Tech firms learning a hard, costly lesson

Back in March, I had a chance to interview Governor Deval Patrick on stage at a Boston hotel, in front of several hundred tech workers. The Massachusetts innovation economy, he boasted, was “one of the reasons why we are growing jobs faster than most other states,” and why the state had regained all the jobs lost in the recent recession.

Earlier that month, a group of legislators led by state Senator Karen Spilka, Democrat of Ashland, formed the Tech Hub Caucus, to help “shine a spotlight on tech’s far-reaching economic importance,” according to the press release announcing it.

But last week, Beacon Hill threw tech under a truck. On Wednesday, with exactly seven days’ notice, a law went into effect requiring anyone in the business of providing “computer system design services” in Massachusetts to collect the 6.25 percent sales tax from their in-state customers.

And what exactly does “computer system design services” mean? It isn’t yet crisply defined, but it may cover everything from the contractor who loads Microsoft Office onto the PCs at your office, to the person who builds a mobile app using open source components, to the team of consultants who customizes an Oracle database.

The bargain between the tech sector and state government has long been, “Leave us alone, and we’ll applaud enthusiastically when you talk about what brilliant job creators we are.” That bargain crumbled last week. And the tech sector learned that sweet nothings from elected officials mean exactly nothing if you don’t have lobbying muscle on Beacon Hill.

The Legislature estimated that the tax will raise about $160 million a year, but the Massachusetts Taxpayers Foundation, a business-financed research organization, predicts it could yield $500 million or more.

Will we see a mob of T-shirt-clad coders dumping laptops into Boston Harbor, shouting “No Taxation of our Applications”? I doubt it. But here are the implications of this new tax, not just on software consultants, but on the broader business community.

• This tax increases the cost of buying semicustomized software by 6.25 percent. (Buying prewritten software, like Quickbooks accounting software, has always been taxable. And the new law isn’t intended to cover software that is entirely custom written.) That means there’s less incentive for small retailers to invest in a software project that might help them understand which products they should order, or for inns to undertake website improvements that could attract more tourists.

Plus, says Mark Kasdorf, founder of the Cambridge software consultancy Intrepid Labs, it affects start-up companies, which often hire firms like his to help with initial versions of their products. “Start-ups need to move fast, and it can be slow for them to hire their own people, so they spend a lot of their money on contractors,” says Kasdorf. “This makes life 6 percent more expensive for them.”

• I remember noting a while back that the trade group Massachusetts Technology Leadership Council (then known as the Massachusetts Software Council) had let go its longtime lobbyist. Other tech trade groups, like MITX and TechNet, have never been a notable presence on Beacon Hill. I think that will change, with members willing to pay to play a bigger role in policy creation.

As Jeremy Weiskotten puts it, “This is jarring for our industry. These kinds of things don’t usually happen to us.” Weiskotten is a director of Terrible Labs, a nine-person software consultancy in Boston that’s trying to figure out how and whether the new tax applies to its work.

• Writing and installing software is exactly the kind of high-skilled, highly paid, environmentally friendly job we should cultivate in this state. Why would we make it less appealing to start a software firm in Massachusetts, move a business here from another state, or open a branch office here? “Other states offer incentives for these kinds of companies to set up shop,” says Tom Hopcroft, president of the Massachusetts Technology Leadership Council. “We’re creating a disincentive.” (Of 15 similar innovation-oriented states, only one, Texas, applies the sales tax to computer design services, according to the Massachusetts High Technology Council, another trade group.)
• If Beacon Hill has decided to tax software developers — a white-collar professional service — does that mean other professional services could be next? Management consultants? Interior designers? Other states have gone in that direction, as services continue to grow as a portion of the overall economy.
• Will the state’s Department of Revenue have to staff up on software specialists to audit code to determine whether it qualifies as totally custom (i.e., nontaxable), or a modification of prewritten software (taxable)? Will software experts need to train state auditors?
• Small software developers and big systems integrators now get to deal with the fun administrative work of collecting and remitting sales tax to the state. For a small company like Boston-based Dockyard, with 13 employees and about $1 million in revenues last year, that can add significant overhead costs, says principal Brian Cardarella.
• The decision to tax software services happened fast, with very little input from tech businesses. “There was no public hearing,” says Chris Anderson of the Massachusetts High Technology Council. That’s a disgrace on the part of state legislators — especially those who tout themselves as champions of Bay State innovation. But it should also be a warning to other industries about the perils of political disengagement.
• At least for the short term, there will be plenty of work for tax attorneys and accountants to help clients understand the ins and outs of the new tax. And those professionals, unlike software developers, aren’t required to tack 6.25 percent onto their invoices . . . yet.

We won’t know for a few weeks precisely how the Department of Revenue will interpret the legislation that mandates the new tax. But one thing is for sure. While techies have long “had their heads down thinking about the next big thing,” in the words of Angie O’ Connor, director of TechNet’s New England office, they’re now going to need to apply some of that intellectual firepower to politics.