Every year, the California Legislature deals with numerous bills, including some that discuss “tax expenditures.” This term refers to specific exemptions from personal, corporate income, and sales taxes that apply to particular financial transactions. These exemptions prevent certain activities from being taxed, essentially reducing the amount of money the government collects. This has the same financial impact as if the government directly spent that money in the budget, which is why these are termed “expenditures.”
Publicly Supported and Special Interest Tax Breaks
Many of these tax breaks enjoy widespread support because they serve public interests, such as exempting prescription drugs and most grocery items from sales tax. This makes essential goods more affordable to the general population. However, other exemptions cater to special interest groups with strong political connections. A notable example from about 35 years ago involves the tech sector in Silicon Valley. Influential tech companies successfully lobbied for a law that exempts custom-designed software from sales taxes. This particular exemption primarily benefits large corporations that can afford to invest millions in bespoke software solutions while standard software, purchased by everyday consumers like Quicken or TurboTax, remains taxed.
The Economic Impact of Tax Expenditures
According to the California Department of Finance, the state loses about $119 million annually from the software tax break alone. While this figure may not seem substantial compared to the total volume of tax breaks, it illustrates the targeted nature of many exemptions. A fiscal consultant for the Legislature, Jason Sisney, highlights that California’s budget could increase by roughly 45% if it weren’t for these tax expenditures. The current system sees California forego about $107 billion in revenue from larger exemptions, impacting the state and local government’s ability to fund services.
Rethinking Tax Exemptions
The discussion around these tax breaks is often less vibrant than it might seem necessary, given their significant impact on the state’s finances. For instance, state law distinguishes between hot and cold prepared foods for taxation, with hot foods generally being taxable at points of sale like restaurants, whereas cold foods are not. This distinction led to peculiar decisions, such as exempting popcorn sold at movie theaters from the hot food tax because it cools by the time it is consumed.
Major tax exemptions include those for employer-provided medical care and pension contributions, which together reduce state revenues by $29 billion. The largest individual tax breaks pertain to personal income tax, such as exempting certain Social Security benefits and gains from inherited property sales. Corporate income tax also sees significant exemptions, especially concerning the earnings of multinational corporations, a contentious issue for over half a century.
With billions at stake, it may be prudent for the governor and the Legislature to dedicate more time to scrutinize these tax expenditures during their budget negotiations, ensuring that California’s financial resources are used effectively and equitably.
