California Governor Gavin Newsom is proposing a new tax on cloud-based software sales, turning to the technology sector for billions of dollars in new revenue as the state’s budget is being lifted by the artificial-intelligence boom.
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The proposal, unveiled Thursday as part of the governor’s annual May budget revision, would likely affect large software vendors such as Microsoft Corp., Salesforce Inc. and Oracle Corp., as well as the growing AI software industry. It is expected to raise $1.1 billion in state and local tax revenue in the upcoming budget year and $2 billion annually in subsequent years.
The tax is one of several revenue measures in a revised budget that shows no deficit this year or next after revenue came in $16.5 billion above projections. Newsom’s plan includes little new spending, avoids major cuts and separately lowers the first-year filing tax for new limited-liability companies.
California currently does not tax sales of cloud-based software transferred online, unlike software sold as part of a new computer purchase or transferred through physical property. Web-based software sales would be subject to a 7.25% sales tax, which is often more with higher local taxes tacked on.
“I was slow to this,” Newsom said of the software tax during a press conference on the budget.
“I’m at Best Buy often, and I’m paying sales tax on a lot of this pre-written software, and then I find out all my friends that aren’t near a Best Buy, they’re downloading it and they’re not paying sales tax. Well, how is that fair?”
Dozens of states have adopted sales taxes on cloud-based software sales, the governor’s office said.
Newsom added that the proposal does not include content streaming platforms and that the majority of taxed transactions would come from businesses buying software. The governor said the additional revenue will be vital for cities and counties facing structural deficits and federal funding cuts coming due to President Donald Trump’s One Big Beautiful Bill Act.
“You could suggest we could have done a year or two prior, but I think now it’s an appropriate time to promote it,” he said.
The better than expected revenue gives Newsom, a Democrat, more room to protect programs popular with the party’s voters as he prepares to leave office after next year’s election and weighs a potential presidential run in 2028. But the windfall is not a lasting fix: The revised plan relies on volatile capital-gains revenue, new business-tax measures and a $9.7 billion surplus holding account to balance the next two years, leaving Newsom’s successor exposed if markets turn.
The latest revenue gain exposes a familiar vulnerability for California, which draws heavily on taxes from high earners and capital gains, making its budget especially sensitive to stock-market swings. When technology fortunes rise, Sacramento benefits quickly. When markets turn, the revenue can disappear just as fast.
The governor is also proposing a permanent limit on business tax-credit use beginning in tax year 2027, when the state’s current temporary credit limitation and net operating loss suspension is lifted. The administration projects the change would raise $850 million in 2026-27 and $1.7 billion in 2027-28, with similar ongoing gains in later years.
Lawmakers are also looking to anticipated initial public offerings from three homegrown companies — Anthropic PBC, OpenAI and SpaceX — as a potential source of future revenue. Any one of those offerings could generate substantial revenue for the state as employees cash in and California’s tax agency collects on capital gains.
The California Chamber of Commerce pointed to taxes proposed for the statewide ballot in November and other looming policy changes to argue lawmakers should hold off on major new taxes.
“State leaders should let some of the dust settle surrounding those flashpoints before adopting the new budget’s proposed tax increases,” the group said in a statement.
The state’s Legislative Analyst’s Office said last week that it expects a stock-market correction and cautioned that any increase in tax collections should be treated as temporary. Newsom also called for changes to the state’s reserve system to set aside a larger share of revenue from future windfalls.
The proposal comes as lawmakers fight over a potential billionaire tax that could appear on the November ballot, a debate sharpened by AI-driven wealth gains and California’s dependence on its richest taxpayers. Newsom’s proposal is subject to negotiations with state lawmakers ahead of the fiscal year that begins in July.
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