The Software Services Tax

I was pleased to report the successful completion of legislative efforts to pass a transportation funding package. It represented the main product of the first leg of the legislative session and was a very necessary and difficult thing to do. I fully supported it and accept full responsibility for every element of it.

Unfortunately, it now appears that one element of the plan just doesn’t work well: The software services tax. A tax should, above all, be reasonably clear in what it applies to. People should not face difficult daily decisions on whether they need to pay a tax. It appears that the software services tax fails this test.

The law has been on the books only three weeks, and the Department of Revenue, valiantly trying to implement the tax fairly, already has a list of 55 “frequently asked questions.”

The new tax is levied in sections 48 and 49 of the funding package. These sections operate together to apply the existing 6.25% sales and use tax to

“the planning, consulting or designing of computer systems that integrate computer hardware, software or communication technologies and are provided by a vendor or a third party . . . and the modification, integration, enhancement, installation or configuration of standardized software” but not to “data access, data processing or information management services.”

The tax needs to be paid on these services when purchased for use in Massachusetts, regardless of whether the vendor is located in Massachusetts.

The recurring ambiguities that individuals and businesses will face include:

  • When is one writing new software as opposed to modifying or integrating standardized software? For example, each page on a website like this one is based on a “template” which defines how the pages are all going to look. Creating a template is creating a separate chunk of computer code. However, that template only functions when it plugs into a standardized software package.
  • When is one configuring a computer system as opposed to engaging in tax-exempt data access or information management? For example, a website is based on a database of text — think of a record where one box on the record might contain the text of a whole web page. A web developer is arguably engaged in the business of data and information management as opposed to the configuration of software.
  • When is the software being used in Massachusetts? If you are a firm with businesses at multiple locations and purchase newly taxable services, you will have to determine how to allocate them to Massachusetts. This problem is not an entirely new one as purchasers of major software packages do already have to make that allocation as the packages have been taxable for many years. However, many major software packages are “open source” — downloadable for free — and not taxable. These packages always require installation and often require customization, services which will now be taxable. Many businesses will need to determine new allocations and compute, report and pay additional taxes.

In any given instance, the Department of Revenue, can take a position and answer a question about taxability. Some are hoping that we will get through a transition period and the protests will settle down and we will get on with the business of the Commonwealth. My fear is that the business of software development is so fluid that the conceptual boundaries may remain forever in flux.

And, of course, we have to ask: Why single out software services for taxation while leaving doctors, lawyers, accountants, dry cleaners and other service providers tax exempt? Software is not like cigarettes — it is not something one wants to discourage by special taxation.

But the big problem is not the money. The problem is the ambiguity of the tax: Most people really want to abide by the law and uncertainty is scary. Many of the players in the software industry are small businesses that can’t pay a staff of lawyers and accountants to sort the issues out for them. We don’t want to make Massachusetts a scary place for nascent information technology businesses — our goal should be exactly the reverse.

Business groups have already announced a ballot plan to repeal the software tax, which accounted for roughly 1/3 of the revenue funding the transportation plan. Sadly, the controversy about this tax has now created uncertainty about the funding of transportation itself — again, exactly what we were trying to eliminate.

When you are herding cats, the one thing you never want to do is change direction. Getting the transportation plan done was difficult for the legislature. Unfortunately, I do believe that the legislature should go back and revisit the transportation funding package this fall.

Published by Will Brownsberger

Will Brownsberger is State Senator from the Second Suffolk and Middlesex District.

68 replies on “The Software Services Tax”

  1. i echo many of the sentiments here. taking away from a major engine of growth (via an ambiguous and not well thought out tax) to cover the mismanagement of the MBTA is ludicrous. Lack of revenue is not the problem. It is a symptom of a deeper problem within the public transportation sector. It’s like our lawmakers lack a basic understanding of economic principles.

    i also find it shameful that something so misunderstood with so many major negative consequences passed through the legislature. i don’t mean to be rude Senator B, but this shows a lack of diligence on the part of our lawmakers and makes me question the diligence you intend to apply to bills that will be covered in the US HOR that could have more far-reaching impacts into our economy and society. (Kind of like how less than 5% of our current US Congressmen fully understood what was in the PPACA, let alone the likely consequences of the myriad elements of such a lengthy bill, before making it law)

