California has aggressively raised taxes over the last few years, more than any other state in the union. In 2009 Gov. Schwarzenegger signed what was then the largest state tax increase in U.S. history and just last year Gov. Brown secured a $50 billion tax increase, retroactively effective, on individuals, families, and employers across the Golden State. Last week, though, it seems California taxpayers finally dodged a bullet.
Budget Trailer Bill 415 originally included language that would raise taxes on software sales. However, in Conference Committee last week the bill was stripped of language that would have changed the definition of storage media to statutorily define a computer program “embodied or stored” on storage media as tangible personal property and therefore taxable.
This good news for the state, as this proposal would’ve resulted in a tax on economic growth at time when California could use more growth in the private sector and less in government. Even though Gov. Brown and legislative Democrats are touting that the budget is now balanced, the failed effort to tax downloads, like the new proposals to raise taxes on soda and tobacco, proves that this hasn’t quenched Sacramento’s thirst for more taxpayer dollars.
The proposal to tax downloads is particularly problematic, as it would have had serious ramifications for tax-exempt software delivered via the Internet, custom software, and items that are sales tax exempt due to the Technology Transfer Agreement.
In California, digital goods; including software, music, movies and books that are delivered via the Internet; are tax-exempt by regulation. Additionally, rights to patents or copyrights that are transferred to a buyer during the transaction, known as a Technology Transfer Agreement, are not taxable. Custom software has been expressly named as tax free, but the language does not limit tax-free status to custom software. California should clarify their language by stipulating that tax-exempt status for licensed software and digital products includes, but is not limited to, custom software and digital goods including music, software, movies, and books.
One of the primary differences between digital goods and tangible goods is that with a digital good the customer only owns a license. This is a license for use; there are restrictions for transferring to other parties, resale, and use of the license. If a buyer violates the license, their access and use can be revoked. Whereas, after a company sells me a tangible book, they have no control over my use of or transfer of the book.
Technically, whether you purchase software on a tangible storage medium or over the Internet, you are still only purchasing a license and your use of the product is therefore restricted. With such a limited standard of ownership, both tangible software products and digital products should be tax-free.
The fact that the Conference Committee removed the problematic language that would have taxed software shows that at least some legislators in California understand the deleterious economic impact that that would come from taxing digital goods. There’s still an incredible need to rein in government spending and taxation in California, but at least a proposal that would have taken the state even further in the wrong direction was defeated for a change.