BILL ANALYSIS Ó AB 717 Page 1 Date of Hearing: May 18, 2015 ASSEMBLY COMMITTEE ON REVENUE AND TAXATION Philip Ting, Chair AB 717 (Gonzalez) - As Introduced February 25, 2015 SUSPENSE Majority vote. Tax levy. Fiscal committee. SUBJECT: Sales and use taxes: exemption: diapers. SUMMARY: Establishes a sales and use tax (SUT) exemption for diapers designed, manufactured, processed, fabricated, or packaged for use by infants and toddlers. Specifically, this bill: 1)Provides that, notwithstanding existing law, the state shall not reimburse any local agency for SUT revenues lost as a result of this exemption. AB 717 Page 2 2)Takes immediate effect as a tax levy, but only becomes operative on the first day of the first calendar quarter commencing more than 90 days after this bill's effective date. EXISTING LAW: 1)Imposes a 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)Imposes a complimentary use tax on the storage, use, or other consumption of TPP purchased out-of-state and brought into California. The use tax is imposed on the purchaser, and unless the purchaser pays the use tax to an out-of-state retailer registered to collect California's use tax, the purchaser remains liable for the tax. The use tax is set at the same rate as the state's sales tax and must generally be remitted to the State Board of Equalization (BOE). FISCAL EFFECT: The BOE estimates that this bill would reduce state and local revenues by $46.7 million annually. COMMENTS: 1)The author has provided the following statement in support of this bill: It is time for California's tax code to reflect the fact that diapers are an absolute health necessity for young children. By updating our tax code to accurately identify diapers as a necessity of life we can also make them more affordable. The high price of diapers has a cost for AB 717 Page 3 public health and our economy. Diaper need puts families in the position of changing their children's diapers less often which has unhealthy consequences ranging from diaper rash to infections requiring medical treatment. It also creates a barrier between parents and gainful employment when families cannot afford the number of diapers required by childcare providers. 2)This bill is supported by the American Academy of Pediatrics, California, which notes: This legislation would follow the lead of seven other states and exempt diapers from sales tax to enable low-income families to better afford this necessity in the care of their children. An attempt to economize on diaper expense by less frequent changes can lead to medical consequences for the baby, from uncomfortable and inconvenient diaper rash, to more serious conditions including abscesses and urine infections. Moreover, low-income parents are less able to take advantage of free or subsidized childcare if they cannot afford to leave disposable diapers at child care centers, a requirement for most childcare centers. Thus, lack of sufficient diapers can lead to multiple problems for families in need, including unhappy babies, unhealthy communities, undereducated toddlers, and underemployed adults. 3)This bill is opposed by the California State Association of Counties, which notes: The State Board of Equalization has estimated state and local losses due to AB 717 would total $46.7 million AB 717 Page 4 annually. After the past thirty years of changes to sales and use tax allocations, counties now receive almost half of sales and use tax revenues. Approximately two-thirds of that revenue is constitutionally dedicated to providing local public safety services and federal and state programs including social services, like CalWorks, and criminal justice and rehabilitation services. Therefore, we respectfully request that the local portion of sales and use tax be unaltered by AB 717 and vital dollars continue to flow to critical county service needs. We have no concern with the state using their portion of sales and use tax revenue to advance the policy goals set forth by this measure. 4)Committee Staff Comments a) What is a "tax expenditure" ? Existing law provides various credits, deductions, exclusions, and exemptions for particular taxpayer groups. In the late 1960s, U.S. Treasury officials began arguing that these features of the tax law should be referred to as "expenditures" since they are generally enacted to accomplish some governmental purpose and there is a determinable cost associated with each (in the form of foregone revenues). b) How is a tax expenditure different from a direct expenditure ? As the Department of Finance notes in its annual Tax Expenditure Report, there are several key differences between tax expenditures and direct expenditures. First, tax expenditures are reviewed less frequently than direct expenditures once they are put in place. While this affords taxpayers greater financial predictability, it