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, which are widely cited below.
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 5th 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 21st 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.”
For list of Kersten Communication publications on California tax policy visit: http://www.kerstencommunications.com/publications.
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