Another KC report, titled “Statewide Protests Target Chase Bank and Wall Street Firms, Summary Report Released with Research Support from Kersten Communications,” which summarizes why a group of community activists and labor and education leaders staged a series of protests on August 10 to call attention to a $17 billion bill itemizing the ways Wall Street banks are shortchanging California residents and state and local governments.  To view the report click here.  

A third report, titled “State General Fund Spending Has Dropped by $20 Billion Since 2006-07, Major Decreases for Every Major Program Area,” provides new KC analysis of Department of Finance data which illustrates how the three state budgets passed since 2007-08 have significantly ratcheted down state spending on major state programs such as education, higher education, and health and human services, despite the increasing needs of a growing state population.  To view the report click here.     

KC Fiscal Focus is periodic electronic newsletter that focuses on California State public policy issues from a fiscal perspective.  KC is a Sacramento-based consulting firm which specializes in public policy research and analysis.  To sign-up for KC Fiscal Focus click here.

Finally, we welcome your feedback on this newsletter and our other publications.  To submit your comments click here.

Another KC report, titled “New Report Finds Major Shift in Property Tax Burden From Commercial to Residential Property Since Prop. 13, Describes Loopholes In System,” summarizes a new report which was co-authored by Lenny Goldberg, executive director of the California Tax Reform Association, and David Kersten, with Kersten Communications.  To view this report click here. 

The full report, titled “System Failure: Califonria’s Loophole-Ridden Commercial Property Tax,” is available by clicking here.   

KC Blog Briefs:

“Summary of Analyses of the Governor’s May Revised Budget Proposal.”

“House and Senate Reach Compromise on ‘Job Creation’ and ‘Tax Loophole Closure’ Legislation.”

The following KC analysis shows that both candidates’ tax plans would provide very marginal economic benefits to the State of California at best and only really serve to benefit the wealthy and ultra rich.  Most of the tax cuts proposed in each plan would accrue to the state’s wealthiest taxpayers—the top 1% of the state’s earners. 

Perhaps most intriguing is that both candidates would reap significant savings, likely to be in the millions of dollars range, potentially tens of millions of dollars, in their own tax bills from their proposed reductions in the state capital gains tax.  More specifics would be known if Whitman and Poizner release their tax returns.      

Whitman proposes to eliminate the state’s capital gains tax, Poizner proposes to cut it by 50%.  Candidate financial disclosure (Form 700s) filed by both Whitman and Poizner show that both candidates are heavily invested in stocks, private-equity firms, and other investment vehicles that generate income, dividends and other capital gains that are largely taxed through the state’s capital gains tax.  Click here to view Whitman’s Form 700 filing and click here to view Poizner’s Form 700 filing.

Democratic candidate Jerry Brown has not outlined a tax package that he would enact if elected Governor but has stated that he would only support tax increases if they are approved by a vote of the California people.         

This report seeks to summarize and critique both Whitman’s and Poizner’s tax cut proposals and provide a revenue impact analysis for each proposal.  

Summary of Meg Whitman’s “Job-Creating Tax Cuts”

Republican frontrunner Meg Whitman has proposed a package of tax cuts primarily consisting of an elimination of the state capital gains tax, which is estimated to cost the state roughly $11 billion annually (note: capital gains fluctuate with the economy). 

Whitman has also proposed a package of more targeted “job-creating tax cuts” which includes a sales tax exemption or tax credit for manufacturing equipment ($1-2 billion), an increase in the state research and development tax credit ($60 million), a $10,000 tax credit for new home purchases ($100-200 million plus), and a hiring tax credit for green technology job creation ($50 to $100 million estimated) (see full summary chart below, click on chart for clear printable version). 

In total, Whitman’s tax package is estimated to cost $12.4 billion to $13.6 billion a year when fully implemented, according to conservative estimates by Kersten Communications. 

“With California facing a $20 billion budget deficit, we have to be strategic and effective in the tax relief we provide.  While making cuts in marginal tax rates is a very important goal, at this moment we simply cannot afford a big, across-the-board tax cut that would irresponsibly grow the state’s already over-sized debt level and drop our bond rating to junk status,” Whitman states in her policy agenda titled “Meg 2010: Building A New California.”  “I have a road map to help create 2 million private-sector jobs by the beginning of 2015,” Whitman wrote in an April 15, 2010 Desert Sun Op-Ed in support of her tax package.       

 Summary of Steve Poizner’s Tax Cut Proposal

 Poizner proposes a 10% across-the-board reduction in marginal rates for the state personal income tax (PIT), sales and use tax (SUT), and corporation tax (CT), and a 50% reduction in the state’s capital gains tax. 

An analysis by Kersten Communications based on Department of Finance data finds that Poizner’s 10% across-the-board tax reduction would cost $8.2 billion annually and the 50% capital gains tax cut would cost $5.5 billion—for a total of $13.7 billion a year in reduced state tax revenues (see chart below, click on chart for clearer printable window).

“Commissioner Poizner will cut rates in every major category of taxation, fueling job creation and jumpstarting economic growth for all Californians,” Poizner states on his website.  “Economic growth due to the Poizner Jobs Plan, combined with hiring, debt, and spending freezes, closes the $20.7 gap,” Poizner states. 

Specifically, Poizner says his plan closes the state’s $20.7 billion budget gap with “$7.4 billion in added revenues from economic growth and $13.5 billion in reduced spending.”  The tax cuts are keyed as a $3.8 billion revenue gain, presumably from their job-creating benefits, and not as a $13.7 billion revenue loss.

“Based on a careful study of state tax cuts over a fifteen year period, Poizner’s proposed 10% cuts in personal income tax rates, the state sales tax rate, and the corporation tax rate are estimated to grow state revenues by an inflation-adjusted 1.77% in the first year and 4.94% in the second year after the cuts are enacted into law,” states Poizner’s website.

“If implemented immediately, Steve’s proposed tax cuts should generate approximately $3.77 billion in General Fund revenues through the end of the 2010-11 fiscal year.  We posit that the revenue enhancement effects of the proposed tax cuts may even be more robust than the estimates provided, given the 50% reduction in capital gains taxes,” Poizner states.  

Reducing California’s Capital Gains Tax Primarily Benefits the Wealthy and Super-Rich and Very Few Middle Income Taxpayers, But Not Low-Income Taxpayers

Whitman proposes to eliminate the state’s capital gains tax, while Poizner proposes to cut it by 50%.  Research indicates that capital gains tax cuts overwhelmingly benefit the wealthy, primarily the top 1% of taxpayers, and do not have a measurable impact on creating jobs and economic growth.  

California’s current treatment of capital gains and dividends was enacted into law in 1987 as part of a tax package passed by the Legislature and signed into law by Governor Deukmejian (R) to conform to President Ronald Reagan’s 1986 federal tax reform package.

Under current state law, California taxes capital gains through the state’s personal income tax, which means that capital gains—from the sale of a home, stocks, or other investment vehicles—is taxed according to California’s marginal income tax rates.  California’s top income tax rate is 9.3%. 

