2013.  

          2)Imposes a complementary use tax on the storage, use, or other 
            consumption in this state of "specified services."  

          3)Defines a "specified service" as any of the following:

             a)   Yacht and boat repair;

             b)   Private aircraft pilot or private jet services;

             c)   Astrology, tarot, and palm reading;

             d)   Personal shopping;

             e)   Party planning services not provided by the facility 
               where the party occurs;

             f)   Spa services provided to pets;

             g)   Elective cosmetic surgery, defined as the surgical 
               reshaping of normal structures on the body to improve the 
               body image, self-esteem, or appearance of an individual, or 
               any medical procedure performed on an individual which is 
               directed at improving the procedure subject's appearance 
               and which does not meaningfully promote the proper function 


                                                                  AB 2540
                                                                  Page  2

               of the body or prevent or treat illness or disease;

             h)   Membership fees to private country clubs; 

             i)   Marina services;

             j)   Limousine rental;

             aa)  Nonmedical massage;

             bb)  Pet grooming where the buyer is charged $50 or more for 
               the grooming;

             cc)  Nonmedical personal fitness training; 

             dd)  Access to the facilities of a ski resort through the 
               imposition of a charge;

             ee)  Access to storage facilities, not including storage 
               facilities used for the storage of food or self-service 
               storage facilities, through the imposition of a charge of 
               $1,000 a month or more; 

             ff)  Furniture repair;

             gg)  Watch repair;

             hh)  Support activities for metal mining;

             ii)  Passenger charter-party carriers as defined in Public 
               Utilities Code Section 5351 et seq.;

             jj)  Access to live theater productions through the purchase 
               of a ticket or membership fees or dues;

             aaa) Access to the facilities of a billiard parlor through 
               the imposition of a charge; or, 

             bbb) Access to private, telephonic chat lines through the 
               imposition of a charge to callers. 

          4)Provides rules for determining the place at which the sale or 
            purchase of specified services occurs.  

          5)Appropriates annually, from the tax revenues collected, $90 


                                                                  AB 2540
                                                                  Page  3

            million to the Department of Veterans Affairs (VA) to operate 
            the following Veterans' Homes:

             a)   The Veterans' Home of California, Redding;

             b)   The Veterans' Home of California, Fresno;

             c)   The Veterans' Home of California, West Los Angeles;

             d)   The Veterans' Home of California, Lancaster; and, 

             e)   The Veterans' Home of California, Ventura.  

          6)Appropriates annually, from the tax revenues collected, $15 
            million to the Department of VA to fund county veterans 
            service officers.  

          7)Appropriates annually, from the tax revenues collected, $85 
            million to the Department of Food and Agriculture for ongoing 
            pest eradication and invasive species eradication programs, 
            including ongoing asian citrus psyllid (ACP)/huanglongbing 
            (HLB) eradication efforts.  

          8)Appropriates annually, from the tax revenues collected, $20 
            million to the Department of Fish and Game for ongoing pest 
            eradication and invasive species eradication programs, 
            including ongoing ACP/HLB eradication efforts.  

           EXISTING LAW  imposes a:

          1)Sales tax on retailers for the privilege of selling tangible 
            personal property (TPP), absent a specific exemption.  The tax 
            is based upon the retailer's gross receipts from TPP sales in 
            this state.  

          2)Complementary use tax on the storage, use, or other 
            consumption in this state of TPP purchased from any retailer.  
            The use tax is imposed on the purchaser, and unless the 
            purchaser pays the use tax to a retailer registered to collect 
            the California use tax, the purchaser remains liable for the 
            tax, unless the use is exempted.  The use tax is set at the 
            same rate as the state's sales tax and must be remitted to the 
            State Board of Equalization (BOE).
          FISCAL EFFECT  :  The BOE's fiscal estimate for this bill is 


                                                                  AB 2540
                                                                  Page  4


           COMMENTS  :   

          1)The author has provided the following statement in support of 
            this bill:

               As California faces ongoing fiscal crisis, many programs 
               that have not benefitted from ongoing constitutional 
               protection have suffered.  Among these are services to 
               California's veterans, to whom we all owe a debt of 
               gratitude and whose numbers continue to grow with recent 
               conflicts.  Currently beds in many of our state's veterans' 
               homes sit unused because there is no funding to service 
               them.  These brave men and women deserve better.

