California's
Tax Expenditure Programs

Sales and Use Tax Programs--Part 1

Contents

• Gas, Electricity, Water, Steam, and Heat
• Organic Products Grown Expressly for Fuel Purposes
• Agricultural, Timber, Municipal, and Industrial Waste By-Products
• Use of Refiners' Gas
• Animal Life
• Animal Feed
• Seeds and Plants
• Qualified Fertilizer
• Poultry Litter
• Food Products
• Candy, Gum, and Confectionery Products
• Bottled Water
• Packing Ice and Dry Ice
• Carbon Dioxide Used in Packaging
• Prescription Medicines

Exclusion/Exemption:

Gas, Electricity, Water, Steam, and Heat

Description

This program exempts from taxation the sale or transfer of gas, electricity, water (including steam), and geothermal brines or other heat sources delivered through mains, lines, or pipes. It also exempts water sold to an individual in bulk quantities (50 gallons or more) for household use, when the residence is not served by mains, lines, or pipes. In addition, the program exempts the transfer of steam, heat, or other energy produced by cogeneration technologies.

Rationale

The basic exemption for gas, electricity, and water dates back to the inception of the sales tax in 1933, when companies providing these services were subject to a gross receipts tax that was levied in lieu of other taxes under the State Constitution. The original tax exemption merely recognized that the Constitution prohibited the imposition of other taxes, such as the sales tax, on these companies. Although these constitutional provisions were subsequently repealed, the exemption nevertheless remained in effect.

Currently, there are two apparent rationales for this program. First, gas and electric bills are subject to municipal utility user taxes in many cities, often at rates higher than the sales tax rate. Thus, it is argued by some that the sales tax exemption avoids subjecting gas and electricity to double taxation.

Second, this program provides tax relief to consumers of gas, electricity, and water to the extent that sales and use taxes normally would be incorporated into the prices charged for these items. Proponents argue that these utilities provide basic and necessary services and, as such, such services should not be made any more costly to consumers by imposing the sales tax on them.

The exemption, however, is not limited to residential gas and electricity service. Rather, it also includes commercial and industrial purchases of electricity and natural gas, to which the "necessity of life" rationale does not apply.

Comments

Cities were receiving around $700 million from utility user taxes as of the late 1980s, but counties were not permitted to impose such levies. However, legislation at the start of the 1990s (Chapter 466, Statutes of 1990 [SB 2557, Maddy]) extended to counties the authority to levy such utility user taxes. In 1995-96, cities and counties raised approximately $1.3 billion from the utility users tax.

It is not clear that electricity, which is not a physical object or substance, would be subject to sales taxation even in the absence of this program.

Organic Products Grown Expressly for Fuel Purposes

Description

This program exempts from taxation the sale or transfer of organic products grown expressly for fuel purposes.

Rationale

This program provides an incentive for the production and use of organic products as fuel. It accomplishes this to the extent that it reduces the cost of buying or using organic fuels, thereby making them more attractive relative to conventional fuel sources. The apparent underlying rationale for the program is to reduce the economy's reliance on depletable border fossil fuels--especially crude oil-- and to encourage profitable border alternative uses of farmland.

Comments

Grain purchases by an alcohol producer generally would be exempt, even in the absence of this program, as a purchase for resale. However, growers of organic products, such as wood, that are sold for direct use as fuel do benefit from this program.

A detailed review of this program appeared in Volume I, Part Two, of our Analysis of the 1987-88 Tax Expenditure Budget. This review recommended that the program be maintained on the basis of (1) tax equity (since competing energy sources are not taxed), and (2) administrative savings to the Board of Equalization from not having to establish taxable values for the exempt items.

Agricultural, Timber, Municipal, and Industrial Waste By-Products

Description

This program exempts from taxation the sale or transfer of qualified waste by-products from (1) agricultural and forest-products operations, (2) municipal refuse, and (3) manufacturing activities. In order to qualify, these by-products must be used as fuel in an industrial facility in lieu of either oil, natural gas, or coal.

Rationale

This program provides an incentive for industry to use waste by-products as an alternative fuel. It accomplishes this to the extent that it reduces the cost of buying or using waste by-product fuels, thereby making them more economically attractive relative to conventional fuel sources. The underlying rationale for the program is to reduce the economy's reliance on fossil fuels, especially crude oil, and to encourage the more effective and complete utilization of scarce resources. The program also equalizes the taxation of waste-fuel materials that are purchased with those that are self-generated.