“In all the years since we conformed with the Reagan treatment of capital gains as ordinary income (Tax Reform Act of 1986), tax treatment of capital gains in California has been essentially a “non-issue” among those who do tax legislation in California,” according to Martin Helmke, former chief consultant to the California Senate Revenue and Taxation Committee. 

Helmke said several bills have been introduced since 1986 to reduce the state’s capital gains tax but none of the bills went further than the Revenue and Taxation Committee in either house.   

In 2003, George W. Bush’s 2003 tax act lowered the top tax rate on corporate stock dividends from 35% to 15%, and reduced the top capital gains tax rate from 20 percent to 15% for gains realized after May 5, 2003, according to Citizens for Tax Justice (CTJ).

Contrary to Whitman’s and Poizner’s assertions that reducing the capital gains tax will increase revenues, and jobs information released by the Internal Revenue Service shows that the Bush tax cuts on capital gains and dividends reduced federal tax revenues by $91.7 billion in 2005, according to Citizens for Tax Justice. 

A 2006 study by the Congressional Budget Office (CBO), titled “A Dynamic Analysis of Permanent Extension of the President’s Tax Relief” (which includes Bush’s income tax cuts and other tax changes), found that under the best possible scenario, making the Bush tax cuts permanent would increase the economy “over the long run” by 0.7%.  Since the “long run” is not defined, economists have suggested that 20 years be used, which would make the best case scenario GDP growth equal to 0.04%.  Previous CBO estimates identified the tax cuts as costing the equivalent of 1.4% of the GDP in revenue—meaning the tax cuts would still cost the equivalent of 1.27% of the GDP, according a report titled “Treasury Dynamic Scoring Analysis Refutes Claims by Supporters of the Tax Cuts,” by the Center on Budget and Policy Priorities.

 An analysis by CTJ found that “the 67 million tax filers who reported adjusted gross incomes of less than $30,000—half of all filers—received virtually none of the benefits of the capital gains and dividends tax breaks.  In contrast, the 0.6 percent of all filers with reported incomes above $500,000 received 73.4% of the total tax reductions, saving an average of $81,204 each,” states CTJ report.

“Most amazing, the 13,776 tax filers with adjusted gross incomes in excess of $10 million—a mere 0.01 percent of all filers—received 28.2 percent of the total tax savings.  Their average tax break was $1.87 million each,” states the CTJ report (see CTJ summary chart below).  

“I have no doubt that for many who favor eliminating or sharply reducing California’s income tax on capital gains, the real motivation is that they simply favor lower taxes on the rich—even if that means higher taxes on everyone else,” stated Robert S. McIntyre, executive director of CTJ, in his testimony before the California Commission on the 21^st Century Economy.

Two Additional Reasons Why Reducing or Eliminating the State Capital Gains Tax is a Bad Idea

Reducing or Eliminating California Capital Gains Tax Would Create A New Tax Shelter for the Super Rich:  “Lots of income that is called “capital gains” is really ordinary income that has been converted into capital gains to minimize federal taxes,” stated McIntyre.  Private-equity managers report a significant amount of income as capital gains to take advantage of the lower marginal federal tax rate.  Reducing or eliminating the state capital gains tax would only exacerbate this problem.  In 2007, almost 40% of the income reported by the top 1% of California taxpayers was capital gains.  “For this small, wealthy group, income taxes paid on capital gains represented 44% of their total 2007 California income taxes paid,” McIntyre stated.

Reducing or Eliminating California Capital Gains Tax Would Not Stimulate Economic Growth or Investment in California:  Whitman and Poizner argue that reducing the state’s capital gains tax would result in significant economic growth in California.  “Careful research by non-partisan analysts shows that there is no connection between lower capital gains taxes and higher economic growth, in either the short run or the long run,” McIntyre states.  In 2002, the CBO released a report titled “Economic Stimulus: Evaluating Proposed Changes in Tax Policy,” which found that “capital gains tax cuts would provide little fiscal stimulus,” since most of the benefits of such cuts would accrue to high income households which are much more likely to save than spend.”  “Indeed, the CBO determined that, of the range of approaches examined, capital gains tax cuts were among the least effective,” according to McIntyre. 

Research by Len Burman, the director of the joint Brookings Institution-Urban Institute Tax Policy Center, shows that over the last 50 years real GDP growth has not varied in response to changes in the capital gains tax rates, even when the possible lag between the rate cut and subsequent economic activity is accounted for.  “The relationship between rates and growth is not statistically significant,” according to McIntye. 

A capital gains tax cut would also not encourage additional investment in California, as opposed to companies in other states or nations, because California-based investors would receive the same tax treatment if they invest in-state, out-of-state, or abroad.  Investors will continue to seek out the highest rate of return on their investment, without regard to location, just as they would in the absence of a state tax break for capital gains, McIntyre concludes.

Critique of Select Whitman “Job-Creating” Tax Cuts

Sales Tax Exemption or Tax Credit for Manufacturing Equipment Will Not Create New Jobs, Only Serve to Significantly Increase State Budget Deficit ($1-2 billion/yr. revenue loss):  This is perhaps the most justified on policy grounds of all of the tax cut proposal, although the state can ill-afford this tax cut at this time given the $20 billion budget deficit.  A sales tax exemption is preferred to a credit given the administrative nightmare of the now expired manufacturers’ investment tax credit (MIC) for both taxpayers and tax administrators.  The MIC was enacted in 1994 with a promise by proponents that it would create 390,000 new jobs by 2004.  The MIC expired at the end of 2003 because it failed to meet even a minimum threshold of 100,000 new manufacturing jobs that it needed to create to stay in effect.  The truth of the matter is that  U.S. manufacturing jobs are going overseas due to market conditions, not state and federal tax rates.  A marginal tax break of 6% of the value of purchases of equipment used in manufacturing will do extremely little, if anything, to stem the flow of U.S. manufacturing jobs overseas.   

Elimination of $800 Minimum Franchise Tax (MFT) for New Corporations Is Unnecessary, Not Fiscally Prudent ($60 million revenue loss):  Whitman proposes to eliminate the $800 limited liability company (LLC) filing fee that new corporations pay to incorporate as an LLC.  Under current law, the MFT is already waived for a C Corporation’s first two years of existence.  Many LLCs currently pay no additional taxes because they are set up as holding companies or take all of their profit in the form of executive compensation and therefore pay no corporation tax.  The $800 tax, which has been in place since the 1987 federal tax reform conformity legislation, is a nominal and fair amount for the privilege of conducting business as an LLC in California.

Tax Credit for Water-Conservation Technology Would Not Increase Development of Such Technology, Only Serve to Widen State Budget Gap (Unknown Revenue Impact, Estimated at $10-20 million/year minimum):  Investors will invest in water conservation technology if it makes economic sense to do so.  While Whitman has not specified the amount of the tax credit, enacting a state tax credit of say 6% would only marginally reduce the costs of producing such technology and would not have a measurable or significant impact on the development of additional water-conservation technology in California.  The escalating prices of water, especially in Southern California, has created a growing market for this technology.  It does not make sense for the state, at significant cost of lost revenues, to reward entrepreneurs for developing products for which there is a thriving market.  The economic benefits of selling such devices is reward enough.