    I do appreciate that you’re trying to have a conversation on it now, but it would save time and resources getting it right the first time around. And sorry, but “it got by me” is not the most confidence-inducing excuse…

  2. ahscruz:

    w/o trying to start a whole new topic, but since you seem to feel strongly that the MBTA is mismanaged and that is the root of the financial problems, not lack of revenue, I’m very interested in hearing the areas that you think significant $ can be saved? Because, while I myself can note areas of poor management where $ could be saved, there will usually be some stakeholder that strongly disagrees and “forces” the MBTA to keep spending. For example, should the MBTA be the agency”subsidizing” the RIDE program to the tune of $100 million or should this be done by the State as a whole? And should MBTA stations be “manned” at additional costs? Should salaries be cut – employees = taxpapers = voters will disagree. Etc, etc. And in any case, the biggest problem (IMO) is that (approximately) all the fare revenue paid by riders goes to the banks as interest, the highest % by far in the USA. This is the ultimate mismanagement – burdened on the MBTA by the State! I would rather pay higher taxes for a few years to pay off this debt and stop “subsidizing” the banks to the tune of $443 million per year. Wouldn’t you?

  3. Will,

    Could you explain how the legislature makes the logical leap from “we’ve got a funding problem on the MBTA” to “let’s tax this one particular industry instead of services in general”?

    Thanks.

  4. @alanmoore:

    sorry.by MBTA, i meant MassDOT in general. and i wasn’t necessarily blaming the people at MassDOT specifically, but rather all stakeholders in transportation, which, yes include the voters. there are numerous areas where savings could be realized or revenue increased (seriously, i could name a dozen ways operational changes could vastly improve long-term financial stability of the system here in Ma). however, as you point out, there’s always someone out there who’s going to disagree.

    but at the end of the day, i elect my reps to be man enough to make the right decision, not the most popular one. e.g., an annual scheduled increase in fares tied to inflation (kind of like that newly passed gas tax…) would be very controversial and probably overall unpopular, but if costs rise every year with inflation, it makes economic and business sense that fares should too. and what politician would risk the political suicide of making changes to the RIDE program (even though this is also necessary)?

    you’re right, even if the MBTA could close its deficit every year, it would still be faced with a very high debt burden, especially when compared to other transit systems. although, i think you’re incorrect in equating interest paid on a debt as a “subsidy” to the banks. is your bank “subsidizing” you when they pay you interest on your savings?

    i actually do mind paying higher taxes if 1) nothing else is being done to fix the operational inefficiencies in the system that will continue to lead to more deficits and thus continued debt in the future and 2) if it’s into a transportation system that’s okay at best. i’d rather my tax dollars go to something else.

    of course, all of this is totally off topic and was not my intent. my whole issue with the tax law was 1)it was passed by people who didn’t bother to understand it, its implementation, and its consequences and 2) it’s essentially a transfer of precious resources from a very particular industry to an inefficient government-managed entity that’s in a completely different sector. excuse me for the colloquialism, but it is straight-up redonkulous.

  5. ahscruz: Thanks for your considered response. I should not have used the work “subsidy” when referring to MBTA debt interest to banks. I was just frustrated because I don’t understand why taxpayers are will to pay higher taxes in the long-run to pay interest on State bonds (and enriching the banks – which just had one of their most profitable years) when we would pay less taxes if we simply taxed ourselves as necessary to pay for what we want/need. Same thing with the huge ($3 billion I think) accelerated bridge program which is all (I think) bonded money. And the Big Dig – it cost $16 billion plus another $5-6 BILLION in bond interest that we are still paying! Maybe someone can explain the (il)logic in borrowing when we can simply pay (less over the long run).

