Proposals to eliminate the sales tax and levy an experimental business tax are said to have 'zero percent' chance of passing. But an overhaul is needed, and the ideas may provide a jumping-off point.
By Eric Bailey in the LA Times - Reporting from Sacramento
September 21, 2009 -- It was to be the sort of big-game victory that California political leaders rarely pull off. Gov. Arnold Schwarzenegger and legislative chiefs set out to shake the roots of the state's tax system to spur the business climate and resuscitate the treasury.
But as the commission they formed for that purpose prepares to release its final report this week, business leaders are grumbling, labor unions have turned wary and once-bullish lawmakers are backing away.
The recommendations from the Commission on the 21st Century Economy, which include some revolutionary ideas such as scrapping the sales tax and imposing a broad and untested new business levy, have been met with shrugs and even a few snickers.
"It's not cooked," said state Treasurer Bill Lockyer, who was a tax lawyer for decades. "It probably needs years of work."
Republicans like some of what they see, such as the plan's call for a flatter income tax, but they don't expect to make much headway in a Capitol dominated by Democrats.
"This is the most significant tax policy proposal in three decades," said Assemblyman Chuck Devore (R-Irvine). "But the chances of this getting approved, as is, are zero percent."
Such conclusions have not completely derailed the prospects for change in a state that Forbes magazine ranks 50th out of 50 for its big tax bite and other high costs of doing business.
Schwarzenegger is expected to call a special session of the Legislature to address the commission's findings.
Assembly Speaker Karen Bass (D-Los Angeles), an early proponent of the commission, has backed away from a vow to hold a yes-or-no vote on the package. But she calls the commission's principal suggestions "intriguing."
While that is not a warm embrace, she and other lawmakers see the package as a worthy starting point for debate on changes considered long overdue. They say the commission report should spark a full reappraisal of California's tax structure, and possibly a push toward a bipartisan compromise that might actually take flight in the fickle political winds of Sacramento.
"The issue is not going to go away," said Senate President Pro Tem Darrell Steinberg (D-Sacramento). "But it's important to get it right."
Sacramento has long been an epicenter of debate about taxation.
The state's tax system was fashioned during the Great Depression, when small manufacturers churned out retail products subjected to a sales tax. As recently as 1950, the sales tax provided nearly 60% of the state's revenue.
But in the years since, California's economy has shifted to one dominated by service industries -- lawyers, engineers and other professionals whose sales are not taxed. Although the state has the nation's highest sales tax, it now accounts for barely a quarter of revenue.
The result has been an increasing dependence on income taxes, which grew from 11% of state revenue in 1950 to more than 53% in 2008. In recent years, the wealthiest 1% of the state's population has generated a big percentage of that.
Liberals say the tax burden borne by the wealthy simply reflects the astronomical rise in incomes of the super-rich in Silicon Valley, Hollywood and other enclaves. But that revenue, too, has proven volatile, soaring or stumbling with the rise or fall of the economy and the stock market.
As the economy slumped and tax proceeds plummeted late last year, Bass and Schwarzenegger got together to form the 14-person tax commission and sidestep the usual Capitol bickering.
But the commission -- attempting to do in months the kind of wholesale reconstruction some states have taken years to accomplish -- slogged along. Partisan fissures cracked open, and the group's ideas fell well short of unanimous approval from participants.
Still, Schwarzenegger believes the panel's proposed changes in the tax system are "the most significant action we can take in ending our perpetual budget crises," said Aaron McClear, the governor's spokesman.
Under the plan, the state's current half-dozen income tax rates would be replaced by two -- 2.75% for those making up to $56,000 a year and 6.5% for those earning more. Sales and corporate taxes would be replaced by a single new business levy that would spread the burden -- at a tax rate of about 4% -- more broadly and would include service professions.
The proposals have drawn heavy fire from all sides.
Business leaders are worried it could make things worse for their bottom lines and the broader economy.
"There is simply too much at stake to adopt this proposal before the implications for jobs and the economy have been fully assessed," said Allan Zaremberg, president and chief executive of the California Chamber of Commerce.
With some tax experts saying the changes would favor the rich and could cost jobs, labor leaders don't like what they see.
"This feels like a dangerous experiment," said Courtni Pugh, executive director of SEIU California, the state's largest union with more than 700,000 workers.
Among the most pointed critics are nine tax experts from Stanford, UCLA, Rice and other universities. They rose up earlier this month to oppose the bid for a broad new business levy, saying in a Sept. 5 letter to Commission Chairman Gerald Parsky that there are "numerous reasons to believe that this is the wrong course for the state to take at this stage."
They cited potential administrative difficulties, legal challenges and competitive disadvantages to California businesses compared to out-of-state firms not hit by the tax.
"The problem with this is it's a poorly designed substitute for a sales tax," said Kirk Stark, a UCLA tax law expert who signed the letter.
Lockyer and other Democrats, meanwhile, say the commission's mandate to ease the volatility of state revenue -- a boom-and-bust cycle that has sent the state spinning into deep deficits -- seems to have masked a hidden agenda.
"What they really wanted to do, in my opinion, was lower taxes on rich people," Lockyer said.
Republicans counter that their foes across the aisle had their own motivation -- to raise taxes.
Still, lawmakers from both parties insist they will fully analyze the proposals and come up with alternatives.
One strategy suggested by Democrats is to broaden the existing sales tax to include more service industries rather than impose a whole new business tax. They also want to look at tapping Internet commerce, hiking the gasoline tax to help fund the fight against global warming and adopting a levy on oil extracted from California, the only petroleum-producing state in the nation without one.
Republicans will probably push for a bigger rainy day fund to help the state better survive slumps. But they draw the line at any proposal to boost taxes overall. Nearly every GOP lawmaker has signed a no-new-taxes pledge.
