Long-standing California law allows state and local government to tax sales of “tangible” property.
Once, identifying that taxable property was simple. It embraced such everyday consumer goods as cars, furniture and clothing, as well as business equipment.
However, as consumers changed spending patterns, buying fewer tangible things and more intangible, tax-exempt services, and as even tangible products such as computers and smartphones included ever-increasing amounts of intangible software, the situation became muddled.
The state Board of Equalization faced increasingly complex issues of what is and is not taxable, and the situation jelled a year ago when the state Supreme Court upheld a landmark 2015 appellate court decision.
Lucent Technologies, which sold packages of communications hardware and software to telephone companies such as AT&T, had sued the Board of Equalization, saying it had improperly taxed the software.
The state appellate court not only ruled for Lucent, but excoriated the tax board for pursuing taxes from Lucent and hit it with a $2.6 million penalty to cover the company’s legal costs.
“It is certainly up to the board to decide whether to take positions at odds with binding, on-point authority,” Justice Brian Hoffstadt wrote, “but … the board is not free to require taxpayers to bear the cost of a litigation strategy aimed at taking a third, fourth, or fifth bite at the apple.”
This week, the Assembly Revenue and Taxation Committee delved into the ramifications of the Lucent case and learned they could be immense, involving not only refunds to Lucent and/or AT&T and its other customers, but potentially other corporations that have been taxed for hardware/software sales.
It could, the committee was told, also lead to exempting software components of consumer goods – such as cars or kitchen appliances – with multibillion-dollar revenue consequences.
What the Lucent decision really tells us is that our revenue system sorely needs top-to-bottom reform, in the precise meaning of that word.
Sales tax revenues have been declining for decades, relative to the economy as a whole. When Jerry Brown was in his first governorship four decades ago, sales taxes were the largest single factor in the state budget, but personal income taxes now account for 70 percent of its general fund revenues, and half of them are paid by 1 percent of the state’s taxpayers.
The sales tax needs to be modernized to align it with the continuing shift in taxable tangible goods to untaxed services, and with the expanding role of technology in the consumer economy.
The income tax needs to be flattened to make it less dependent on how well a handful of wealthy people are doing in their investments and thus less volatile.
Tax reform is heavy lifting from a political standpoint, but it stands with water supply, transportation and K-12 education at the top of what should be the political priority list.
The Lucent case is another wakeup call that politicians ignore at their – and our – peril.