  6. alanmoore: haha. that’s so true! i think a lot of it has to do with the natural myopia of human beings. but i also think it’s politically easier to pass some of these projects if funded through bonds than through higher taxes. can you imagine if every time you wanted to build a bridge you had to bring up the idea of a tax? as you say, it’s a tax burden either way, but most folks don’t know that. that’s a sad reflection on both the politicians and the taxpayers. politicians, because they are going for political expediency and the taxpayers for not understanding the ramifications of what they are voting for.

    still, there isn’t enough taxpayer money to cover all these (concurrent) projects and there are consequences to high taxation as well. thus, in many (if not most) cases, it makes sense to use debt to fund these capital improvement projects ASSUMING these projects can generate some type of return (whether social or financial) on investment and not add to the debt burden once completed. and assuming the true cost of the project is accurately figured out upfront. (how much over was the bigdig?) this is not the case with most projects, which is why we end up seemingly paying more on the backend as opposed to the front end. but i don’t have a public finance background so this is all just my opinion.

    as much as I complain about the MBTA, i will say, it does seem like it got “screwed” with the BigDig. But that opens up a whole new topic of government mismanagement and waste in overseeing capital projects, which is also totally off topic here : )

  7. The thing about Massachusetts that I don’t understand is the legislature reacts counterproductively to any revenue problem. Instead of looking at projects that can be put on hold to free up revenue to pay for urgent priorities before resuming, They pull out the plastic and charge it, pay a little down and over the long term pay a lot more in interest costs. I think we can live within current revenus streams. If we can’t, use the tools at hand that capitalists use. DOT is a poster child for chapter nine bankruptcy. That would force a pay as you go paradyne. The legislature would need to define the projects, get absolute cost bids, save up for it in mini-rainyday funds, get the work done and pay the contractors out of the fund at completion. And if managed right the funds on deposit could possibly generate small amounts of revenue for, not burden taxpayers with interest costs.

  8. Views from the Inside: ‘Repeal the software services tax’
    Sen. Karen Spilka shares her views from the inside on the software services sales tax.

    http://www.bizjournals.com/boston/blog/mass-high-tech/2013/09/views-from-the-inside-repeal-the.html?ana=e_bost_tf&s=newsletter&ed=2013-09-04&page=all

    Sen. Karen Spilka shares her views from the inside on the software services sales tax.

    Senator Karen E. Spilka, Co-chair, Tech Hub Caucus
    Tomorrow, Governor Patrick will meet with Speaker DeLeo, Senate President Murray and a group of Massachusetts business leaders to discuss the problems created by the new software services tax and to develop a plan going forward.
    Contained in the Transportation Finance Reform bill passed by the legislature earlier this session, the software services tax extended the sales tax to include “computer system design services” and “the modification, integration, enhancement, installation or configuration of standardized software,” effective July 31st.
    After many conversations with constituents and other technology business owners across the state, I am deeply concerned by how this new policy will impact the tech industry, especially small businesses. In a state that prides itself on a thriving innovation economy, this tax is excessively burdensome. As chair of the Tech Caucus in the legislature, I am proud to be fighting for its full repeal.
    Once this tax went into effect, my office was flooded with phone calls and emails from tech industry leaders – in particular small business owners – who were deeply concerned with the impact the new tax would have on their ability to sustain and grow their companies. When our leaders sit down to discuss the impact of this new tax, they need to be especially mindful of what is happening to small businesses and entrepreneurs. These people will not be present at that meeting, but it is critically important that their voices be heard.
    A systems integrator from Natick, whose company has only two full-time employees, explained the difficulties of determining which services are taxable and the time tracking and billing systems that are now needed to ensure compliance. As a consultant, his day is structured around many different tasks, many taxable and others not. State regulations to clarify which activities are subject to the software services tax are still being formulated – this small business owner is being asked to design and implement an expensive new billing system, before the final regulations are even established.
    A software developer with a small firm in Franklin described other ambiguities. Developers regularly reuse pieces of code when providing services to their clients, even when writing custom software. His business already faces competition for clients and contracts. Collecting this new tax from clients would force him to raise his rates – potentially losing clients in the process – and alter his business model.
    A student studying Computer Science on the South Coast worried that employers in her industry would be less likely to add new employees in Massachusetts due to the added tax burden. Small businesses unable to absorb the added cost of compliance with the new tax may seek to cut back on their labor costs or relocate. Qualified professionals in the fields of Science, Technology, Engineering and Mathematics (STEM) are in high demand nationwide, yet small businesses in Massachusetts may now be unable to afford to add new talent.
    Here in Massachusetts, we are very proud of our technology industry and our reputation as a spectacular place for start-ups, entrepreneurship and innovation. This new sales tax is detrimental to the open, innovative business climate we hope to foster throughout the Commonwealth. Based on the concerns and extensive feedback I received, I filed a bill last month to repeal the software services tax in its entirety. Now, I urge the Governor, Speaker and Senate President to agree when they meet to discuss this issue tomorrow.

