Illustration by Jesse Lefkowitz.
Not so long ago, a San Francisco tax lawyer and habitual hot chocolate drinker named William Weissman was puzzled as to why he paid sales tax at some Starbucks, but not others. So, he did what habitual hot chocolate-drinking tax lawyers do, and penned an article titled "Why Is Buying Hot Chocolate So Confusing?" for the niche periodical State Tax Notes.
A few months later, Weissman was surprised to receive an unsolicited response to his article from the California Board of Equalization addressing his "concern that the application of sales tax is unexplainably inconsistent." The "explanation" stretched to nearly 2,000 words over four pages and liberally referenced half a dozen enclosed government tax publications and regulations. A key point was broken down into six subsections, the last of which contained a sub-subsection.
One thing the explanation did not include, however, was an explanation. "It is not clear why sales tax was collected by Starbucks on the sale of hot chocolate," the letter concludes. It is clear, however, that California's rules governing food taxation are demonically complicated and cluttered with reams of arcane and arbitrary regulations. This could, of course, describe any number of government programs — but, in the realm of taxes relating to food, matters quickly veer into the surreal.
Like 30 other states, California exempts "food for home consumption" from sales tax. Giving consumers a daily tax break has been an easy sell politically — 25 states have ceased taxing food in the past 40 years. In addition to leaving many billions of dollars on the table, states now find themselves plunged into the bizarre role of defining exactly what constitutes "home consumption" — and, more basically, "food."
As a result, California's government has spent vast amounts of time and effort determining that sales tax is due on a sandwich a convenience store clerk warms in a microwave for a customer, but not on a sandwich a customer warms in the store's microwave — a price difference of 8.5 percent in San Francisco and up to 9.75 percent in other California counties.
Among many hundreds of rulings, California's Board of Equalization has decreed that, specifically, a product called "Dr. Chen's Secret Sauce" is food (as are "Tom and Jerry Eggnog Batter" and communion wafers), and therefore exempt from tax; aloe vera juice is a dietary "adjunct" and therefore taxable; and honeybees' royal jelly could be either, depending on the description on its packaging, and may or may not be taxable.
Carbonated water and most carbonated juice drinks are taxable; carbonated 100-percent juice is not taxable; but carbonated alcohol-free wine is. The lengthy rulings behind these decisions eerily resemble voluminous dispensations within the Talmud regarding the finer points of consuming milk and meat. Hearings before the Board of Equalization determining that the sale of the very same batch of carrots would or would not require collection of sales tax if the buyer is a homeless shelter (no), a racetrack (yes), an ostrich farm (no), or a zoo (maybe) take on the absurd specter of medieval trials in which animals were accused of human crimes such as fraud or theft.
"It could be viewed as comical in a lot of contexts," says San Francisco tax attorney Robert Wood, who has argued cases before the BOE. "But not if you're the one paying." Debates over how to ring up cake decorations or seltzer lose their humor for retailers facing the Scylla of a government audit if they under-collect on sales taxes and the Charybdis of a class-action lawsuit if they over-collect.
Apart from the obvious political boon of giving taxpayers a break on one of life's daily necessities, the state entered this administrative quandary with, ostensibly, the best of intentions. California's base sales tax rate of 7.25 percent — the highest in the nation — is collected whether the buyer is Joe Six-Pack or Joe Millionaire. Poorer people, not surprisingly, spend a higher percentage of their money on food than richer people do. A flat sales tax is "regressive;" that is, forking over a static percentage of one's money is harder on the poor than the wealthy. Exempting purchases of food for home consumption is meant to somewhat ameliorate this. This it does — but in perhaps the most wasteful and inefficient manner possible. In order to provide limited relief to its poorest residents, the state allows every last person to benefit, even the wealthiest of the wealthy, buying caviar-stuffed lobster tails from exclusive upper-class markets that make Andronico's look like Grocery Outlet. Breaks aimed at aiding the underprivileged are being snapped up by the well-to-do. Research by Indiana University's professor John Mikesell, one of the nation's foremost sales tax scholars, indicates a full 45.5 percent of the tax relief provided by food exemptions benefits households earning upward of $70,000. (In a reality check for San Franciscans — who enjoy a median income a shade higher than this — the nationwide median household income is around $49,900).