In addition to ideological opposition, attempts to increase taxes would face a gantlet of special interests with something to lose.
"Any revision of the tax code is a Herculean undertaking," conceded Assembly GOP Leader Sam Blakeslee (R-San Luis Obispo).
But the commission's report -- along with the Legislature's abysmal legislative approval ratings and an election year sure to be dominated by the cry for California government to fix itself -- could still provide enough impetus for change.
"The bottom line is we've got a tax system designed back in the 1930s, when we were building widgets," said Assemblyman Charles Calderon (D-Montebello), chairman of the lower house tax committee. "We need reform. We need a system for the information age."
…Nothin' t' read while you're waiting for th' Commission on the 21st Century Economy report?
State of California Department of Finance (DOF)
- Summary Document for the 2009 Budget Act (.pdf, <1 MB, www.dof.ca.gov)
- Tax Expenditure Report, 2008-09 (.pdf, <1 MB, www.dof.ca.gov)
Legislative Analyst's Office (LAO)
- Proposition 1A, State Finance (.pdf, <1 MB, www.lao.ca.gov)
- Informational Hearing on Tax Expenditures, February 2008 (.pdf, <1 MB, www.lao.ca.gov)
- California's Tax System: A Primer (www.lao.ca.gov)
- Revenue Volatility In California (.pdf, <1 MB, www.lao.ca.gov)
- California's Fiscal Outlook: LAO Projections — 2008-09 Through 2013-14 (www.lao.ca.gov)
- California’s Changing Income Distribution (.pdf, <1 MB)
Other Governmental Organizations
- California State Assembly: California State Assembly Committee on Revenue and Taxation Reference Book 2007 (www.assembly.ca.gov)
- California State Board of Equalization: Sales and Use Taxes: Exemptions and Exclusions (.pdf, <1 MB, www.boe.ca.gov)
- State of California Franchise Tax Board: California Income Tax Expenditures, Compendium of Individual Provisions (.pdf, <1 MB, www.ftb.ca.gov)
Reports by Non-Governmental Organizations
- Center for Continuing Study of the California Economy "Are Businesses and High-Income Residents Fleeing California?" (.pdf, <1 MB)
- "Manufacturing 2.0," Milken Institute. June 2009. http://www.milkeninstitute.org/pdf/CAManufacturing.pdf
Interactive data site :
- "Lone Star rising," Economist, July 9, 2009. Overview of the report, a section on California/Texas rivalry and another on the Texas economy.
- California Forward: Report to the Commission on the 21st Century Economy: Discussing Tax Reform (.pdf, <1 MB)
- American Institute of Certified Public Accountants, Tax Division: Guiding Principles of Good Tax Policy: A Framework for Evaluating Tax Proposals. (.pdf, <1 MB, ftp.aicpa.org)
- California Forward: It’s about trust: A state budget process that restores public confidence (.pdf, <5 MB, news.caforward.tv)
- Stephen M. Sheffrin and Marla Dresch, California Policy Seminar: Estimating the Tax Burden in California (.pdf, <10 MB)
- Joint Venture: Silicon Valley Network: Statement of Principles: California Budget and Tax Reform Initiative (.pdf, <1 MB, www.jointventure.org)
- Michael J. McIntyre & Richard D. Pomp: A Policy Analysis of Michigan's Mislabeled Gross Receipts Tax (.pdf, <1 MB)
- Thomas S. Neubig & Robert Cline: Future State Business Tax Reforms: Defend or Replace the Tax Base (.pdf, <1 MB)
- Next 10: California's Budget (www.next10.org)
- Silicon Valley Leadership Group: California Tax Policies and Business Expansion, "Tough Choices — Real Solutions" (.pdf, <5 MB, svlg.net)
- Steven M. Sheffrin, Professor of Economics, UC Davis: Economic Aspects of a Split-Roll Property Tax (.pdf, <1 MB)
- Tax Analysts: Repeal State Tax Breaks for Capital Gains (.pdf, <1 MB)
- Tax Foundation: Background Paper: 2009 State Business Tax Climate Index (.pdf, <5 MB, www.taxfoundation.org)
- The Urban Institute: Tax Expenditures and Tax Reform: Issues and Analysis (.pdf, <1 MB)
California Budget Project
- To Have and Have Not (.pdf, <1 MB)
- Available Data Do Not Support Claims That High-Income Californians Are Leaving the State (.pdf, <1 MB)
- Budget cuts or tax increases: Which are preferable during an economic downturn? (.pdf, <1 MB, www.cbp.org)
- The number of high-income tax payers increased … (.pdf, <1 MB, www.cbp.org)
- Who pays taxes in California? (.pdf, <1 MB, www.cbp.org)
California Tax Reform Association
- Commercial Property Assessment in California: Bad Law, Bad Economics, Bad Fiscal Policy, Bad Land Use (.pdf, <1 MB)
- Recommendations on California’s State Budget Crisis (.pdf, <1 MB)
Council on State Taxation (COST)
- Total state and local business taxes — 50 state estimates for fiscal year 2008 January 2009 (.pdf, <3 MB)
- (With the Tax Foundation): Gross Receipts Taxes in State Government Finances: A Review of Their History and Performance (.pdf, <5 MB)
- Sales Taxation of Business Inputs (.pdf, <1 MB)
- The Best and Worst of State Tax Administration (.pdf, <1 MB)
- LECG Economic Jobs Report (.pdf, <1 MB)
- LECG Economic Jobs Fact Sheet (.pdf, <1 MB)
- LECG State Tax Comparison Report (.pdf, <1 MB)
- LECG State Tax Comparison Bar Graph (.pdf, <1 MB)
Public Policy Institute of California