               As well, funding to programs that protect our state's vital 
               agriculture industry has suffered.  The result has been a 
               deterioration of programs designed to protect crops from 
               invasive species that have the potential to destroy entire 
               sectors of the industry.  One recent threat has been from 
               Asian Citrus Psyllid (ACP)/Huanglongbing (HLB), which will 
               destroy California's citrus industry.  In Florida, HLB has 
               resulted in about 200,000 acres of commercial citrus groves 
               being uprooted and another 40,000 acres being abandoned.  
               In comparison, California has more than 285,000 acres of 
               commercial citrus groves, with about 119,000 of those acres 
               in Tulare County.  This is a real threat to the state.

               AB 2540 would provide much needed funding for our state's 
               veterans services, including: $90 million to operate the 
               Veterans Homes in Redding, Fresno, West Los Angeles, 
               Ventura, and Lancaster and $15 million to fund county 
               veteran services officers statewide.  The measure also 
               helps our state's agriculture industry by funding ongoing 
               programs that deal with pest and invasive species 
               eradication by providing $85 million to the Department of 
               Food and Agriculture and $20 million to the Department of 
               Fish and Game for such efforts.

               In order to pay for these important programs, the measure 
               would expand the current state sales tax on 21 services by 
               adding a small set of discretionary, mostly luxury services 
               to the current list.  Some of these services include: 
               country club memberships, elective cosmetic surgery, and 


                                                                  AB 2540
                                                                  Page  5

               yacht repairs.  For most middle-class Californians, this 
               tax will never be noticed as it only applies to luxury 
               services that are not essential to everyday life.  

               Many states already charge sales tax on a number of 
               services. The list of states includes Texas (83), New York 
               (57), Arizona (55), Kansas (74), and Iowa (94).
          2)Opponents of this bill state:

               While AB 2540 currently taxes only a specified number of 
               services, this bill would open the door to a major shift in 
               state tax policy.  By setting the precedent of taxing 
               services, AB 2540 would make many other key services 
               vulnerable to a sales tax.  This would threaten many of 
               California's critical industries, including high-tech 
               research and development, the financial sector, legal 
               services, and advertising.  The Tax foundation ranks 
               California as the third worst business climate in the 
               nation due to the state's high taxes, high energy costs, 
               restrictive labor laws, and onerous regulations.  A sales 
               tax on services would further adversely impact California's 
               business climate and kill jobs - and the threat of such a 
               tax already is sending a negative message to those still 
               considering doing business here.

          3)The BOE notes the following in its staff analysis of this 

              a)   Sponsor and purpose  :  "This bill is sponsored by the 
               author.  According to the author's office, a tax on 
               services such as those listed in this bill is progressive. 
               These services are purchased primarily by individuals in 
               higher income brackets whose discretionary income would be 
               less impacted by a tax on the selected services.  The 
               author notes that people who can afford personal and 
               professional services, such as those described in this 
               measure, can better afford to bear a larger share of the 
               tax burden."

              b)   The bill is not specific as to whether tangible personal 
               property purchased for use in the course of providing a 
               service would be subject to sales or use tax  :  "With 
               respect to sales of goods, tax applies to the Ŭsale] of any 
               property to persons who purchase the goods for the purpose 


                                                                  AB 2540
                                                                  Page  6

               of using them in the provision of a service.  Tax does not 
               apply to sales of any property to persons who purchase the 
               goods for the purpose of reselling them - whether the goods 
               are incorporated into the manufactured article to be sold, 
               such as any raw material becoming an ingredient or 
               component part of a manufactured article, or whether the 
               goods themselves are simply resold.  It is unclear whether 
               property purchased for use in the provision of a service 
               will still be taxable if the service itself is subject to 
               tax, or if the use of a good in the provision of a taxable 
               service would be considered to be a form of reselling, in 
               which case the purchase of the property would not be 
               subject to tax.  For example, would the purchase of 
               champagne by a limousine driver who provides the champagne 
               to clients as part of the service be considered an item 
               resold in the course of providing the service, so that the 
               limousine driver may properly purchase the champagne 
               without payment of sales tax?  . . .  The application of 
               tax on such purchases should be made clear in the bill, 
               particularly with regard to service industries for which 
               special rules already exist."