  9. Paul, the basic steps to this tax were: (1) The Governor proposed a whole package, including a big income tax increase, a sales tax rate cut and, oddly, a software tax; (2) the House and Senate Ways and Means Committees generated a joint proposal that didn’t pass that package but picked up on the software tax; (3) business leaders were so relieved that the Governor’s package didn’t pass that they said supportive things about the new package; (4) objections to the software tax got lost in the shuffle.

  10. The argument for bonding is that it spreads the cost of the project over the life of the project so that the taxpayers using the project in 2030 help pay for it. That is a powerful argument when you are smaller entity with only a few projects. The state has projects always ongoing so that we could maintain a more or less level pay-as-you-go funding stream. That would save interest costs.

  11. Will,

    That’s not quite what I meant. I understand the workings of the legislature on a basic level (how bills travel through committee, etc).

    What I meant was, how did someone come up with the idea of a software services tax vs. a more broad based tax?

  12. Thanks Will for the explanation: while that bonding arguement makes sense for “fairness”, IMO it would be better for the State or whatever entity, to minimize interest costs, and therefore total costs over the long run, by increasing taxes a little now rather than into the future. Of course, that arguement would reverse if inflation was high but interest rates low (which is not the case now).

  13. it also raises the question of whether tomorrow’s folks should be paying for the choices of the folks today. yes bonding spreads the cost of a project intergenerationally, allowing for many concurrent projects (i disagree with your logic that a steady-state of ongoing capital projects results in level pay-as-you-go funding or savings in interest. would love to hear your explanation on that one).

    but my primary question (perhaps rhetorical at this point) is: is it really “fair” that our grandchildren or great grandchildren have to pay for something we want today? especially when they will likely be paying for it at a much higher cost given these projects always end up being more expensive than originally projected, which in addition to other external factors (e.g. growing pensions and health care costs) impact credit ratings and increase interest rates in the long run? not to mention, will the folks of 2030 get as much value from a project like the Big Dig as the folks of 2013? doubtful. so they are paying more in the future and getting less value out of it. kind of a shoddy deal if you ask me.

    once again, happy to have this discussion offline as I think it’s taking away from the issue at hand, which is this software services tax.

  14. I’ll be interested in hearing the Senator’s specific reply of how this specific tax came about, but the bigger picture problem (IMHO) was that legislators were “scared” of enacting sufficient transportation related taxes like higher gas taxes or vehicle mileage charges to properly fix, maintain, and improve our transportation infrastructure. The simplest way to do this is higher gas taxes, that only now has been increased 3 cents after remaining constant since 1992. Increased fuel taxes can fund our aging infrastructure while providing an economic incentive for people to drive less miles and get more efficient cars. And I’ll respond now to the forseeable criticism that we can’t afford higher gas prices – if we can afford to drive to the local store instead of walking or biking, if we can afford SUVs and minivans for mostly driving a single person to work, then we can afford a few more cents per gallon fuel.

  15. I agree. One thing to consider. All sin taxes become difficult because as you decrease the sin you lose revenue. If you google gas consumption in Massachusetts, you will find that the consumption has declined significantly over the last 5 years or so. This is probably due to increased fuel efficiency and perhaps also to younger generation ( such as my 25 year old daughter ) choosing to be car-less. Regardless, an increase in the gas tax makes the most sense- you will ask find many states with a much higher gas tax than Massachusetts. Not sure what it would take to get 161 million.

  16. The intergenerational funding has built-in obsolescence problems with it. The T is a poster child for it. We have a Boston centric system that is of little or no use for those whose commutes are from suburb to suburb which is the dominant mode. If we gave the planning process back to where the tax dollars came from we would have a lot more nimble system that can provide more options for those in the suburbs. What we have now is funding transportation nostalgia.

  17. Just catching up . . . some summary replies.

    I agree that pay-as-you-go is preferable generally to bond funding especially when interest rates are at normal levels. Just pointing out the other side of the argument — it’s not a slam dunk either way.

    Would support a further gas tax increase — that’s the cleanest alternative to the software tax, which we do need to repeal.

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