Increasing State Research & Development (R&D) Tax Credit from 15% to 20% of Qualified Expenses Further Expands an Already Generous Tax Credit at Great Cost to the State ($60 million/yr.):  California already has the most generous research and development credit in the country.  It is so generous, relative to the amount of corporation tax, that many companies already zero out their entire tax liability.  Adding more to that makes no economic sense.   The September 2009 budget agreement permitted the sharing of these credits among affiliates, which means much more income can now be sheltered than ever before through use of the R&D tax credit.  The state corporation tax is ¼ the federal rate, which is why state R&D tax credits are usually so much lower than the 20% federal rate.  If California’s corporation tax rate was anywhere near as high as the federal rate, presumably there would be an argument for raising it, but, as noted, it is disproportionate to the corporate income which is sheltered by the credit.  There has been no evidence presented that the current R&D rate is somehow ineffective in increasing R&D in California.  In order to provide an additional credit, there should presumably be some evidence that this is necessary beyond the generous credit we already have in place.  Otherwise, increasing the credit at the margin merely deprives the state of tax revenues which would be better invest in such things as education, universities, community colleges, transportation, and for other purposes that enhance workforce development and R&D activity in California.    

Establishing Academic Enterprise Zones Near Universities Would Expand the State’s Already Inefficient and Wasteful Enterprise Zone (EZ) Program ($50 to $100 million/yr. annual revenue loss):  The state’s current $300 million EZ program, which provides tax benefits in targeted zones throughout the state, is fraught with waste, fraud, and abuse as well documented by the California Budget Project and others (see California’s Enterprise Zones Miss the Mark).  Unfortunately, all reform attempts have failed in the Legislature thus far.  Expanding a current program that is widely regarded as wasteful, inefficient, and loophole-ridden, is not a smart idea.  Companies, largely specializing in R&D, are already congregated around the state’s premier university campuses.  Most of these firms already take advantage of the state’s generous R&D tax credit.  It makes no economic sense to reward these companies for locating in areas where it already makes economic sense for them to be located. 

Poizner’s Proposed 10% Across-the-Board Tax Cut Serves To Widen State’s $20 Billion Budget Deficit by $8.2 Billion, Misleading “Supply-Side Economics” Math Does Not Pencil Out

Poizner proposes a 10% across-the-board tax cut to the marginal tax rates for the personal income tax, the sales and use tax and the corporation tax at a cost of roughly $8.2 billion in state tax revenue.  Poizner argues that his overall “jobs-package”, which also includes the 50% reduction in the capital gains tax rate, regulatory reform, spending reductions, and a hiring freeze, among other things, would fully close the state’s $20.7 billion budget deficit. 

According to Poizner’s revenue estimates, his total tax package would result in a $3.8 billion revenue gain, as opposed to a $13.7 billion revenue loss as determined by an objective analysis by Kersten Communications—a difference of $17.5 billion or 85% of the state’s current budget deficit.  Assessing the true economic impact of Poizner’s tax cut proposal is key to determining if his deficit cutting proposal pencils out using real math (click here see summary chart of Poizer’s Budget Plan).

It has already been shown that Poizner’s proposed 50% reduction in the state’s capital gains tax would lead to a $5.5 billion state revenue loss without creating any significant economic growth in California. 

The Congressional Budget Office’s (CBO) 2005 study, titled “Analyzing the Economic and Budgetary Effects of a 10% Cut in Income Tax Rates,” analyzed the dynamic effects on economic growth of a hypothetical 10% income tax cut at the federal level and concluded that under various scenarios there would be minimal offsets to the loss of revenue.  “The budgetary impact of the economic changes was estimated to offset between 1% and 22% of the revenue loss from the tax cut over the first five years,” states the report. 

Thus, only under the most optimistic assumptions, a 10% reduction in the state personal income tax could lead to as much as a 25% revenue offset over the first five years—or a $1.2 billion annual offset over the first five years. 

The 10% reduction in the state sales and use tax (SUT) is likely to generate greater revenues than the reduction in the PIT, given the regressive nature of the SUT, and is more likely to be spent by lower-income and moderate income taxpayers. 

But even if it is assumed that 50% of the SUT and corporation tax (CT) cut is returned to the state in offsetting tax revenues—for a total offset of $1.75 billion, even under these overly optimistic assumptions, the cost of Poizner’s total $13.7 billion tax package could be offset by just over $3 billion.  That still leaves a $10.7 billion revenue gap from Poizner’s tax reduction package that is unaccounted for in Poizner’s calculations.

The Poizner campaign needs to explain how his “jobs plan” accounts for this $10.7 billion revenue discrepancy?            

Conclusion

Despite a $20 billion plus looming state budget deficit, both Meg Whitman and Steve Poizner have proposed grandiose tax cut proposals—to the tune of an estimated $13 billion–that the state cannot afford. 

It has been shown that the vast majority of these benefits would accrue to the wealthy, and ultra-rich, which would serve to benefit their own personal fortunes and the fortunes’ of their current and former colleagues and business partners in Silicon Valley.  Specifically, Whitman and Poizner stand to reap millions of dollars in personal tax savings from their proposed reduction in the capital gains tax. 

The proposals would have very marginal impacts on economic development at best and little, if any, tax policy justification for the vast majority of the revenue costs.  Moreover, they would only serve to further increase the state’s ballooning $20 billion budget deficit. 

Voters should not be mislead by their elaborate campaign promises about erasing the state’s budget deficit by using phony revenue estimates, based on faulty supply-side economics.  The real revenue estimates underlying both proposals do not lie.  A $13 billion tax cut means roughly $13 billion less for essential state programs and services such as education, health care, public safety, transportation, and infrastructure.

Other KC Fiscal Focus Reports: 

“Ballot Measures Qualified for June and November 2010.”

“Federal Stimulus Funding Slow to be Spent in California, Other States.” 

“KC Fiscual Focus Guide to Searching for Federal Stimulus Funding in Your Community.”

Other KC Fiscal Focus Reports: 

Lawmakers Budget Forum Illustrates Deep Partisan Divide, Foreshadows Budget Stalemate for 2010 and Beyond

Poll Highlights Need for Better Public Education on State Budget and Tax Issues

Want more frequent updates from KC, we now have a more frequent publication than KC Fiscal Focus–this monthly E-Newsletter.

Earlier this month, KC debuted KC Blog Blast, which provides email subscribers with up to date email blasts when significant new KC reports or blogs are released.  To subscribe, click here.  Here are some recent archives of recent updates. 

–DOF Proposes Controversial Budget Trailer Bill Language to Defer State Payments    

–Senate Democrats Introduce Jobs Bill Package

–CTA Kicks In $500,000 For Signature Drive To Repeal Corporate Tax Loopholes

KC Fiscal Focus is an electronic newsletter that focuses on California State public policy issues from a fiscal perspective.  Kersten Communications is a Sacramento-based consulting firm which specializes in public policy research and analysis.  To sign-up for KC Fiscal Focus click here. 

Finally, we welcome your feedback on this newsletter and our other publications.  To submit your comments, click here. 