              c)   The imposition of use tax on out-of-state purchases 
               could pose some administrative issues  :  "The bill would 
               impose a complementary use tax for out-of-state purchases 
               of the specified services, when purchased for storage, use, 
               or other consumption in this state. Some issues could arise 
               with respect to whether a specific service was purchased 
               for use in this state.  Some states that impose a use tax 
               on out-of-state purchases of services base this on whether 
               the purchaser derives a benefit from the service in the 
               state.  Also, it is unclear how a service could be 
               purchased for "storage" in California.  These are areas 
               that may pose administrative problems in enforcement and 
               compliance in the use tax.  For example, if a California 
               resident had his or her palm read in Nevada while on a 
               weekend getaway, would the charge for the palm reading be 
               regarded as a service purchased for use in California?  If 
               a California resident's yacht needed repair while cruising 
               outside the territorial waters of Mexico, and the yacht was 
               moored in a California marina a week later, would those 
               charges be subject to use tax?"

              d)   More complexities are associated with sellers of both 
               services and tangible personal property  :  "For example, a 


                                                                  AB 2540
                                                                  Page  7

               pet groomer may provide pet grooming services as well as 
               sell pet grooming products, such as brushes, pet shampoo, 
               etc.  When a customer purchases both the service and 
               products, the groomer would be required to perform two 
               calculations to reimburse him or herself for the proper 
               amount of tax - 7.5% for the service, and 7.25% to 9.25% 
               (depending on the location) on the sale of the product.  
               This would add another level of complexity for the affected 
               service providers and a possible increase in cash register 
               programming costs that must be borne by the affected 
               service providers. Also, these complexities tend to be more 
               prone to errors in reporting the proper amount of tax, 
               which results in additional BOE administrative workload."

              e)   The language will need to be refined as the bill 
               progresses  :  "This bill provides some basic language to 
               impose a tax on services. However, in order to clarify 
               specific areas of the law, some contradictory references 
               will need to be amended.  BOE staff is willing to work with 
               the author to refine the language as the bill progresses."

          4)Committee Staff Comments

              a)   The current proposal  :  AB 2540 would expand the state's 
               SUT to cover a list of selected services ranging from yacht 
               repair to elective cosmetic surgery.  From the revenues 
               raised, this bill would annually appropriate $210 million 
               for specified purposes including the support of veterans' 
               homes in Redding, Fresno, West Los Angeles, Lancaster, and 

              b)   California's SUT Law:  an overview  :  California's SUT 
               Law imposes a sales tax on retailers for the privilege of 
               selling TPP, absent a specific exemption.  The tax is based 
               upon the retailer's gross receipts from TPP sales in 

             While the SUT represents the state's second largest source of 
               General Fund (GF) revenues, the past 60 years have seen a 
               dramatic reduction in the state's reliance on the SUT and a 
               corresponding increase in its reliance on personal income 
               tax revenues.  For example, in fiscal year (FY) 2011-12, 
               SUT revenues are estimated to comprise 21% of the state's 
               GF revenues, down from nearly 60% in FY 1950-51.


                                                                  AB 2540
                                                                  Page  8

              c)   What explains the decreased reliance on the SUT  ?:  The 
               SUT Law was enacted in a very different era.  In the 1930s, 
               California's economy was largely dominated by manufacturing 
               and agriculture, and residents mostly bought and sold 
               tangible goods.  Thus, it made sense to impose a 
               consumption tax on sales of TPP - defined as personal 
               property that may be "seen, weighed, measured, felt, or 
               touched . . . ."  Over the past 80 years, however, 
               California's economy has seen a dramatic increase in the 
               service and technology sectors, resulting in a significant 
               erosion of the SUT base.  As a result, the ratio of taxable 
               sales to income is currently about 35%, compared to 55% in 

              d)   Proposals to expand the SUT base  :  The state's decreased 
               reliance on the SUT has led to various proposals for 
               expanding the SUT base.  Such an expansion could be 
               accomplished through two principal means:  (1) expanding 
               the SUT to cover so-called digital equivalents (e.g., 
               downloaded movies and music); and, (2) expanding the SUT to 
               selected services.  

