Governor Patrick's Misguided Tax on Software Design and Development

by Jon Follett

Under a provision in Governor Deval Patrick’s fiscal 2014 plan for the state, a "modern products" Massachusetts sales tax of 4.5% will be levied on the design and engineering services that create the digital world. Massachusetts is filled with software development companies — with verticals from mobile to healthcare to enterprise. It's a key innovation sector that drives the growth of our state economy and keeps our employment — which has consistently been better than that of the nation as a whole — at a healthy rate.

So, what will the consequences of this new tax be? For every $1 million in revenue, under the Governor's proposal, a software shop will pay an additional $45,000 — on top of the payroll, property, real estate, business and any other taxes it already pays. Consider this: For every $2 million in revenue, that's $90,000 in taxes, which could cover the salary of an entry-level software engineer including benefits. The 2011 Index of the Massachusetts Innovation Economy, indicates that software and computer services accounted for $31 billion of Massachusetts economic output. If, for the sake of argument, we consider just half of the economic output as taxable software design and development services, that would result in about $695 million in tax revenue, or roughly the equivalent of 7,750 entry-level software engineering jobs. Will this new proposed tax eliminate the creation of 7,750 high-quality jobs in Massachusetts? I'm not eager to find out. Now, to be fair, the Governor's budget estimates show a figure of just a quarter billion dollars in revenue to be realized from this tax, but the true consequences, like the law itself, remain unclear. The law is vague enough that the sales tax could cover all kinds of software, from mobile apps to even Web sites.

At a time when the Massachusetts economy is growing at the anemic rate of 1%, it just seems punitive to selectively and arbitrarily tax one of the most important sectors of the Massachusetts innovation economy. If the Governor's plan was to tax all professional services in Massachusetts — including accountants, architects, consultants, engineers, lawyers, etc. — then maybe it would seem less harsh. But, then again, the entire state house is populated by lawyers and former lawyers ... so the Governor knows not to go there.

There's no doubt that this proposal is bad and confusing economic policy. Massachusetts software companies are made up of the knowledge workers and innovators that we're trying so hard to retain in our state. They're battling cut-rate outsourcing in an extremely competitive environment. Do they really need the additional drag of a sales tax on services? As a state, do we really want to encourage companies to go elsewhere? New Hampshire and Rhode Island are beckoning.

Is this tax going to crush the Massachusetts Innovation economy? Probably not. But it will ding it, and it's definitely not going to help it. State government has a funny way of talking out of both sides of its mouth: Out of one side, it touts the entrepreneurs driving the creative economy, out of the other, it dismisses them and sends them on their way. The Governor has started his charm campaign, defending his fiscal 2014 plan, which includes some proposed income tax increases for state residents as well. He conveniently left out his software services tax during his appearance at the Massachusetts Technology Leadership Council Annual Meeting last week. This software sales tax story has generated only minimal press, so far. No doubt the Governor likes it that way.

Here's the proposed language from the Governor's FY2014 Budget:

[Extend the sales tax to computer and data processing services and custom software]

(AA) Section 1 of chapter 64H of the General Laws, as appearing in the 2010 Official Edition, is hereby amended by inserting after the definition of "Commissioner" the following definitions:
"Computer and data processing services," services that include but are not limited to programming, code writing, modification or testing of existing programs, feasibility studies and design and installation of computer systems that integrate computer hardware, software, and communication technologies, whether or not such services are rendered in connection with the development, creation or production of standardized or custom software, provision of access to software or the storage of data on the seller's or a third party's server including disaster recovery services, and bundled charges where the value of computer and data processing services is the predominant portion of the bundle and regardless of whether any report that is furnished or made available is unique to a particular customer. "Computer and data processing services" include provision of data or access to data that are sold together with a computer or data processing service, unless the purchase of the data or access to data is optional to the customer and the cost to the customer of the data or access to data is stated separately from any charge for computer or data processing service on the invoice provided to the customer at the time of purchase. Computer and data processing services do not include the provision of (1) downloaded books, music, videos or ringtones, or (2) computer facilities management services.

"Custom software," a software program prepared to the special order of a customer that is not standardized software, including modifications or enhancements to standardized software.

Topics: Design, Ideas, sales tax, knowledge work, innovation economy, development, Blog, software, creative class