The consequences of food tax exemptions are hardly peanuts — California and its 30 like-minded states forgo 20 to 25 percent of their potential sales tax revenue. In 2009-10, California collected $42.2 billion in sales tax. In the current year, California's Department of Finance estimates revenue losses from exempting food and bottled (non-carbonated) water to be nearly $10 billion — with much of this money staying in the pockets of people who would be difficult to categorize as requiring "tax relief." This comes at a time when programs aiding the needy — the very people California aims to benefit by limiting food taxes — are being systematically dismantled due to lack of funds. Other states have implemented intriguing — and lucrative — solutions to this conundrum. But California continues to give up billions, while still grappling with applying exemptions based on whether foods are hot or cold, carbonated or flat, or served to a human, cat, or wildebeest.
"It's just baloney," says Mikesell. "Which would not be taxed," he quickly adds. "Unless it were served in a sandwich."
The life of a Board of Equalization member isn't always the stuff of movies — but the stuff of movies does fall under the adjudication of the Board of Equalization. Bill Leonard, an elected member from 2003 to 2010, chuckles when he recalls "the popcorn case." Since cold food to go is often exempt from sales tax and hot food rarely is, Century Theaters faced an uphill battle arguing that it shouldn't remit sales tax to the state for movie popcorn. "They said those weren't heat lamps — those were dehumidifier lamps," Leonard recalls. "The whole room was laughing out loud." Despite being laughed out of court, Century Theaters returned several months later. This time, Leonard claims, it enlisted "popcorn experts" who had jammed "temperature probes in the boxes to show us what the temperature was." On second thought, the BOE bought the argument. Sales of movie popcorn is now tax-exempt in California; while the popcorn may be hot, the heat is simply a by-product of those "dehumidifier lamps." Since there is no "intention of heat," the popcorn is not taxable.
A rundown of California's food taxes and exemptions — and exemptions to the exemptions — rapidly begins to resemble an Abbott and Costello routine.
A hot sandwich to go would be taxable, while a prepackaged, cold one would not — but a cold sandwich becomes taxable if it has hot gravy poured onto it. Cold foods to go are generally not taxable — but hot foods that have cooled are taxable (meaning a cold sandwich slathered in "hot" gravy that has cooled to room temperature is taxable). Cold, non-carbonated, non-alcoholic beverages to go aren't taxable. Hot beverages to go are, but coffee and tea are specifically exempted from taxation. Soup, however, is taxable. Hot soup that has cooled? Still taxable. But, the BOE specifically informs SF Weekly, cold soups such as gazpacho are exempt.
Yet while neither an individual bowl of gazpacho nor a cup of hot coffee to go is taxable, the sale of gazpacho and coffee as a combo meal is taxable. Moreover, hot food to go isn't taxable if it falls under the "hot bakery goods" exemption. There is, however, no written definition of what constitutes "hot bakery goods."
"The BOE considers to be exempt from tax 'bakery goods', croissants, and similar products filled with cream or fruits, but as taxable the croissants and similar products when filled with meat, fish, eggs, vegetables, etc.," the BOE writes. "Samosas, empanadas, and other savory items would therefore be taxable, while cream-filled donuts would not."
The BOE does not have a ready answer for how to tax goods filled with the taxonomically ambiguous tomato.
How identical items are used — and who uses them — looms large in their tax status. Multiple states have pondered charging sales taxes on pumpkins used for jack-o'-lanterns, but not for pie or soup. (What to do about a consumer who carves a jack-o'-lantern, but roasts the pumpkin seeds, may be an unresolvable scenario.) Sob stories about people eating cans of dog food are even more lamentable as pet food is taxable while canned foods intended for humans are not.
In perhaps the most eye-opening case of this sort, the BOE claimed a business that sold fruits and vegetables to the San Francisco Zoo should have collected sales taxes on the transaction and sent them to the state. Per state law, sales tax is exempted on food sales when the food in question will be consumed by animals that are ordinarily suitable for human consumption. So a company selling the very same bag of animal feed will owe the state sales taxes if the feed is bought by a horse farm — but none if it's bought by a dairy farm. The BOE claimed that, since zoo creatures don't often end up on the dinner table, the state was owed back taxes.
Yet attorney Robert Wood redefined "California cuisine" by arguing that, since people in various corners of the globe consume monkeys, bison, antelopes, and other beasts, the fruit and vegetable sales should have been sales tax-exempt. He won his case. "It's amusing — but it's also distressing," he says now, 20 years later. "This stuff is bizarre; it makes you think of Dostoevsky. How could people sit around and think this stuff up?"