               It should be noted that California currently imposes a tax 
               on only 21 services, while some other states tax nearly all 
               services (e.g., Hawaii and New Mexico).  Thus, in his 
               budget proposal for FY 2009-10, Governor Schwarzenegger 
               proposed extending the SUT to various services, ranging 
               from appliance and furniture repair to veterinarian 
               services.  More recently, the Think Long Committee for 
               California released a proposal to expand the SUT to most 
               services at a rate between 5% and 5.5%, with an exemption 
               for educational and medical services.  

              e)   Policy considerations for any service tax proposal  :  Any 
               proposal to extend the SUT to services calls for a careful 
               weighing of numerous policy considerations, ranging from 
               the proposal's administrative feasibility to its likely 
               economic consequences.  Thus, the following discussion 
               highlights some of the main issues to consider in assessing 
               AB 2540's SUT expansion proposal:

                i)     Administrative feasibility  :  In reviewing any 
                 proposal to expand the SUT to services, it is important 
                 to consider the proposal's administrative feasibility.  
                 Namely, one should consider how difficult it would be for 


                                                                  AB 2540
                                                                  Page  9

                 the BOE, which administers the existing SUT, to identify 
                 new taxpayers.  Some have argued that any expansion of 
                 the SUT to services should begin with service providers 
                 already registered with the BOE.  For example, a provider 
                 of palm reading services has likely never been registered 
                 with the BOE or filed a SUT return.  It would take 
                 significant effort on the part of the BOE to identify 
                 such service providers, register them as taxpayers, and 
                 inform them of their obligations under the new service 
                 tax regime.  This, however, would likely not be the case 
                 for other service providers, like watch repairers.  
                 Ostensibly, a large percentage of such repairs are 
                 undertaken by retail jewelers, who are already registered 
                 with the BOE and familiar with the SUT.  These retailers 
                 would simply have to begin reporting their gross receipts 
                 from such services.  In any event, any expansion of the 
                 SUT to services will require the BOE to expend 
                 significant time and resources drafting new regulations, 
                 training staff, registering new taxpayers, and informing 
                 the public of the change in law.  Thus, the author may 
                 wish to consider amendments delaying the implementation 
                 of the service tax from January 1, 2013 to a later date 
                 to provide both the BOE and the public sufficient lead 
                 time to adapt.

                ii)    Avoiding perverse incentives  :  In assessing a 
                 proposal to expand the SUT base, one should also consider 
                 the degree to which taxing a specific service would 
                 encourage consumers to purchase the service out-of-state, 
                 thereby creating a competitive disadvantage for 
                 California businesses.  For example, if the state were to 
                 tax a service that is both expensive and can be obtained 
                 out-of-state (e.g., elective cosmetic surgery), some 
                 customers would have a large incentive to purchase the 
                 service outside California.  This same incentive does not 
                 exist, however, in the case of services that nearly all 
                 people purchase, for reasons of necessity or convenience, 
                 instate.  For example, if California were to expand the 
                 SUT to pet grooming services, it is unlikely many people 
                 would drive to Nevada to avoid the California tax.

                iii)   Avoiding the taxation of services used primarily by 
                 businesses  :  Most economists and tax experts agree that 
                 states should avoid expanding the SUT to cover services 
                 used primarily by businesses.  This is because any sales 


