AI boom not enough: California plans digital tax for cloud software

The ongoing boom driven by the AI hype is unexpectedly channeling a lot of money into California's state treasury. However, for Governor Gavin Newsom, this is no reason to rest. On the contrary, the Democratic politician is planning a fundamental reform of tax law that is likely to hit the tech industry in Silicon Valley particularly hard. With his revised budget proposal for 2026/27, Newsom is proposing the introduction of a sales tax on cloud-based software. He aims to hold the tech sector accountable to secure permanent additional revenues in the billions for the world's fifth-largest economy.

The initiative is part of the regular budget revision, which traditionally takes place in May. Specifically, sales of software provided over the internet are to be subject to a base tax rate of 7.25 percent in the future. Since local municipalities can levy their own surcharges, the actual burden in many regions of California is likely to be even higher in the end.

The new regulation would primarily affect large software companies such as Microsoft, Salesforce, and Oracle, but also the growing number of AI application providers. These typically sell their services via the cloud. The government in Sacramento estimates that the new levy would generate around 1.1 billion US dollars in state and local tax revenue as early as the next fiscal year. In subsequent years, this amount is expected to stabilize at around two billion US dollars annually.

Until now, California was an exception when it came to software purchases: sales tax is regularly levied when purchasing physical media from electronics stores or buying a new computer with pre-installed programs. However, online purchases via the cloud remained tax-free. Newsom justified his change of heart with a personal anecdote about shopping in brick-and-mortar retail. Some other US states have already introduced a cloud tax.

Streaming platforms for media content such as Netflix or Disney+ are to be exempted from the Californian regulation, as the majority of taxable transactions occur in the business-to-business sector anyway.

A global trend?

EU parliamentarians are also simultaneously pushing for a billion-dollar levy on Big Tech. With an ambitious financial plan for the years 2028 to 2034, the EU Parliament is demanding that tech giants be made to pay. The goal is to increase the EU budget and secure important future investments. The US administration under Donald Trump disapproves of this. The fact that California – the home base of the affected giants – is now driving its own digital tax lends a piquant note to the debate.

Newsom's initiative comes at an opportune time for California's budget planning. While the Golden State's budget is currently looking strong because revenues have exceeded previous forecasts by 16.5 billion US dollars, and there is no deficit looming for the next two years. However, the windfall is heavily dependent on volatile returns from capital gains tax and stock profits of the tech elite. This makes the West Coast state's budget vulnerable to stock market fluctuations.

Furthermore, municipalities are under pressure due to federal cuts resulting from Trump's “One Big Beautiful Bill Act.” Newsom, who is in his last year of office and is rumored to have ambitions for a presidential candidacy in 2028, therefore wants to seize the moment, according to Bloomberg. This is to secure his party's social and climate programs in the long term.

Hope for IPOs

In addition to the software tax, the administration plans a permanent limitation of tax incentives for companies from the 2027 tax year onwards, which is expected to bring in further millions. At the same time, California is hoping for a series of spectacular IPOs from the region. The expected IPOs of industry giants like Anthropic, OpenAI, and SpaceX are considered potential goldmines, as the realization of stock gains by employees and investors would lead to massive tax back payments.

However, resistance from the business community is already forming. The California Chamber of Commerce warns against hasty steps and points to other far-reaching tax initiatives that are up for a vote in November. Among these is an already hotly debated billionaire tax. The executive branch must now negotiate the final budget, including the potential digital tax, with the representatives in the Sacramento parliament by July.

(nen)