Sincerely,  

Kersten Communications

Other KC Fiscal Focus Reports: 

Five Measures Qualify for June 2010 Statewide Ballot

Assembly Tax Panel Revisits Governor’s Tax Panel Recommendations, Examines Alternatives 

KC Blog Post with Links to Governor’s Budget and Analyses by CA Budget Project and Legislative Analyst 

KC Fiscal Focus is an electronic newsletter that focuses on California State public policy issues from a fiscal perspective.  It is also the primary means for announcing the public release of publications by Kersten Communications–a Sacramento-based consulting firm which specializes in public policy research and analysis.  To sign-up for this newsletter click here.   

KC Fiscal Focus is an electronic newsletter that focuses on California State public policy issues from a fiscal perspective.  It is also the primary means for announcing the public release of publications by Kersten Communications–a Sacramento-based consulting firm which specializes in public policy research and analysis.  To sign-up for this newsletter click here.

Another KC publication, titled “Flurry of Fiscal Initiatives Filed With California Attorney General’s Office for Possible Consideration on November 2010 Ballot,” summarizes a series of fiscal inititatives, and their proponents, that have been filed for the November 2010 ballot.  

Initiatives include measures that would enact a “split-roll” property tax, reform state and local finance, increase the cigarette tax, tax marijuana, call a constitutional convention, and more.  Links to the initiative texts are provided in the KC report.    

KC Fiscal Focus is an electronic newsletter that focuses on California State public policy issues from a fiscal perspective.  It is also the primary means for announcing the public release of publications by Kersten Communications–a Sacramento-based consulting firm which specializes in public policy research and analysis.  To sign-up for this newsletter click here. 

Finally, we welcome your feedback on this newsletter and our other publications.  To submit your comments, click here.

Commission chair Parsky, along with several other commissioners and tax experts, appeared before the Assembly Revenue and Taxation Committee earlier this month to discuss the commission’s recommendations.  Legislative hearings on the commission’s work product will continue into December.  To view video tapes of the hearings held by the Assembly Revenue and Taxation Committee click here.    

In October 2008 Governor Arnold Schwarzenegger and legislative leaders created a bipartisan commission—called the Commission on the 21^st Century Economy—to “re-examine and modernize California’s tax laws.”  The Commission issued its final report last month after nine months of deliberations, but only nine of the commission’s 14-members chose to sign onto the report.

The major components of the recommended package include the enactment of a new “business net receipts tax”, a less progressive state income tax, and the elimination of the state sales tax and corporation tax.  For a summary of potential issues with the proposed recommendations click here.    

Chairman Parsky, Commission Majority State Their Case For Reform, Rebut Critics

Commission chairman Parsky and a handful of commissioners who signed onto the report appeared before the committee to support their recommendations and rebut criticism of their recommendationss. 

“Doing nothing is not an alternative…the system is antiquated,” Parsky said, noting that the commission sought an “updated tax structure” to reduce the volatility of the state’s current system that has forced severe cuts in state services. 

“Please don’t let the naysayers…who try to spark fear or confusion…stop you from addressing this,” said Parsky.  Parsky said tax policy is “extremely contentious” and the commission’s work product was going to be criticized regardless of what the commission presented “because it is new.”

“Please don’t abandon the process because it is difficult,” Parsky said.    

“I think you have the makings of bipartisanship,” Parsky said.  Parsky agrees that “more work needs to be done,” noting that the report identifies areas that needed additional work such as how the financial community (i.e. banks) would be treated under the business net receipts tax, how to address existing tax credits, how to transition to the new system and a closer review of revenue estimates. 

“Our job was to look at the big picture…I wanted to focus on volatility,” said Commissioner Curt Pringle, current Mayor of Anaheim and former Assembly Speaker.  Pringle said the commission intended to present a tax structure that “may be better” than the current system. 

Commissioner Ruben Barrales said he supports the report as a “starting point” because it includes a recommendation for an expanded rainy day fund. 

“We suggested a sound system for taxing out-of-state businesses,” said Commissioner Christopher Edley, Jr., noting that there would be some issues to deal with in the transition to the new system such as transferring and rolling over tax credits.

“I’m a risk taker…the state is in deep trouble and we need a new start,” said Commissioner Rebacca Morgan, a former state Senator, who noted that there were some unresolved issues such as the treatment of independent contractors and that more revenue estimates are needed. 

Dissenting Commissioners Say Commission’s Recommendations Were Predetermined From Very Early On

Dissenting commissioners said the commission’s recommendations were “predetermined” from “very early on” and that Parksy “severely hemmed in what kind of package could be presented” to ensure that his desired proposal was presented to the Legislature. 

“It is important to understand how this report came to be,” said Assemblyman Ron Calderon, chair of the Assembly Revenue and Taxation Committee.  Calderon said there is an “element of autocracy” in all chairs and part of the purpose of the Legislative hearings is to examine the commission’s process and question “if this was an exercise to come up with this result?”     

At least three commissioners—Fred Keeley, a former Democratic Assemblyman, Commissioner Richard D. Pomp, a preeminent tax expert, and Jennifer Ito, policy director of the community-based non-profit organization SCOPE—say that chairman Parsky used his power as chair to drive the commission towards his intended result.  They say that it became apparent from very early on that Parsky wanted the commission to recommend the imposition of a new “business net receipts tax”, the flattening of the personal income tax and the elimination of the corporation tax and state portion of the sales tax.     

“In my judgement bad process is going to lead to bad product.  I think it did in this case,” Keeley said at an October 8 committee hearing.  Keeley said the commission’s package of recommendations “does nothing to address the vision for the 21^st Century Economy” and does little to address the volatility of the state’s tax system—the two main objectives outlined by the Governor’s executive order.

At an October 14 hearing, Keeley said chairman Parsky did not allow commissioners to “delve into their own issues…ask staff to look into various things” and allow commissioners to “hold workshops on anything other than the business net receipts tax.” 

Commissioner Keeley, said the commission’s “process” and “lack of openness…taints the report.”  Keeley noted that the “chair had a very strong opinion about the right product would be” and had the “business net receipts tax”—the centerpiece of the commission’s reform package—developed without a formal vote of the commission.

Keeley said someone, presumably Parsky, paid $140,000 to Ernst and Young, a national consulting firm, to develop the BNRT proposal without placing the request on the commission agenda or even discussing it with the commission.

“I was never quite sure where this business net receipts tax came from,” said Commissioner Ito at an October 8 hearing of the Assembly Revenue and Taxation Committee.  Ito said she was at every meeting and heard a lot of expert testimony against the proposal but never knew where it came from to begin with.

“My recommendation is that this is not the right direction to move in,” Ito said, commenting on the report.  

Keeley said there were some hearings held early on to familiarize the commission with the tax system “but without much debate or discussion, what appeared before the commission was a fully formed BNRT together with other elements of a package.”

“The unfortunate aspect is that all other ideas were frozen out…once that package was placed on the table,” Keeley said. 