                                                                  AB 2540
                                                                  Page  10

                 tax paid by a business will be factored into the prices 
                 it charges for goods and services, which, in turn, may 
                 again be subject to taxation.  This results in consumers 
                 paying a tax on a tax (i.e., pyramiding), making the tax 
                 system less transparent.  It would appear that this 
                 proposal largely avoids the problems inherent in 
                 pyramiding, by targeting services either primarily or 
                 exclusively consumed by individuals (with the exception 
                 of 'support services for metal mining.')

                iv)    Promoting progressivity  :  One should also consider 
                 the fact that California's SUT is already inherently 
                 regressive, because lower-income individuals typically 
                 spend a larger percentage of their earnings on taxable 
                 goods.  This bill attempts to address this issue by 
                 selecting services that are mainly consumed by 
                 higher-income earners (skiing, yacht repair, etc.).

                v)     Avoiding definitional ambiguity  :  As noted above, 
                 this bill would expand the SUT to cover a list of 
                 selected services, ranging from yacht repair to 
                 astrology.  Some of the service categories are 
                 self-explanatory, and the BOE would likely have little 
                 trouble interpreting the intended scope of services 
                 covered.  Other categories, however, could benefit from 
                 further clarification.  For example, this bill would 
                 impose a service tax on "elective cosmetic surgery" as 
                 defined.  While this bill does specify certain procedures 
                 that would be covered (e.g., hair transplants, cosmetic 
                 dentistry), this list is not meant to be exhaustive.  
                 Would the BOE be responsible for promulgating regulations 
                 specifying which additional cosmetic surgeries are 
                 elective and which are not?  Is the BOE really in the 
                                                best position to determine whether a particular procedure 
                 "meaningfully promoteŬs] the proper function of the 
                 body"?  Such terminology seems inherently subjective, 
                 potentially requiring case by case analysis.   Moreover, 
                 how would BOE field auditors properly conduct such case 
                 by case determinations?  Would they seek to review 
                 confidential patient files to assess whether a particular 
                 procedure was truly designed to "treat illness or 
                 disease"?  It might make more sense to simply enumerate 
                 an exhaustive list of medical procedures that will be 
                 subject to tax rather than provide language susceptible 
                 to varying interpretations.  In the end, many of the 


                                                                  AB 2540
                                                                  Page  11

                 service categories listed in this bill would benefit from 
                 greater definitional precision to avoid ambiguity, 
                 uncertainty, and potential litigation.  

              f)   Related legislation  :

               i)     AB 1963 (Huber), of the current legislative session, 
                 would, among other things, reduce the state SUT rate to 
                 4% and impose a new service tax at the rate of 4%.  AB 
                 1963 is set to be heard in this Committee on May 14, 

               ii)    AB 9 (Coto), of the 2005-06 legislative session, 
                 would have imposed a sales tax on specified services to 
                 increase funding for K-12 education.  AB 9 was held in 
                 this Committee.     
              g)   Technical Amendments  :  Committee staff recommends the 
               following technical amendments to this bill: 

               i)     On page 7, line 35, strike "means" and insert 
                 "defined as"; and, 

               ii)    On page 12, line 4, strike "determinations" and 
                 insert "overpayments and refunds".  


          None on file

          American Council of Engineering Companies of California
          American Massage Therapy Association
          Building Owners and Managers Association of California
          California Aerospace Technology Association
          California Alliance for Golf
          California Asian Chamber of Commerce
          California Bankers Association
          California Building Industry Association
          California Business Properties Association
          California Chamber of Commerce
          California Delivery Association


                                                                  AB 2540
                                                                  Page  12

          California Healthcare Institute
          California Manufacturers and Technology Association
          California Retailers Association
          California Ski Industry Association
          California Society of Enrolled Agents
          California State Club Association
          California Yacht Brokers Association
          Greater California Livery Association
          Howard Jarvis Taxpayers Association
          Independent Maintenance Contractors Association
          International Council of Shopping Centers
          Investment Company Institute
          Marina Recreation Association
          Messenger Courier Association of America
          NAIOP of California, the Commercial Real Estate Development 
          National Federation of Independent Business
          Pacific Association of Building Service Contractors
          Spidell Publishing
          Analysis Prepared by  :  M. David Ruff / REV. & TAX. / (916)