KC Fiscal Focus: Dissenting Tax Commissioners Say Chairman Used A “Bad Process”

October 22nd, 2009

At least three commissioners on the Governor’s bipartisan 14-member tax commission have criticized commission chair Gerald Parsky for using a “bad process” that “froze out” other ideas. 

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 21st 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 21st 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 21st 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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