In a written statement, Commissioner Pomp said the commission’s “early and enthusiastic embracing of the BNRT” reminded him of “a police department that latches on early to a prime suspect in a murder case, looking for a quick and easy arrest.  By the time DNA testing shows the wrong person was arrested, all other leads have gone cold.  We have ignored the equivalent of DNA testing and not pursued other leads.  We have not pursued other avenues for fundamental reform that are more likely to achieve the goals of fairness and economic efficiency.  I think in time it will be apparent that we have made a serious misjudgement, and have not served the people of California as well as they had a right to expect.”    

Summary of Issues Raised By Critics About Commission Process:

Chairman Parsky Did Not Listen To Input Of Several Commissioners In Setting Commission Agenda and Process:  Commissioners Keeley and Ito noted that chairman Parsky decided from very early on that the commission was going to recommend the BNRT, as opposed to all other possible tax reforms.  Commissioner Keeley said he tried to conduct workshops on other issue areas but the chair would not hold workshops on anything other than the BNRT.  Keeley said he tried to delve into his own issues but Parsky would not allow any commission resources to be spent on pursuing alternative reform options.  “All resources available to the commission were put into continuing to advance the package in front of you,” Keeley told the committee.      

Chairman Parsky Declared Early On That The Commission’s Recommendations Must Be Revenue Neutral, Even Though The Final Recommendations Are Not Revenue Neutral:  Keeley said the chair made it clear very early on that the package “must be revenue neutral…that appears nowhere in the executive order.”  Parsky then told the commission the reason for this was that the Senate Pro Tem and Speaker committed to an up or down vote on the package, according to Keeley.  Keeley said he spoke to both Legislative leaders and they never committed to this.  “This should have disappeared as an issue but it didn’t…that severely hemmed in what kind of package could be presented,” Keeley said.  Several advocates and some of the commissioners noted that the package is not revenue neutral.  “This package is not revenue neutral,” commissioner Keeley said, noting that the recommended changes will grow the General Fund slower than existing law. 

BNRT Tax Proposal Did Not Originate From The Commission Or Any Testimony In Support Of The Proposal:  Commissioners Keeley and Ito noted that no commissioner voted to put forward the BNRT, rather the proposal mysteriously appeared before the commission after somebody, presumably Parsky, contracted with Ernst and Young to produce the proposal.  Commissioner Ito noted that “It was not clear how the BNRT became the centerpiece of the program,” and that “the primary agenda was the reduction of the income tax and elimination of the corporation tax,” according to a report by State Tax Notes.  Keeley said the BNRT “did not come as a result of any testimony through the commission…it came from a contract with Ernst and Young.”  Assemblymember Calderon said the commission’s expenditures will be made publicly available which will allow the committee to determine if the commission paid to contract with Ernst and Young.

Report Fails To Recommend Many Potential Reform Options Such As Property Tax Reform, Internet Taxation:  At least two commissioners, Keeley and Ito, told the Assembly Revenue and Taxation Committee that they supported examining a “split-roll property tax.”  Other advocates and critics say the commission should have recommended extending the sales tax to more services and taxing the Internet.

From Reading The Final Report It Appears That Every Commissioner Signed Onto The Report:  Commissioner Keeley noted that “from reading the report it appears that every commissioner signed the report.”  The report itself lists all 14 of the commissioners’ names and does not make any reference to the fact that only nine of the commissioners agreed to sign onto the report.  

Report Draws Conclusions That Were Not Substantiated In Commission Hearings:  Commissioner Keeley noted that the report suggests that high marginal tax rates impede our competitiveness but “this was never substantiated in all the hearings,” Keeley said. 

It Is Unclear How Many Of The Commission’s 14-Members Support The Conclusions And Recommendations Outlined In The Commission’s Final Report:  According the commission’s website, nine commissioners endorsed submitting the report to the Governor and Legislature for consideration, but at least some of those nine commissioners signed onto the report without endorsing all, or even most, of the aspects of the report. 

For example, Commissioner Edward De La Rosa signed onto the report but then wrote a statement saying “my statement of support is not a statement of support for this plan, but a support to forward this document to the Legislature as a starting point for debate.”    De La Rosa’s statement, which was read by Assembly Revenue and Taxation Committee Chairman Charles Calderon, listed a number of concerns De La Rosa had about the package.  De La Rosa said he was concerned about the package transferring the tax burden from high income earners to low income earners and said he remains “unconvinced that it is a good idea to eliminate the corporation tax and replace it with the BNRT,” among other concerns. 

At the October 9 hearing, Committee Chairman Calderon asked a panel of commissioners what the vote means.  Commissioner Christopher Edley, Jr. said he endorsed the report because it includes some key elements that he liked while Commissioner Ruben Barrales said he supports the report as a “starting point” because it includes a recommendation for a rainy day fund.  Commissioner Curt Pringle said the commission intended to present the report as a structure that may be better than the current system.  All of the commissioners, including chairman Parsky, agreed that “more work needs to be done.”

Chairman Parsky’s Response

Assemblymember Calderon asked Parsky why he chose to move to a new tax rather than improving on the existing system and why the property tax was not included. 

Parsky said the commission did look at bringing services into the sales tax base but the conclusion reached by the commission was that there are many flaws in the existing sales tax system.  “There is an element of double taxation,” Parsky said, noting that business inputs are taxed and he did not believe this was “sound tax policy.  He said the commission “looked at exempting business inputs from taxation” but this “created a huge revenue loss.”

“It became difficult for us to reach a conclusion about including enough services to make a strong recommendation,” Parsky said, adding that the sales tax is a regressive tax that would hurt lower income taxpayers.   Parsky also said there were “practical considerations” because it would be hard to extend the sales tax to services in the Legislature.  Parsky noted that broadening the tax base to include services was “almost unanimous” around the table and the commission thought the BNRT was the best way to get there.    

Parsky  the commission devoted a full hearing to the property tax but decided not to include it because of the “complexity and effect on local districts.”  Parsky said it would be “too complicated” for local governments to administer.  

“We could not have achieved a consensus to change Prop. 13,” Parsky said.  Parsky said “not one commissioner” supported recommending a split-roll property tax when commissioners were asked at the last meeting to raise their hands if they supported including the split-roll.  Commissioner Ito said she did not raise her hand to vote for it because each recommendation needed the votes of three commissioners and the split-roll would not have gotten that.  Keeley also said he supported the “split-roll” recommendation.

Parsky said the proposal is “revenue neutral” noting that the commission provided the best estimates it could for the revenue impacts of the proposal for 2012 to 2016, but urged a closer review of the revenue estimates. 

“The charge of the commission was clear…it was to deal with the tax system not budgeting or expenditures…we noted that this was only one element of reform,” Parsky said.  Parsky said a different commission may come up with a different result but this commission produced this result. 

He urged the Legislature to establish a commission to examine improvements to the budget process and the creation of state programs. 

Parsky said the goals of the commission were “very good” and urged the Legislature to pursue some kind of reform even if they did not agree with the specific reforms outlined by the commission.  

“We want the business net receipts rate to be as low as possible,” Parsky said, noting that the rate could be as low as 1.5% or 2% when the increased revenues from AB 32 are factored in.  

Assembly Revenue and Taxation Committee Members Inquire About Commission Process and Recommendations

“Who paid the $140,000 to Ernst and Young?” Assemblymember Lori Saldana (D) asked commissioner Keeley, who responded, “I have no idea.