Of course, all of the aforementioned rules and exemptions may be moot if a retailer uses "the 80/80 rule." If 80 percent of a California merchant's gross receipts are from food products and 80 percent of retail sales are usually taxable, then, to streamline bookkeeping, the retailer may simply tax all sales. So a customer buying the very same bottle of milk — or, indeed, cup of hot chocolate — at the McDonald's on Haight and Stanyan and the Whole Foods across the street could pay sales tax at the first establishment but not the second.
A scenario in which McDonald's patrons are taxed but Whole Foods' clientele isn't leads to the multi-billion-dollar question: Is a convoluted, onerous system with the supposed upside of aiding the poor really aiding the poor?
A sign on the black metal door barricading Jim Ayers' spartan room at the Lawrence Hotel on Sixth Street reads "Don't knock on this door for nothing." The portal is a point of pride for Ayers, a retired sixtysomething ironworker and bartender who has lived behind it for 21 years. "I'm the only one here who has a steel door," he notes. "The only one."
Ayers lives off $909 a month. By the time he's paid rent, utilities, fuel for his truck — which he dutifully moves in the pre-dawn hours every night to avoid parking tickets — he doesn't have much left. He also doesn't have a kitchen, so you'll find him in a Tenderloin restaurant more days than not. Ayers gives a spirited rundown of the slings and arrows of the fare offered by local eateries; he knows them all and they all know him. Money's tight, naturally — but that's okay, Ayers says wearily. He can get by on two meals a day. Of course, he's being taxed on those two meals. "I just don't understand why I should be taxed for food that is cooked, yet I can have the same thing that's cold and not even prepared and I'll pay less," he says. "I just don't get it."
Neither does Richard Pomp — and he literally wrote the book on this. (State and Local Taxation is now in its seventh edition.) The University of Connecticut law professor probably spends Ayers' yearly income on "coffee picked on the mountaintops of Papua New Guinea by virgins, cheeses that look like they were deported from foreign countries after being used for medical research, and tiny Japanese mushrooms with unpronounceable names" — none of which is taxed at the high-end grocery stores Pomp frequents. He earns a good living. The vagrants he sees eating burgers in fast food parking lots do not. "Why should I not pay any sales tax and they should?" asks the professor. Allowing the Richard Pomps of the world to skate on paying sales taxes to supposedly benefit Jim Ayers — while taxing Ayers — is "probably the silliest of all approaches," Pomp notes.
The silliness extends beyond necessitating an overarching bureaucracy to determine the tax status of the Icee ("a carbonated beverage and ... therefore subject to tax") and dinging impoverished people forking over spare change for Big Macs. The 20 to 25 percent sales tax revenue losses states incur by exempting food are massive — and the way to make up for those lost billions is to raise the overall sales tax rates. The poor, intuitively, spend an oversize portion of their money on food. But they also buy clothes, books, and steel doors — and now pay an accordingly higher rate of sales tax on it.
A state with myriad tax exemptions and a high sales tax rate is essentially gambling more chips on fewer slots — meaning California's official policy is "exactly the reverse of what we teach in taxation courses," notes Indiana University's Mikesell. Not surprisingly, high tax rates collected on limited items lead to fluctuating, unpredictable returns — and render states vulnerable to economic swings. Professor Bill Fox, the director of the University of Tennessee's Center for Business and Economic Research, points out that states' tax revenues have grown far more unstable in recent decades — "right when sales tax was taken off food in many states.... What was done is a fairly stable tax structure was taken out of the base, and that made it more volatile."
As Californians know all too well, this sort of volatility leads the government to establish spending commitments based on rosy projected revenue streams that, following the onset of bad times, quickly become the subject of nostalgia. We'll give you one guess as to who suffers in this scenario — and it's not rich people.
A shotgun approach to food taxation that allows everyone to partake in benefits intended for the poor — while states hack apart the social safety net — may not be "regressive." But it is perverse. "What's sensible is to tax food — and then give the money back to the truly needy," says Pomp. To do so, adds Fox, "is much more effective — we can aim right at the people we care about."
When asked where states should look for inspiration, Fox can answer in one word: Aloha.
Hawaii has plenty going for it — the sun, the surf, the Spam sushi. But the real paradise — at least according to a subset of economists and number-crunchers — is its general excise tax. Singing "Tiny Bubbles in the Wine" kept Hawaiian musician Don Ho employed for life. But Hawaiian state attorneys have been spared the chore of discerning the taxable status of carbonated alcoholic beverages. Arcane rules regarding hot chocolate's taxability don't apply in Hawaii either. "You don't have to guess as to what's taxable and what's not," notes Cathy Tokishi, an information specialist for Hawaii's Department of Taxation. "Most things are." Champagne is. Cocoa is. And so is food.