can also result in tax expenditures remaining a part of the tax code without demonstrating any public benefit. Second, there is generally no control over AB 717 Page 5 the amount of revenue losses associated with any given tax expenditure. Finally, it should also be noted that, once enacted, it takes a two-thirds vote to rescind an existing tax expenditure absent a sunset date. This effectively results in a "one-way ratchet" whereby tax expenditures can be conferred by majority vote, but cannot be rescinded, irrespective of their efficacy or cost, without a supermajority vote. c) An overview of the SUT Law : 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 a retailer's gross receipts from TPP sales in California. The SUT Law also imposes a mirror "use tax" on the storage, use, or other consumption of TPP purchased out-of-state and brought into California. The use tax is imposed on the purchaser, and unless the purchaser pays the use tax to an out-of-state retailer registered to collect California's use tax, the purchaser remains liable for the tax. The use tax is set at the same rate as the state's sales tax and must generally be remitted to the BOE. The SUT represents the state's second largest source of General Fund (GF) revenues. Nevertheless, 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. In fiscal year (FY) 2014-15, SUT revenues are estimated to comprise 23% of the state's GF revenues, down from nearly 60% in FY 1950-51. d) What accounts for the state's reduced reliance on SUT revenues ? The SUT Law was enacted in a very different era. In the 1930s, California's economy was largely dominated by manufacturing, and residents mostly bought and sold tangible goods. Thus, in establishing the base for a new AB 717 Page 6 consumption tax, it made sense to impose the 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 growth in the service and information sectors, resulting in a significant erosion of the SUT base. For example, the Commission on the 21st Century Economy noted that spending on taxable goods represented 34.6% of personal income in 2008, down from 55.4% in 1980. As a result, tax experts and economists from across the political spectrum argue that California should expand its SUT base. It could be argued that, while well-intentioned, additional SUT exemptions further erode an already shrinking SUT base. This, in turn, increases fiscal pressures to maintain or even increase California's relatively high SUT rate. High rates arguably promote non-compliance and encourage out-of-state purchases, placing California retailers at a competitive disadvantage. High rates also risk impacting consumer decision-making, which runs counter to widely accepted principles of sound tax policy. e) What would this bill do ? This bill would provide a complete SUT exemption for all diapers made for infants and toddlers. The proposed exemption would apply to both disposable and non-disposable diapers alike. f) The diaper dilemma : By some estimates, up to 95% of U.S. families use disposable diapers. Nevertheless, environmental and health concerns have persuaded some parents to purchase cloth diapers that can be reused. Experts, however, are divided on whether reusable diapers are more environmentally friendly. According to WebMD, research suggests that both disposable and cloth diapers impact the environment negatively - albeit in different ways. Disposable diapers require more raw materials to AB 717 Page 7 manufacture and generate more solid waste for landfills. Cloth diapers, on the other hand, use up large amounts of electricity and water for laundering. Thus, the American Academy of Pediatrics takes no position in the ongoing debate regarding the relative merits of cloth versus disposable diapers. g) How are diapers currently taxed ? Current law does not provide a SUT exemption for diapers. The BOE notes, however, that businesses providing diaper services, where cloth diapers are furnished in connection with the recurring service of laundering the diapers, are considered "consumers" of the diapers they provide. Thus, the tax applies only to the diaper service's purchases, and the business's diaper rental receipts are not subject to SUT. h) An inherently regressive tax : The SUT has been widely criticized as a regressive exaction that most heavily impacts those least able to pay. For example, a survey by the Nevada Legislative Counsel Bureau long ago concluded that in the case of a retail sales tax with food exempt, "the lowest income group would experience the highest ratio of tax to income . . . ." (Survey of Sales Taxes Applicable to Nevada 59 (Bull. No. 3, May, 1948).) Others, however, contend that a degree of progressivity is provided via the various exemptions built into most state SUT laws (i.e., for certain necessities of life such as food, housing, and medical