Comments

This program was established by Chapter 1248, Statutes of 1980 (SB 1576, Nielsen), and was permanently extended by Chapter 254, Statutes of 1986 (SB 1083, Boatwright). The program was amended by Chapter 1059, Statutes of 1983 (SB 1031, Boatwright) to delete the original requirement that qualifying by-products be "delivered in bulk." This change ensured that the program would apply to waste by-products consumed at the same site where they are generated, such as the burning of wood chips in a lumber mill.

A detailed review of this program appeared in Volume I, Part Two, of our Analysis of the 1987-88 Tax Expenditure Budget. This review recommended that the program be maintained on the basis of tax equity (since competing sources of fuel are not taxed), and the administrative savings to the Board of Equalization from not having to establish taxable values for the exempt items.

Use of Refiners' Gas

Description

This program exempts from taxation the use of "still gas" which has been produced as a by-product during the refining of purchased crude oil.

Rationale

The underlying rationale for the program is to equalize the tax treatment of still gas used by refiners who purchase their crude oil, with those who use oil they produce themselves. It is agrued that the program also encourages resource conservation through more efficient use of crude oil supplies.

Comments

The use of still gas produced from proprietary (that is, nonpurchased) petroleum is not subject to the use tax, because state law requires that a formal transfer of a product occur in order to "trigger" a tax levy.

This program was established by Chapter 1059, Statutes of 1983 (SB 1031, Boatwright), as declarative of existing law under Chapter 1248, Statutes of 1980 (SB 1576, Nielsen), which provided a tax exemption for waste by-products derived from manufacturing activities. This program was permanently extended by Chapter 254, Statutes of 1986 (SB 1083, Boatwright).

A detailed review of this program appeared in Volume I, Part Two, of our Analysis of the 1987-88 Tax Expenditure Budget. This review recommended that the program be maintained on the basis of tax equity (since competing sources of fuel are not taxed) and the administrative savings to the Board of Equalization from not having to establish taxable values for refiners' gas.

Animal Life

Description

This program exempts from taxation the sale or transfer of animal life, the products of which ordinarily constitute food for human consumption.

Purchases of dairy cows and of any livestock or poultry for breeding (or egg laying) purposes ordinarily would be subject to sales and use taxes in the absence of this program. This is because these animals are put to use by the purchaser, rather than simply fattened and resold, as with most beef cattle.

Rationale

This program provides tax relief to producers of animal-based food products, by eliminating the sales and use taxes that ordinarily would apply to animals that are not purchased solely for resale. By reducing the cost of producing animal-based food items, the program benefits consumers to the extent that these lower production costs reduce retail food prices. As such, this program basically is an extension of the sales and use tax exemption for food. The underlying rationale offered for the program is that food is a basic necessity of life, and that its price should not be increased by taxation.

Animal Feed

Description

This program exempts from taxation any sale or transfer of animal feed which is fed to qualified animals. Qualified animals are those whose products either ordinarily constitute food for human consumption, or are to be sold in the regular course of business.

Rationale

This program provides two basic types of tax relief. First, it provides tax relief to consumers of animal-based food products by reducing the prices of these products. As such, this aspect of the program basically is an extension of the sales and use tax exemption for food. The underlying rationale offered for this aspect of the program is that food is a basic necessity of life, and its price, therefore, should not be increased by taxation.

The second type of tax relief provided by the program is to consumers of nonfood animal products, to the extent that sales and use taxes on feed ordinarily would be incorporated into these products' prices. The rationale offered here is that feed is a "component part" of an item which subsequently is itself subject to taxation and, therefore, should not be double-taxed. An example is the use of feed to raise animals, the pelts of which are used to make coats, which in turn are subject to sales taxes.

Seeds and Plants

Description

This program exempts from taxation the sale or transfer of seeds and plants whose products either ordinarily constitute food for human consumption, or are to be sold in the regular course of business.

Rationale

This program provides two basic types of tax relief. First, it provides tax relief to consumers of seed and plant-related food products by reducing their prices. As such, this aspect of the program basically is an extension of the sales and use tax exemption for food. The underlying rationale for this aspect of the program is that food is a basic necessity of life and its price, therefore, should not be increased by taxation.

The second type of tax relief provided by the program is to consumers of nonfood products that are derived from qualifying seeds and plants, to the extent that sales and use taxes ordinarily would be incorporated into the prices of these seeds and plants. The rationale here is that these items are "component parts" of products which, themselves, are subsequently taxed and, therefore, should not be subjected to double taxation. An example is the purchase of flower seeds by a nursery in order to grow flowers, which themselves are taxed when sold to consumers.

Comments

Chapter 323, Statutes of 1998 (AB 2798, Machado), extended this sales tax exemption, formerly limited to annual plants, to perennial plants.