“It was not the most open process,” said Assemblymember Fiona Ma, noting that Parsky appeared to focus on the BNRT from the third commission meeting on to help spare the Legislature the politics of other reforms such as a carbon tax or split-roll.

“I am disturbed now.  I thought that this package that came out was recommendations by the commission members based on a thoughtful process of all the recommendations that are out there,” Ma later said.   

“I see a lot of what I like but also what I don’t like,” said Assemblymember Diane Harkey (R), adding that she “hasn’t heard any support for the business net receipts tax” and is concerned about the tax “possibly encouraging outsourcing.”

Assemblymember Anthony Portantino (D) said he “came into the process with an open mind” but he was “concerned about five members of the commission not signing onto report,” noting that he wanted to “hear their opinions.”

“Was this a done deal in terms of the proposal that came out?” Assemblymember Calderon asked commissioner Keeley, who responded “the chair had a very strong opinion about what the right product would be.”

Calderon also asked Keeley if the research was found to “substantiate” the recommendations of the commission.  Keeley said the “BNRT did not come as a result of testimony through the commission, it came from…Ernst and Young.”  Keeley went on to say that report should be viewed as but one of several documents and points of view considered by the commission. 

Calderon sounded surprised when he read Keeley’s statement which noted that “there was no formal vote to obtain Ernst and Young.

“Why didn’t the commission present alternative approaches?” Calderon asked Parsky, suggesting the property tax (see Parsky’s response in previous section).  Calderon thought the property tax should be included even if it was “politically infeasible.”

Calderon went on to say that “there could have been a menu of things” for the Legislature to consider and said he was still trying to figure out if a vote for the report was an endorsement of its recommendations.   

“My fundamental question is why are we using tax law to reform government?” Calderon said.  Calderon agreed that the charge of the commission was “very limited” in that the commission was charged with dealing with the issue of volatility by making changes to the state’s tax system, when the budget process is the real source of the problem.  “Volatility is only a problem if you continue to charge on your credit card,” Calderon said.

“What did the vote of this commission mean?” Calderon asked Parsky, who responded that the vote means that “the report is something the Legislature should consider.”  Calderon said the “report is not a complete view of how the tax system has changed” and does not completely address how to address the new economy.

“We’re going to look at this tax [BNRT], but it is important to understand the process that produced this document,” Calderon noted.

“Nobody in the business community that I’ve talked to yet thinks it’s a good idea,” Calderon said, noting that it is ironic that Democrats are commonly criticized for not creating jobs but it is not clear that the BNRT will create jobs.  “The bottom line is if this will grow jobs…if you can cut through the devil that we don’t know,” Calderon said. 

Assemblymember Chuck DeVore (R) said he “tends to agree that the budget process is superior to using the tax code to deal with volatility.”

Assemblymember Joe Coto (D) said he took lessons from commissioners Keeley’s testimony.  Coto noted that there was never a clear sense of objectives laid out by the commission and thought the Legislature should “spell out a clear set of outcomes that we want to achieve and not limit ourselves to this report.”  These specific objectives should determine what the Legislature is seeking to address in the state’s tax system.  For example, does the Legislature want to address the 21^st Century economy, the volatility in state revenues and whether potential changes be revenue neutral, Coto said.

Conclusion

The Legislature will continue to examine the commission’s recommendations and the process it used to reach its results.  Everyone involved in the process agrees that the commission worked very hard over nine months to examine potential tax reforms and forward a set of recommendations to the Legislature for consideration.

It is now up to the Legislature to examine those recommendations and potential alternatives to come up with a course of action for reforming the state’s tax system.  It has become apparent that the overall goals of the tax commission were somewhat limited in scope.  The Legislature may look to broaden the scope of its inquiry into reforming the state’s tax system, and the implications for the state’s budget process, beyond an examination of what can be done to reduce volatility in the state’s tax system.   The Legislature should continue its inquiry into the process that lead to the production of the commission’s recommendations. 

KC Fiscal Focus will continue to monitor the Legislature’s consideration of the commission recommendations and the special legislative session on tax reform.       

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The Commission on the 21^st Century Economy was supposed to release its final report on Sunday but asked the Governor for a few additional days, which he granted, to finalize a few peripheral details. 

The 14-member Commission is preparing to release the final report later this week, however, the report is already as good as dead in this legislative session (The final report will be available here).  The major components of the recommended package have been known for weeks—the enactment of a new “business net receipts tax”, a less progressive state income tax, and the elimination of the state sales tax and corporation tax.   

The Commission held its final meeting last week.  The only thing that remains to be seen is how many of the 14-commissioners will sign onto the proposal, which is currently being circulated for signatures.  At least two commissioners, Fred Keeley, a former Democratic Assemblyman, and Richard Pomp, a tax expert, have rejected major components of the plan. 

Governor Schwarzenegger has announced that he will call the Legislature into a special session immediately after the commission submits its report. 

This analysis seeks to summarize the problems with the commission’s proposal and examine why the commission was destined to not produce a politically viable plan from the very beginning. 

Commissioners Admit Proposal Not Ready For Prime Time, Business Groups, Tax Reformers Agree

Even the strongest proponents of the reform package, commissioners John Cogan, a Schwarzenegger appointee and Hoover Institution fellow, and UC Berkeley Law School dean Christopher Edley, admitted to the Sacramento Bee last week that the proposal is not ready for an up-or-down vote by the Legislature.

A consensus of tax reform advocates and business groups agree that the proposal, at minimum, raises a number of serious questions that need to be answered before moving forward.  Several tax reform experts have flat out opposed the concept of a “business net receipts tax” (BNRT) and rejected the plan because it reduces the progressivity of the state’s tax system.

“Given the monumental changes that the BNRT would bring to the state’s tax system, we believe more time is necessary to study the BNRT and to receive public input once the details of the BNRT are provided,” wrote Teresa Casazza, president of the California Taxpayers’ Association in an August 21, 2009 letter to Gerald Parsky, chairman of the commission.  In a September 3, 2009 letter, the California Chamber of Commerce and a series of major business groups submitted a long list of concerns about the BNRT that need to be addressed before any vote is taken.   

The California Budget Project  (CBP) and California Tax Reform Association (CTRA) have also submitted letters (links to CBP letter and CTRA letter) opposing the commission’s recommendations to eliminate the state corporation and sales tax and reduce the progressivity of the personal income tax.

Tax Commission Founded Upon Assumptions That Conflict With Democratic Support For A Progressive Tax System

The main reason that the Commission on the 21^st Century Economy failed to produce anything of value is that the Governor and Legislative leaders set the commission up for failure from the very beginning.  In a nutshell, the Governor and legislative leaders essentially asked the commission to come up with a plan for making the state’s tax system less progressive–an outcome which Democratic leaders are hard pressed to support because it is unpopular with the public and violates core Democratic values of progressivity in the state’s tax system.    

