Just days after the Governor reiterated his support for the recommendations of his Commission on the Twenty-First Century Economy (COTCE) in his State of the State address earlier this month, the Assembly Revenue and Taxation Committee held a four-hour hearing to re-examine the recommendations of the commission and hear from dissenting tax panel commissioners Richard Pomp and Fred Keeley, a representative from the Legislative Analyst’s Office (LAO), and San Jose State Professor Annette Nellen.
The hearing, held on January 13, 2010, marks the fourth time the committee has met to review the Commission’s package of reforms which include the enactment of a new “business net receipts tax” (BNRT), a less progressive state income tax, and the elimination of the state sales tax and corporation tax. (To view the commission’s final report click here. For a summary of potential issues with the proposed recommendations click here.)
LAO Projects that Commission Proposal Would Create Additional $10 Billion Budget Gap
“It’s a very complex proposal. One of the questions we wanted to understand: how would it affect revenues in California,” said Paul Warren, director of State and Local Finance for the LAO.
Warren said that the Franchise Tax Board assisted the LAO to produce a revenue simulation that suggests the proposal would lead to a $10 billion annual drop in state revenues and only result in a “modest change” in the volatility of the state’s tax system. The primary charge of the tax commission, which was formed by the Governor and legislative leaders in October 2008, was to produce recommendations to reduce the volatility of the state’s tax system.
Warren said state revenues would still fluctuate with the economy under the COTCE proposal, albeit slightly less than under current law.
The LAO completed a simulation of what state revenues would be if a 4% BNRT had been in effect between 2000 and 2007 and found that the proposal would have resulted in a consistent $10 billion annual budget gap. The LAO suggested that Legislature would need to consider a higher BNRT rate or smaller tax reductions to make the proposal revenue neutral.
Warren cautioned that the “results should not be considered definitive” because the “business net receipts tax is so different it is difficult to estimate using existing data.”
Assemblymember Chuck Calderon (D) asked Warren if the BNRT would grow the economy. “We don’t know,” Warren said, noting that some of the aspects of the proposal appear very attractive while noting that a lot of businesses would be getting a substantial increase in the taxes paid under the BNRT.
For example, the LAO projects that the BNRT would raise $14.6 billion of the $40 billion raised under the new tax from taxpayers who do not currently pay corporate taxes, including $1.6 billion from multi-state corporations, $1.1 billion from in-state corporations, $400 million from Subchapter S Corporations, $3.3 billion from limited liability companies, $7.3 billion from partnerships and nearly $1 billion from sole proprietors.
The reason is that the state’s current 8.83% corporate tax is on profits while the 4% BNRT would be on net receipts, which means businesses that operate at a loss in a given tax year would still be taxed.
Dissenting Commissioner Pomp Says Switching to BNRT Would Be “Terrible,” Cautions Against Pursuing “Race to Bottom” in State Tax Rates, Suggests Alternative Tax Changes
Dissenting tax commissioner Richard Pomp appeared before the committee to reiterate some of the points made in the four memos that he has written opposing the COTCE proposal.
Pomp questioned why some of the dissenting reports or critiques of the proposal did not make it in the published COTCE final report.
“Unlike the commission, I do not have a public relations firm working for me. In fact I was unaware we had a public relations firm working for the commission. They’ve done a nice job because if you go to the commission’s website…you will not find any of the 400 public letters in opposition to this commission,” Pomp stated.
“We as a commission heard no credible evidence that the California corporate tax was discouraging investment…You folks out here were the model for the country at one time…We know what the answers are—it requires a real political backbone ,” Pomp said, adding that the corporate tax now “leaks like a sieve.”
Pomp said that many states are currently in a “race to the bottom” over tax rates and that it does not make sense for California to try to compete with states without a personal income tax to encourage business investment because it would require a zero percent rate to be competitive.
Pomp said the two states that are leading the nation in migration out are Nevada and Florida—both states do not have personal income taxes. “Why? Because of jobs,” Pomp said.
“A lot more goes into where you relocate,” Pomp stated, noting that state taxes do not rank very high when a business is deciding where to relocate compared to all other considerations.
Pomp proposed $20 billion in suggested tax reforms. He suggested that the state broaden the sales tax base to include services to raise $2 billion, improve tax administration by cracking down on tax havens and improving tax collections to raise $2 billion, reform the corporate income tax to restore it to what it once was, and restoring the vehicle license fee.
Pomp also suggested that the state tax digital downloads and said an oil severance tax was “perfectly reasonable and long overdue.” Pomp also said the public should be informed about how much companies are getting in corporate tax breaks and that this could be done by requiring public disclosure of corporate tax expenditures.
Commissioner Keeley Reiterates Opposition to COTCE Proposal
Commissioner Keeley has appeared before the Assembly Revenue and Taxation Committee on several occasions to oppose the COTCE recommendations.
Keeley said there was “no common agreement from the outset” about the BNRT proposal. “It literally appeared fully formed…and then set the stage for all the discussion.” Keeley described this as a “fatal” flaw of the commission proposal.
“The chair intentionally excluded a robust discussion….I believe they all knew where they wanted to go before our discussion,” Keeley said.
Keeley encouraged the committee to broaden the state’s tax base and lower the rate to encourage compliance and pay for an education system that is “affordable and first class,” among other things.
Keeley said his focus on the commission was on the need to deal with the global warming issue by taxing fuels and carbon emissions but his proposals were not accepted by the commission.
San Jose State Professor Proposes Tax Alternatives
Annette Nellen, a San Jose State Professor in the College of Business, recommended a series of tax changes as alternatives to the commission’s report. Nellen recommended broadening the state’s sales tax base and lowering the rate, expanding the state’s rainy day fund, implementing administrative tax reforms, enacting an oil severance tax, and enacting gasoline excise taxes.