Qualified Fertilizer

Description

This program exempts from taxation the transfer of fertilizer to be used on land, if the land is used to produce either food for human consumption or other products to be sold in the regular course of business.

Rationale

This program provides two basic types of tax relief. First, it provides tax relief to consumers of food products grown with the help of fertilizer, by reducing their prices. As such, this aspect of the program basically is an extension of the sales and use tax exemption for food. The underlying rationale offered for this aspect of the program is that food is a basic necessity of life, and its price, therefore, should not be increased by taxation.

The second type of tax relief provided by the program is to consumers of nonfood products which fertilizer helps produce, to the extent that sales and use taxes on fertilizer ordinarily would be incorporated into these products' prices. The underlying rationale offered here is that the fertilizer is a "component part" of an item which subsequently is, itself, subject to taxation and, therefore, should not be double-taxed. An example is the use of fertilizer by a nursery in growing flowers, which themselves are taxed when sold to consumers.

Comments

For the purposes of this program, the term "fertilizer" includes commercial fertilizers, agricultural minerals, and manures, but does not include soil amendments. The latter are excluded on the basis that they do not constitute a "component part" of the grown products, but rather are capitalized into land values. Such soil amendments include hay, straw, peat, leaf mold, sand, potting mediums, and specified mineral and chemical constituents.

Poultry Litter

Description

This program exempts from taxation the sale or use in California of certain products that are used as litter in poultry and egg production and that in turn are ultimately resold as, or incorporated in, fertilizer products. This exemption applies to wood shavings, sawdust, rice hulls, or other related products.

Rationale

This program provides two types of tax relief. First, it provides tax relief to consumers that purchase fertilizer products. Second, it provides indirect tax relief to consumers of food and nonfood products which fertilizers help to produce, again to the extent that the product prices would reflect the sales and use tax paid on the components incorporated in the fertilizers. Program proponents note that the program is consistent, at least to some extent, with the related program for qualified fertilizer.

Food Products

Description

This program generally exempts from taxation the transfer of food products for home consumption (other than carbonated or alcoholic beverages). The program does not extend to sales of most prepared food, including take-out food items and restaurant meals.

Special rules apply to vending machine sales of otherwise nontaxable food items, such as candy. Generally, 33 percent of the receipts from these sales are taxed as an approximation of the portion of these sales that otherwise would be taxable because they are items consumed on the same premises as the vending machine. Vending sales of any food item costing 15 cents or less, or of any bulk food items (such as nuts) costing 25 cents or less, are fully exempt from taxation. This is accomplished by treating these retailers as the consumers of the items that they sell. Since the food products are exempt when purchased by the vendor (under the general food exemption), this treatment is equivalent to a full tax exemption.

Rationale

This program provides tax relief to consumers of food products, by reducing their price. The underlying rationale put forth for the program is that food is a basic necessity of life and, therefore, its price should not be increased through the application of the sales tax.

Comments

Although the basic rationale offered for this program is to exempt food products from taxation because they are a necessity of life, it should be noted that the term "necessity" is somewhat loosely, and even inconsistently, applied. For example, restaurant meals and most take-out foods are taxed. This treatment generally is justified on the grounds that they are luxuries, or at least a convenience, compared with cooking at home. However, some of these taxable foods also appear to be necessities, if purchased by an individual lacking cooking facilities.

In addition, in the case of food products that qualify under this program, there is no attempt to restrict the quality or cost of exempted items. For instance, the program applies to high-grade or expensive products, which do not constitute basic necessities.

In 1991, the Legislature passed legislation that would levy the sales and use tax on snack foods. "Snack foods" were defined to include products that were sold in a condition suitable border for immediate consumption, such as cookies, potato chips, and snack cakes. The legislation (Chapter 85, Statutes of 1991, [AB 2181, Vasconcellos] and Chapter 88, Statutes of 1991, [SB 179, Deddeh]) met with some resistance and confusion among taxpayers and retailers, especially with regard to certain apparent inconsistencies. For example, pre-popped popcorn was subject to taxation but unpopped popcorn was not. The so-called "snack tax" was repealed by Proposition 163, approved by the voters in November 1992.

Candy, Gum, and Confectionery Products

Description

This program generally exempts from taxation the sale or use of candy, gum, and other confectionery products for home consumption. This program is included within the overall food exemption and is subject to the same limitations. Vending machine sales of candy, gum, and other confectionery products may be subject to tax under certain conditions (see discussion under the previous program entitled "Food Products").

Rationale

This program provides tax relief to producers of candy and to candy consumers by reducing the prices of such products. The program's rationale is that candy, gum, and confectionery items also constitute food products and as such, deserve the same tax exemption granted for food generally.