care). Proponents of this bill might argue that an exemption for diapers would further promote a degree of progressivity in an already regressive tax regime. Critics, however, might contend that SUT exemptions are a blunt instrument for affecting social policy. While this bill would provide meaningful financial relief to low-income parents AB 717 Page 8 struggling to make ends meet, it would also provide relief indiscriminately to wealthy consumers who might not even notice the exemption. In addition, critics might question why diapers are being singled out for preferential tax treatment as opposed to other items of TPP indispensable to raising a child (e.g., car seats, cribs, baby clothes, bottles, strollers, etc.). i) A more targeted approach ? To better target the low-income parents this bill is aiming to assist, the Committee may wish to consider whether a slightly more tailored approach would be preferable. Specifically, if the Legislature chooses to dedicate a certain amount of money (e.g., $50 million annually) to help parents purchase diapers, it might be preferable to channel this money directly and exclusively to the beneficiaries of an existing means-tested program. For example, existing law provides for the California Work Opportunity and Responsibility to Kids (CalWORKs) program, under which each county provides cash assistance and other benefits to qualified low-income families and individuals. AB 1516 (Gonzalez), of the 2013-14 Legislative Session, would have established a young child special needs supplement of $80 per month within the CalWORKs program for each child younger than two years of age in an assistance unit. AB 1516 was held on the Senate Appropriations Committee's Suspense File. AB 492 (Gonzalez), in turn, would provide that necessary supportive services would include vouchers in the amount of $50 per month for diaper products for every child two years of age or younger enrolled in child care, as specified. AB 492 is currently pending by the Assembly Committee on Human Services. Alternatively, the Committee may wish to consider whether it would be preferable to provide a SUT exemption for diapers sold directly to nonprofit entities that, in turn, provide free diapers to low-income and homeless families. AB 717 Page 9 The nonprofit Help a Mother Out organization notes that it has provided diapers to low-income and homeless families through a network of social service partners since 2009. At the same time, this nonprofit notes: For the present fiscal year, the sales tax assessed for bulk purchasing diapers for our programs is close to $22,000.00. That's critical funding that takes away from our organization distributing more diapers to vulnerable families through life changing programs. j) Filling in the details : As noted above, this bill would establish a SUT exemption for diapers designed and manufactured for "infants and toddlers". This bill, however, lacks definitions for these terms. Thus, it might be challenging for retailers to determine with any degree of precision which specific products qualify for the exemption and which do not. The Committee may wish to consider whether it would be beneficial to provide greater definitional clarity through references to specific age or weight ranges. aa) Absence of a sunset date : In its current form, this bill's proposed tax expenditure lacks an automatic sunset provision. This Committee has a longstanding policy favoring the inclusion of sunset dates to allow the Legislature periodically to review the efficacy and cost of such programs. The author may wish to consider the addition of an appropriate sunset provision. bb) Prior legislation : i) AB 1291 (Hollingsworth), of the 2001-02 Legislative Session, would have provided a SUT exemption for diapers. AB 717 Page 10 AB 1291 was held on this Committee's Suspense File. ii) AB 5 (Battin), of the 1999-2000 Legislative Session, would have provided a SUT exemption for baby diapers, whether disposable or not, and over-the-counter, nonprescription drugs. AB 5 was never heard by this committee. iii) AB 13 (Dickerson), of the 1999-00 Legislative Session, would have provided a SUT exemption for, among other things, products for incontinence, including disposable and reusable diapers, pads, and briefs. AB 13 was never heard by this Committee. REGISTERED SUPPORT / OPPOSITION: Support ACCESS Women's Health Justice American Academy of Pediatrics, California Board of Equalization Member Diane L. Harkey Black Women for Wellness California Latinas for Reproductive Justice AB 717 Page 11 Forward Together Help a Mother Out National Center for Youth Law National Diaper Bank Network San Diego County Taxpayers Association Opposition California State Association of Counties California Tax Reform Association Analysis Prepared by:M. David Ruff / REV. & TAX. / (916) 319-2098 AB 717 Page 12