Will SB-522 Lead to Sales Tax on Legal Services?
Back in February, State Senator Hertzberg proposed SB-522. The purpose of this bill is to “make legislative findings regarding the need for further efforts to modernize and restructure the state’s tax system.” Further, the bill would “state the intent of the Legislature to enact legislation that would accomplish specified purposes, including realigning the state’s outdated tax code with the realities of California’s 21st century economy.”
Efforts to “modernize and restructure” sound great at first blush. But diving beneath the surface, there’s more to the story. Right now California’s tax base is subject to wide swings for two main reasons:
California has a boom and bust economy and;
Over the years the California economy has evolved from one of agriculture and manufacturing to a service-based economy, which is less reliable year-to-year.
The question to the legislature, and to Californians engaged in commerce, is how to regulate the boom-and-bust cycle. State Senator Hertzberg believes that the solution lies in a sales tax on professional services, including law firms.
The logic is simple. By continuing to tax only a portion of gross domestic product (GDP) that is shrinking annually, your tax revenues will also shrink. But if you expand the tax base to include other portions of GDP – in this case, professional services in addition to goods – the tax base expands and thereby increases tax revenue. Moreover, because the tax base is expanded to include different portions of GDP, overall reliance on any one sector will decline and thus volatility will also decline, moving from boom-and-bust to a steady chug.
The California Department of Finance reports that in 1950, sales and use tax made up 61 percent of the General Fund revenue. That amount dropped to 19% for the fiscal year 2018-2019. In 1950, personal income tax comprised 12% of General Fund revenue. By the fiscal year 2018-2019, personal income tax made up 70% of the General Fund revenue. This data supports Hertzberg’s argument, demonstrating that taxes on sold goods are a shrinking portion of the economy and income produced by providing services is the lion’s share of the general tax base.
What is the upshot of this proposal for a California attorney? For starters, administrative costs are likely to increase. Personnel will be required to calculate the sales tax on professional services, collect it, and remit it to the state. Business service providers will almost certainly raise their rates due to an increase in their tax burden, so fees for expert witnesses, messengers, and consulting attorneys will all go up. Overhead costs will increase due to higher IT consulting fees, marketing services, cleaning services, and other services necessary to run a law firm.
At this time, we at Legal Thrive are not hitting the panic button. However, we are on alert. The bill in its current form lacks specifics including the affected industries, proposed tax rates, or a time frame for implementing such a sales tax on professional services. But the senator has put up a strong fight for introducing a sales tax on professional services and if he is successful, the fiscal landscape for law firms and other professional service providers will be altered.