This exemption was repealed effective July 15, 1991 as part of a broadening of the sales and use tax base. The exemption was reinstated in November 1992 as part of Proposition 163 and was incorporated into the California Revenue and Taxation Code Section covering food products.

Bottled Water

Description

This program exempts from taxation the transfer or use of noncarbonated and non-effervescent bottled water.

Rationale

This program provides tax relief to the consumers of bottled water. The underlying rationale offered for the program is that water is a basic necessity of life. Many individuals use bottled water because of impurities and other related problems with the quality of their normal water supplies.

Comments

The statute allowing the exemption (California Revenue and Taxation Code Section 6359[b]) was repealed effective July 15, 1991 as part of a broadening of the sales and use tax base. The exemption was reinstated as part of Proposition 163 in November 1992, and was incorporated into the California Revenue and Taxation Code Section covering food products (see previous program entitled "Food Products").

Packing Ice and Dry Ice

Description

This program exempts from taxation the transfer of ice and dry ice, when the ice is used or employed in packing and shipping qualified food products for human consumption by qualified carriers.

Rationale

Proponents of this program argue that it is needed to equalize the tax treatment of packing ice and dry ice with that of various other competing cooling processes. These various other means of cooling (such as forced air and chilled water baths) are not directly subject to sales and use taxation because they are "processes" and not tangible personal property (as is ice). The program also has been rationalized on the grounds that coolants are needed to provide consumers with unspoiled food products, many of which are, themselves, exempt from taxation because they are viewed as basic necessities of life.

Comments

This program became operative on January 1, 1986 as provided by Chapter 1045, Statutes of 1985 (AB 1887, Areias). An earlier program had been in effect for ice used in interstate transportation only, until its repeal in 1979 by Chapter 1150, Statutes of 1979 (AB 66, Lockyer).

The rationale that this program is needed to equalize the tax treatment of ice with that of other cooling methods overlooks the fact that the equipment for these alternative coolant systems generally is subject to sales and use taxation at the time it is purchased. A detailed review of this program appeared in Part Two of our Analysis of the 1988-89 Tax Expenditure Budget. In our review, we found no evidence that this program was having any significant impacts on the basic economic competitiveness of the affected California industries, or on prices paid by consumers. Accordingly, in the interests of tax equity, we recommended that this program be repealed.

Carbon Dioxide Used in Packaging

Description

This program exempts from taxation the sale or use of carbon dioxide used in packing, shipping, or transporting fruits or vegetable borders for human consumption, provided that the fruits and vegetable borders are not sold with the carbon dioxide packaging and any nonreturnable materials containing carbon dioxide. To qualify for the exemption, the fruits or vegetable borders must be shipped or transported in the carbon dioxide packaging by common carriers, contract carriers, or proprietary carriers.

Rationale

This program provides tax relief to consumers of fruits and vegetable borders that have been packed and shipped. The underlying rationale for the program is that food products such as fruits and vegetable borders are basic necessities of life, and therefore, their price should not be increased through taxation. This program also attempts to equalize tax treatment of carbon dioxide packaging with other types of packaging (such as dry ice and forced air) that are used to provide consumers with unspoiled food products. These alternative types of packaging also are exempt from taxation as described under separate programs.

Comments

As discussed in the program entitled "Packing Ice and Dry Ice," this program may result in a tax advantage of exempt methods over certain other cooling methods. While cooling methods such as forced air and chilled water are not directly taxed, the equipment for these coolant systems is generally taxed when purchased.

Prescription Medicines

Description

This program exempts from taxation the sale or use of specified medicines and medical-related products used for treating the health problems of human beings. Items which qualify for the program include medicines which are: (1) prescribed by a physician and dispensed by a registered pharmacist; (2) furnished by a licensed physician, dentist, or podiatrist to patients; (3) furnished by a health facility to patients pursuant to the order of a licensed physician; (4) sold to a licensed physician or health facility for treating human beings; (5) sold to the state or other political subdivision for use in treating human beings; and (6) furnished without charge by a pharmaceutical manufacturer or distributor to a licensed physician, health facility, or institution of higher learning for research which will be used to treat human beings. In addition to medicines, qualifying items include such medical products as prosthetic and orthotic devices, hemodialysis products, insulin syringes, sutures, bone screws, and artificial limbs and eyes.

Rationale

This program provides tax relief to consumers of certain medicines and medical-related products. The underlying rationale for the program is that the price of medicines should not be increased by taxation because proper medical care and treatment is a basic necessity.

Return to California's Tax Expenditure Programs, Sales and Use Taxes, Table of Contents
Return to California's Tax Expenditure Programs, Full Table of Contents
Return to Legislative Analyst's Office Home Page