In October 2008, when the commission was first formed by Executive Order S-12-08, its primary charge “re-examine and modernize California’s out-of-date revenue laws that contribute to our feast-or-famine state budget cycles…[the commission] will suggest changes that will result in a revenue stream that is more stable and reflective of our economy.  This long-term action will help avoid the extreme revenue swings that have caused crippling deficits while maintaining a fair and equitable revenue structure that will ensure our continued competitiveness and attraction to employers and workers,” states an October 2008 press release by Governor Schwarzenegger.

It is true that California’s tax system is volatile and outdated, but the primary reason for this is that the system is progressive.  Lenny Goldberg, executive director of the California Tax Reform Association, in a recent letter to the commission states that “volatility is a function of income distribution” and the “volatility problem is an income distribution problem, one which tax policy cannot change.”

California’s overall tax structure is progressive due to the personal income tax, which raises a large amount of revenue from a relatively small number of persons.  This progressivity has increased over time as more and more of the state’s wealth has become concentrated in the hands of very few taxpayers.  According to the Department of Finance (DOF), the share of state personal income taxes paid by the top 1% of taxpayers has grown from 33% in 1993 to 48% in 2006.  Click here for a presentation to the commission by Phil Spilberg, DOF chief of financial research, on volatility in the state’s tax system. 

“Upper income persons tend to receive a disproportionate share of income that is volatile, such as dividends, interest, and capital gains,” states Commissioner Richard Pomp in correspondence to the commission.  Pomp is a nationally recognized tax expert who serves as a consultant to the Multistate Tax Commission and is chairman of the Board of the Institute on Taxation and Economic Policy.  Pomp goes onto say that earned income, such as wages and salaries, tends to be much less volatile that unearned income such as capital gains and dividends.

“The commission has expended much effort discussing volatility…or more accurately, the inability to predict volatility.  From the outset, I have argued, and continue to believe, that volatility, which is a feature of every state’s tax system, is a spending problem and not a tax problem,” states Pomp.

Thus, it follows that one cannot reduce the volatility of the state’s tax system without reducing its progressivity—shifting the existing tax burden from the rich to poor and middle-class taxpayers.   

Commission Recommends Making State’s Tax System Less Progressive To Reduce Volatility

Over the course of nine months, the commission heard from a number of tax experts and produced a plan designed to reduce the progressivity of the state’s tax system by implementing a new business net receipts tax and reducing personal income taxes of the top 3% of taxpayers by an estimated $7.5 billion, among other things.  Click here to see all the testimony and presentations heard by the commission over the course of its nine months of review of the state’s tax system.    

The proposal would implement a new tax structure that would rely on a new “business net receipts tax” to raise just under 50% of the state’s general fund revenue.  Under current law, the state raises its tax revenue from the following sources:  personal income tax (44%), sales tax (34%), other excise, motor vehicle, and insurance taxes (13%), and the corporation tax. 

Under the alternative system proposed by the commission the state would be estimated to receive its tax revenue from: a newly implemented net receipts tax (47%), a less progressive personal income tax (31%), significantly reduced sales tax (9%), and other excise, motor vehicle, and insurance taxes (13%).

The business net receipts tax is “designed to tax the value a business adds to its production of products and services in California and thus attempts to approximate the benefits of services and programs utilized by the business,” according to commission documents.  The base on which the tax is imposed is the net receipts of a business which would be calculated by adding all the receipts the business receives from all sources such as sale or exchange of property, performance of services or the use of property or capital in a trade or business.  All purchases from other businesses would be then subtracted from gross receipts, resulting in the business’s net receipts.  This amount would then be multiplied by the BNRT rate (estimated to be 4.5%) to calculate the tax liability of the business.

The BNRT was selected by the commission because it would broaden the state’s tax base, grow with state economic growth, enable the reduction in the marginal rates of the California personal income tax, eliminate the corporation tax, and reduce volatility by reducing the state’s reliance on more volatile sources of revenues (i.e. the personal income tax, corporation tax).

The commission proposes to flatten the state’s personal income tax by implementing two rates: 2.75% for income of up to $28,000 for single taxpayers and $56,000 for joint filers, 6.5% for taxpayers with incomes above those levels.  The state’s current top income tax rate is 9.3% with a 1% surtax for adjusted gross income of above $1 million.

The proposal would allow a standard deduction of $22,500 for single taxpayers and $45,000 for joint taxpayers and allow itemized deductions for mortgage interest, property tax, and charitable contributions.  For a chart showing the the estimated tax reductions for each class of taxpayer under the personal income tax click here.  The tax changes would be phased over five years.  The final proposal is also expected to recommend an expansion of the state’s rainy day fund to smooth out the budget cycle.      

Comparison Of Current Income Tax Brackets To Proposed Income Tax Brackets 

**The standard deduction for single taxpayers in 2009 is $3,637, compared to $22,500 under the proposed plan, which means most taxpayers making under $22,500 a year will not pay any income taxes under the proposed plan.      

 Summary of Problems With Commission Proposal

There are a number of issues with the commission’s proposal that have been widely noted by businesses, tax reform groups and other tax experts.  Two of the most comprehensive critiques of the proposal were completed by Jean Ross, executive director of the California Budget Project and Commissioner Richard Pomp, a preeminent tax expert.  The CBP critique, dated September 9, 2009, is available by clicking here.  Pomp has written at least two major critiques, “Why I Think We Are Heading In The Wrong Direction,” (Sept. 14, 2009), and “The Red, White, and Blue Plan,” (Sept. 4, 2009).      

Business Net Receipts Tax (BNRT) Unproven And Risky To Implement In California.  Perhaps the biggest problem with the commission’s proposal is that the business net receipts tax (BNRT) is experimental and, with the exception of Michigan, has not been tried anywhere in the world.  Michigan implemented a business net receipts tax a year and a half ago but still does not have any estimates on how much the tax has raised.  “The problems with the tax will be more important in California than in Michigan because the suggested rate for the NBRT is likely to be at least four times that of Michigan,” stated Pomp in recent correspondence to the commission.  It would be extremely risky for a state as large as California to implement a new tax, that would be estimated to provide half of its General Fund revenue, without the tax having been fully implemented or studied anywhere in the world.

Proposal Would Reduce Growth In State Tax Revenues That Would Lead To Larger, Not Smaller, Budget Gaps In The Future.  The California Budget Project and others tax experts have pointed out that the proposal would reduce reliance upon, or in the case of the corporate income tax, eliminate the two taxes that have posted the strongest average annual growth rates over the past four decades and replace them with taxes that are likely to grow more slowly.  “Documents prepared by Commission staff clearly show that the changes under consideration would lower the growth of revenues relative to the state’s existing tax structure.  This report estimates that the revenues raised by California’s current tax system would rise by 40.2 percent between 2012 and 2016, while the options under consideration by the Commission would increase revenues by 32.4 percent or 35.6% over the same period.  In dollar terms, the difference translates into $4 billion to $7 billion at the end of the five-year period,” according to a September 2 letter by Jean Ross, executive director of the California Budget Project to the commission chairman Gerald Parksy. 

BNRT Would Make California Businesses Less Competitive With Those In Other States and Nations.  Commissioner Pomp noted that several aspects of the BNRT are likely to make California businesses less competitive with other states and nations.  Pomp notes that “although the new tax has been described as a “value added tax (VAT),” it is not the kind of VAT used in Europe and throughout the world.  The VAT tax is collected at the time of each sale, and widely viewed as a tax on the consumer or a retail sales tax collected in stages, Pomp writes. 

