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California

Tom Gray
Never Trust a Hungry Legislature
California’s assembly speaker tries to squeeze more taxes from beleaguered businesses.
11 May 2012

You know a tax bill faces an uphill fight when its author feels the need to earmark the projected revenue for something everyone can love. Such is the case with California Assembly Speaker John A. Pérez’s Assembly Bill 1500, which would establish a “Middle Class Scholarship Fund.” As often happens in California, the Los Angeles Democrat is trying to promote a controversial tax measure in the guise of supporting education. But AB 1500 is really about business, and, as written, the outcome would not be good for the state’s still-struggling economy.

Pérez’s bill would change the way the state requires businesses to apportion profits subject to corporate income taxes. The policy may be arcane, but the bill’s effect is easy to grasp. Companies based out of state would see their taxes go up, while those based in California would see little change in most years. All would lose potentially cost-saving options.

Currently, under a system worked out as part of the 2009 budget bill, businesses may choose between two formulae. One computes profits from a company’s sales, payroll, and property held in the state. The other computes profits based on sales alone. AB 1500 would force companies to use the second method. The “single-sales factor” could have sharply different impacts, depending on where a company is based and where it books most of its sales.

Take Company A, which has all its payroll and property in California and generates half its sales within the state. Its profit in the United States is $100 million. Under the sales/payroll/property formula, sales are “double-weighted” at 50 percent, with property and payroll each accounting for 25 percent. Since half of Company A’s sales are in California, the sales factor is reduced to 25 percent (50 percent of 50). Adding 25 percent each for property and payroll (based on 100 percent of both being in the state), the share of profits subject to California’s corporate income tax is 75 percent, or $75 million.

Under the so-called “single-sales factor” that AB 1500 would make mandatory, Company A would figure its taxable profit based on the 50 percent California share of its total sales. It would pay state tax on half of its profits, or $50 million. Since Company A already can use the single-sales factor if it chooses, it would neither gain nor lose from AB 1500 as long as it’s making a profit. If it runs a loss, though, the company would be better off using the formula based on double-weighted sales, payroll, and property, because it would have a larger loss to carry forward against future taxable profits. Under AB 1500, Company A would lose that option.

Now consider Company B, headquartered outside of California but selling extensively in the state. It has just 10 percent of its property and 10 percent of its payroll here, but takes 30 percent of its total sales from the Golden State. Suppose Company B also earns $100 million in profits. Under the three-factor formula, with sales double-weighted, the sales portion would be 15 percent (50 percent of 30). The company’s property share is 10 percent in state, as is its payroll share; 25 percent of each is 2.5 percent. That adds up to 5 percent, which combined with the 15 percent for sales makes 20 percent of profits taxable under the state law—or $20 million. Under the single-sales factor, the taxable profit goes up to 30 percent, or $30 million. In other words, AB 1500’s mandatory single-sales formula would raise Company B’s taxable income by $10 million and its tax, at the state’s 8.84 percent corporate rate, by $884,000.

State Legislative Analyst Mac Taylor has estimated that a shift to a mandatory single-sales factor would raise about $1 billion a year in new revenue. Firms of the Company B type would probably pay most of that. So it’s no surprise that opposition to AB 1500 is being led by big companies based outside of California but with high sales in the state. Procter & Gamble, Kimberly-Clark, General Motors, International Paper, and Chrysler have banded together against the bill in a coalition called California Employers Against Higher Taxes. As out-of-staters, these companies make ripe political and fiscal targets. The complexity of apportionment formulae also makes it easy for Pérez and other AB 1500 backers to claim they’re just trying to close a “loophole” rather than bore the public with the facts. Most states don’t allow a choice of formulae, but then again, most states have lower corporate tax rates than California’s. Some, such as neighboring Nevada, have no corporate taxes at all. What the state really needs, and the legislature won’t deliver, is a business-tax code with lower rates and fewer breaks for the businesses lucky enough to be in the right place or the right industry.

Pérez can’t get around the truth: AB 1500 is a tax hike, requiring either a two-thirds vote in the legislature or a voter referendum. A similar measure, Proposition 24, failed in 2010. Other efforts to repeal the two-option apportionment system have failed, though that hasn’t kept legislators or activists from trying. The Pérez legislation now shares the stage with a proposed November ballot initiative that would impose the mandatory single-sales factor to raise money for energy-conservation projects and the state’s general fund. That measure, sponsored by hedge-fund manager Tom Steyer, fits a familiar pattern: present the public with a tax hike that few, if any, voters will pay directly—indirect impacts, on jobs for example, are another matter—then earmark all or some of it for a popular cause. Steyer seems to sense the public’s well-founded reluctance to raise taxes, even on big businesses based out of state.

That same anti-tax streak explains why Pérez is presenting AB 1500 as a measure dedicated to making college more affordable to middle-class families. He told the Sacramento Bee that, for families earning less than $150,000 a year, AB 1500 would cut the cost of attending state universities by two-thirds (the scholarship program is established through a companion bill, AB 1501). He also promised that the new corporate tax revenue would mean an additional $150 million annually for the state’s long-suffering community colleges. Pull down the higher-education window dressing, however, and you’re left with the fact that AB 1500 would make California an even more expensive place to do business (it already ranks 48th in the Tax Foundation’s rankings of states by their business-tax climate). The bill would hurt many companies while helping none.

The irony is that, if it were not simply being used as a way to raise corporate taxes and bludgeon businesses, the formula in AB 1500 would be worth considering. As part of comprehensive, revenue-neutral tax reform, the single-sales factor seems to make economic sense and might stimulate job growth. It is probably the best of all apportionment methods for encouraging companies to set up shop and hire workers in-state. The Legislative Analyst’s Office gave the idea a thumbs-up in a 2010 analysis, suggesting that a shift to single-sales could produce roughly 40,000 new jobs. But tacked on to a crazy-quilt tax system where the goal seems to be to extract additional revenue from business, and to fund a new middle-class entitlement on top of it all, the single-sales factor is more punitive than stimulating.

AB 1500 is not about reform, job creation, or fairness rightly understood. It would simply hijack a good idea in order to squeeze more money out of businesses already squeezed enough.

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