Looking Backwards for Answers: The PA Tech Tax
Admittedly, I’m late to the game. Not quite as late as the Pennsylvania budget however, as the deadline was July 1st. While the budget passed, it is unbalanced, leaving many issues on the table. This budget cycle, Governor Tom Wolf of Pennsylvania introduced the idea of a “technology tax” against technology service providers to help address the $3B state budget deficit.
For context, the Pittsburgh Technology Council has a list of the NAICS codes impacted based on the Pennsylvania Independent Financial Office’s (IFO) report, Analysis of Revenue Proposals FY 2017–2018 Executive Budget (page 22).
As you can see below from the IFO report, the tax of technology service providers would dis-proportionally account for the majority of sales tax increases in Pennsylvania, accounting for an estimated $349M.
Clearly, if your business falls into this category, you could be soon facing an additional 6% sales tax on services which you will either have to eat or pass along to your customers. A move like this could make these firms abandon the state altogether. After all, why deal with this sales tax when only 4 other states have it in place (Connecticut, Hawaii, New Mexico and South Dakota)?
There are three potential outside forces that one needs to consider when thinking about the technology tax.
First, the movement from goods to one of services across modern business, has caused a loss of sales tax revenue for all states. This problem has cropped up over the past 20 years and has been a gap that states have struggled to fill.
Second, Pennsylvania has been over the national average for unemployment since late 2015, according to the PA Center for Workforce Information and Analysis (red is PA, blue is US).
Don’t get me wrong, the state unemployment rate isn’t high and it has been dropping, but it should be noted. Pennsylvania does offer a Job Creation tax credit for businesses under 100 employees.
Third and possibly most important, the state ranks 45th out of 50 as a great place to start a business, according to a July 2017 WalletHub study.
A big part of this is that Pennsylvania has the second highest corporate tax rate in the country at 9.99%. This statistic and others can be found at the Tax Foundation’s report titled “Location Matters: The State Tax Cost of Doing Business.”
Lastly, Pennsylvania is the sixth most populous state in the United States at 12.7M people as of 2016 estimates. That is a lot of sales and income tax to be collected out there.
No Company is Safe
Certainly, this impacts technology providers located in the state and leaves them with 3 options. The ones located around the state’s two largest cities, Philadelphia and Pittsburgh, could easily hop over the border and set up shop while others may simply choose to close and still others will try to compete regardless of the burden.
They wouldn’t be the only ones impacted however.
Companies purchasing technology services from providers based in Pennsylvania will be impacted. For complex IT projects, a 6% difference could be the difference between winning and losing a bid on a project or choosing to innovate or stay stagnant.
There is yet another consideration. Satya Nadella, CEO of Microsoft, and several other large technology company CEOs have stated that every company is a technology company.
This quote means that companies that innovate are building new technology based experiences and services for their customers in order to stay competitive. Some companies are shifting their business model to these digital services, which could require taxation.
There is also a movement to create technology incubators to try out new things and fail fast. These new spin-off companies, built on driving innovation, could be sent out of state or shut down entirely due to a concern of how they might be classified. This kills innovation, jobs, and revenue for the state, driving it elsewhere.
The Factors that Increase Competition
Technology services is a tough market to compete in and it is only getting harder. In the state today, hardware, software, SaaS, and technology warranties are taxed, where they are not in some of the surrounding states. This tax could push companies to look away from Pennsylvania for these types of services.
Companies are leveraging cloud services more and more to stay ahead of the market as they innovate and build a digital portfolio. Since cloud services are not geographically relevant to technology service providers, any customer can go anywhere to get the associated technology services.
Competing with other states isn’t the only challenge. The US saw a rise in the early 2000s of technical offshoring to India and other countries. There is no longer a reason why any customer needs to leverage local resources to service them, let alone pay 6% more for the convenience of doing so.
The Benefits of Keystone State
Facing a $3B budget deficit is no small hill to climb and still needs to be addressed, so where does that leave Pennsylvania?
I can think of at least 2 places to look that could help the state regain revenue, having to do with Pennsylvania’s nickname as the Keystone State.
Pennsylvania is the gateway to the Northeast and as a result, it is uniquely positioned to capitalize on 2 areas of potential for tax revenue.
- Truck Based Distribution
- Electricity Transmission
The idea of leveraging Pennsylvania’s unique location isn’t new. Pennsylvania is already taxing distribution centers at a high rate. If the growth in the Lehigh Valley is any indication, companies will pay higher taxes for central distribution center locations for the convenience. Certainly trucking falls into this category. It would be worth doing analysis on the trucking and goods transport services to see where taxes can be applied.
In 2010, I was in a fight with my local utility. They wanted to build a 500kV line from the Susquehanna power plant in north central PA into eastern New Jersey in my backyard (quite literally). The line ended up getting built elsewhere, but Pennsylvania generates a lot of energy for New Jersey and New York. There is a tax is in place, but perhaps could be increased for out of state transmission.
Both of these expand on the same premise the distribution center tax was built on — namely Pennsylvania has the massive benefit of location within the US and companies that provide goods need the land for distribution.
Incentivizing Emerging Technologies
There is also one other consideration for gaining additional revenue, which flips the technology tax on its head. Pennsylvania should be looking to emerging technologies to drive revenue.
In late 2016, Arizona stepped up to help Uber when permits kept them from testing their driver-less cars program in California. Guess what Arizona doesn’t have for a second phase? Crowded cities, weather changes and some of the worst maintained roads in the US. Surely, Uber would be better served in Pennsylvania?
This is just one example, but emerging technology could be a place to look. Incentives for high tech companies to come to Pennsylvania to test their software, hardware or cloud services could be a natural boon without looking to something like a Retail Marijuana tax or redoing the antiquated liquor laws and embracing privatization, which no one seems to be able to move forward.
Taxing Technology Doesn’t Work
Certainly, there are other ideas out there besides strapping the technology services industry in Pennsylvania. In 1991, then Pennsylvania governor Bob Casey made a similar move and instantiated the tech tax along with several other technology purchases (software, hardware, etc.). Technology services were removed from the law in 1997 under intense lobbying from the computer services industry, but those other technology taxes remain in place.
Over and over, this tax just doesn’t work and makes Pennsylvania less competitive. Liz Farmer published an excellent article in 2015 about states struggling to tax services vs. goods, trying the technology services tax and repealing it. More recently, David Oh, Member of the Philadelphia City Council, published his opposition to the technology tax.
Instead of looking back to ideas that were tried over 20 years ago and haven’t proved successful, Pennsylvania should continue to leverage the resources it has and look to the future to see what’s coming next.
A special thanks to Lauren Schwartz for contributing to this story!