The European VAT has two features that are critical to the proper operation of a value added tax that cannot be incorporated into the BNRT.  First, imports are taxed, which “maintains neutrality between the sale of domestically-produced goods and foreign produced goods… so that domestic producers are not put at a competitive disadvantage.”  Pomp says this feature cannot be used under the NBRT for two reasons:  1) under the U.S. Constitution producers cannot be brought under the NBRT unless they have nexus in the state, and 2) the draft proposal explicitly excludes foreign corporations from the tax by adopting the same water’s edge limitation now existing in the corporate income tax.  The result is that California producers will be placed at a competitive disadvantage. 

Pomp states that a second feature of the VAT which is critical to not putting domestic producers at a disadvantage is a rebate of the tax on exports.  European countries exempt exports from the VAT because they will be taxed when they are sold in the county to which they are imported.  “Under a transactional VAT, the amount of tax previously paid by the exporter is known and thus can be rebated,” Pomp states.  With the BNRT, on the other hand, the amount of tax previously paid by the exporter is unknownable, thus making it impossible to rebate that amount.  “Consequently, California exporters are put at a competitive disadvantage in competing outside the state,” Pomp states. 

Pomp argues that it is different to impose a VAT in a common market such as the European Union in which the member states have a similar value added tax, but it is a much different environment from the United States where only Michigan and California would have NBRTs.  “This latter point is critical to understanding the possible harm that could result to the California economy from adopting this tax,” Pomp writes.  

BNRT Proposal Would Be Difficult To Implement Without Being Riddled With Loopholes And Special Interest Tax Breaks.  “The unfamiliarity with the concept of the NBRT will virtually ensure that the tax will be riddled with special provisions,” Pomp writes, noting that legislators will have a difficult time resisting please by lobbyist and special interests for special tax breaks.  Pomp notes that the NBRT is an “opaque and nontransparent tax that defies easy characterization” and talking about the proper treatment of specific industries such as financial institutions would “quickly deteriorate into an esoteric and fairly inaccessible discussion.”  “I have no confidence that the integrity of the NBRT will remain intact.  Indeed, one can easily imagine an incentive introduced for salary paid to employees, special rules for the payment of interest, the wholesale exclusions of certain industries or types of services and so forth,” Pomp writes.             

2/3 Vote Requirement For New Taxes Would Make It Nearly Impossible To Bring Back Corporation Tax Or Sales Tax If Revenues From BNRT Do Not Materialize.  Pomp also notes that it would be next to impossible to bring back the corporation tax or sales tax if the revenues from the BNRT do not materialize as expected or come in below estimates.   “I am especially troubled by eliminating the corporate income tax, in existence for more than 70 years, and used by 90% of the states, and replacing it with a totally new, regressive tax, never seen before in either California or the world (with the exception of Michigan),” Pomp states.  “Revenue projections for a new tax are always tricky, if not wildly inaccurate.  They are especially suspect when they are made before any tax has worked its way through the legislative process and before taxpayers have become familiar with tax minimization strategies,” Pomp writes. 

BNRT Would Tax A Number of Things That Should Not Be Taxed Such As Utilities, Medical Services, Food, Housing And The Sale of Homes.  The BNRT would tax a wide range of goods and services that are currently exempt from state taxation such as utilities, medical services, food, housing, and the sale of houses.  Pomp notes that the NBRT would tax real estate rentals and the sale of homes by businesses.  “As far as I know, it is highly unusual for a state to impose a sales tax on the sale of homes…and I cannot think of a worse time than in the middle of a recession marked by thousands of foreclosures to imposes a new tax on the sale of housing by businesses,” Pomp writes.  The California Budget Project notes that lawmakers have exempted food purchased for consumption at home, prescription drugs, and essential services such as health and child care for taxation.  “All of these items would be subject to tax under the BNRT, which would exacerbate the regressive impact of the tax on lower-income households,” states the California Budget Project.  The proposed changes to the personal income tax would eliminate deductions for medical care and the child and dependent care tax credit, which benefits working families.         

Proposal Would Increase The Gap Between Rich and Poor.  The level of inequality in California is already large and growing larger and the commission’s proposal would exacerbate these gaps, according to the California Budget Project.  Under the commission’s proposal, the top 19% of taxpayers would receive 90% of the tax reductions or roughly $13.5 billion of the proposed $15.1 billion in tax reductions proposed under the personal income tax.  The bottom 81% of taxpayers, those making less than $100,000 a year, would receive only 10% of the reductions or $1.5 billion.  “In absolute dollar terms, the new structure would reduce the amount owed by a couple with an adjusted gross income of $50,000 by $85, while a couple with an AGI of $999,999 would receive a tax break of $21,315, according to the California Budget Project. 

Proposal Would Increase Prices for California Consumers and Place Downward Pressure on Wages.  The California Budget Project notes that documents prepared for the commission indicate that three quarters (71%) of the BNRT would be passed on to consumers in the form of higher prices, and just under one-fifth (19%) would be passed on to workers in the form of lower wages or fewer benefits, while the remainder would be divided between shareholders and business owners (9%) and individuals outside of California (1%).

Major Portions Of Proposal Could Be Found Unconstitutional, At A Cost of Billions Of Dollars To The State Of California.  The California Budget Project notes that a September 5^th letter signed by some of the nation’s most prominent tax experts finds that major portions of the BNRT could be challenged as unconstitutional.  This conclusion is supported by an analysis by the Franchise Tax Board.  The challenge would stem from a so-called “nexus” issue whereby the state would have to levy the BNRT on firms outside California to discourage outsourcing, but the state may not have the authority do so under the U.S. or State Constitution if those firms do not have “nexus” in California, commonly defined as a “physical presence” in the state.  An August 21^st analysis completed by the Franchise Tax Board, concludes that “the BNRT, if enacted presents some novel tax issues that lead to court challenge.  The BNRT relies upon a factor presence nexus standard, the validity of which has not been addressed by the California courts or by the U.S. Supreme Court.  We believe that such a standard should pass constitutional muster, although a favorable outcome is not certain.”  The analysis goes onto say that “there is a risk that the effectiveness of the BNRT could be undermined if the Business Activity Tax Simplification Act of 2009 currently under consideration in the U.S. Congress (or similar federal legislation) were to be adopted.”    

Conclusion

The Commission on the 21^st Century Economy worked hard to produce a proposal that addresses the charge that it was given by the Governor—come up with a proposal to reduce volatility in the state’s tax system—unfortunately the charge that the commission was given was misguided. 

Kersten Communications continues to produce research and analysis that document the myriad of problems with the state’s tax system that need to be addressed.  In short, the Legislature and any future tax reform efforts need to start by fixing what we have–improving efficiency, fairness, and equity in the state’s personal income tax, corporation tax and property tax—instead of starting over with an unproven tax that is fraught with its own host of problems, both known and unknown.

For list of Kersten Communication publications on California tax policy visit:

http://www.kerstencommunications.com/publications.        

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