As a result, the state doesn't have to create volumes of labyrinthine regulations, riddle them with confusing exemptions, and impose the system upon retailers. Retailers simply pay a percentage of their gross revenue. Because Hawaii's sales tax base is so broad, its corresponding rate is very low: 4 percent. And residents qualifying as "low-income" receive all or much of their estimated food expenditures back through an income tax credit — a system similar to those in Idaho, Kansas, Oklahoma, and South Dakota. "This is a way you can direct the relief to the people you really want to," notes Mikesell. And you can use the rest — billions of dollars — to run the state.
Since everything from soup to nuts is taxed in Hawaii — albeit at a rate less than half of many California counties — there's no worry about whether that soup is gazpacho or cream of tomato, or if the nuts are hot or cold. When asked if a consumer could initiate a class-action lawsuit because she was charged 71 cents in sales tax on supposedly tax-exempt to-go coffee at Target, Hawaiian tax officials broke out laughing. Their California equivalents did not — and also declined to discuss pending litigation. Just such a case has worked its way to the state Supreme Court. Its outcome may set a precedent on whether class-action lawsuits are permissible in pending cases against Ralph's (regarding sales tax on hot coffee to go); Sav-On (accused of collecting sales tax on tax-exempt glucose test strips and skin puncture lancets); and even Cingular Wireless (a litigant claims he was charged sales tax "based on the full value of the cellular phone purchased rather than the bundled price.").
If California were to adopt a system more like Hawaii's, the state would be saddled with the task of deciding just how "low-income" a household must be to qualify for a food credit — or could simply disburse a flat amount that would likely represent all or most of a poor family's expenditures but only a fraction of a well-off family's. But, under such a scenario, even those not qualifying for the food credit could prosper. If the state began taxing food — but also lowered its tax rate by even 1 percent — a wealthier family would, naturally, pay hundreds more in food taxes. But it could also save hundreds on big-ticket purchases now taxed at a lower rate.
Such a system is still a non-starter with many poverty advocates, who argue that the needy require point-of-sale relief. Well, fair enough. "With technology the way that it is today, we ought to be able to deliver tax relief in ways other than just sending people a chunk of money when they file their returns," notes Kirk Stark, a UCLA law professor and tax expert. That could include a system akin to federal food stamps, or a state-issued card. "This could all be done electronically. This ought to be possible."
Politics is, after all, the art of the possible. But Stark issues a huge caveat — he dwells in academia, not politics. In California, such drastic alterations to the tax system would necessitate a constitutional amendment. A ballot measure, meanwhile, would require citizens to voluntarily subject themselves to taxation on food items long exempt — and now considered sacrosanct — while withstanding howls that this would equate to a middle-class tax hike.
Admittedly, a setup like Hawaii's is not perfect. "But the perfect is the opposite of the good," argues Pomp. "If you try to get it exactly perfect you do nothing. You're paralyzed." Actually, not quite — things can always get worse.
No politician unwilling to be immolated by powerful anti-taxation forces would propose widening California's tax base, even if that means lowering its tax rate. Yet the opposite route has long been the state's go-to quick revenue-generator. Too bad: Former California Franchise Tax Board head Jerry Goldberg notes that keeping the tax base narrow and hiking up the rate — as we've done — is far more regressive than doing the opposite.
Maybe we don't care so much about being regressive after all.
In 2007, Jim Ayers learned that his elderly neighbor at the Lawrence Hotel was storing a World War II-era Japanese mortar shell in his room. Ayers promptly phoned police and led them to the live explosive. Had it gone off — and it may well have as it continued to deteriorate — it would have blown the building apart.
Ayers is a no-frills kind of guy, so it's a good bet he celebrated his good fortune in not being vaporized at one of his two favorite restaurants — The Lafayette or The Manor House — with "the usual," a ground beef steak.
"I like a big ol' hunk like that," he says, holding his hands a rather large steak-sized length apart. "A baked potato or mashed potatoes, Jell-O or pudding for dessert — and what I can't finish I can wrap it up, bring it back home, and slap together some sandwiches."
That he's being taxed at a relatively high clip pains him. So does the demise of some of his favorite Tenderloin restaurants, which have been replaced by faux working-class joints serving $10 burgers — and that's before tax. "The taxes — it doesn't make sense," he says. "At least not to me. But I don't like to get involved with politics." Like food from the wrong restaurant in Ayers' neighborhood, "it hurts my insides."