Legislators debate tax reform

SEPT. 3, 2010

By KATY GRIMES

The state is still operating without a budget, but not all the legislative budget discussions this week focused on that pressing problem. The Assembly’s Taxation and Revenue committee on Wednesday looked at the broader issue of tax reform in a hearing filled with representatives from business groups who are concerned about the anti-business effect of California’s progressive tax system.

The committee met for the purpose of discussing the governor’s Commission on the 21^st Century Economy Findings and Recommendations on Tax Reform. Financial experts from the state and the commission were present to explain what the commission recommended, and answer legislators’ questions.

The report contains several recommendations to overhaul the state’s tax structure:

• a reduction in personal income tax rates for all income groups
• elimination of the corporate tax and minimum tax
• elimination of the state sales tax
• adding a business net receipts tax (BRNT), which would have a broader base than the sales tax, to include services as well as goods.

The commission also recommended a strengthened rainy day fund and a new tax dispute forum.

A five-year phase-in plan for the changes to the tax structure is recommended as well, beginning in 2012, “designed to smooth the process and limit the impact on any particular sector of the economy,” the governor’s office reports.

Gerald Parsky, chairman of the commission appointed by the governor, insisted that tax reform “can be done,” and warned, “naysayers can cause people to be confused” and “create fear.” Parsky asked legislators to remain focused on the goals and recommendations of the commission, and not listen to naysayers.

Mark Hill, a budget specialist with the finance department, explained in detail how the commission’s proposal is “as revenue neutral as possible.”

Assemblyman Charles Calderon, D-Montebello, asked Hill, “If the tax is revenue neutral, why are we deciding this now?” Hill explained, “the recommendations from the commission are not going to be a budget solution, or even a budget fix, or the endless cycle of thinking that we’ve solved the problem.”

It was apparent that Calderon did not buy Hill’s explanation and said, “We are talking about reform for the sake of reform. Shouldn’t we be talking about true reform, restructuring our revenue system? What’s the basis?”

Parsky explained that because of the state’s taxes, some companies are choosing not to establish operations in California, and many others are leaving the state. “The deterrent in our state is the tax system,” said Parskey.

Calderon argued that Parsky didn’t have any basis to determine reform for the economy, and asked how it could be done.

“Any expert will say that tax rates effect business,” Parsky said.

Debate continued between legislators and the commission panel about which types of business leave the state, and what goods and services California residents currently choose to purchase out of state. But both Hill and Parsky agreed that the businesses and services leaving the state are an issue of concern.

The income tax reductions were discussed as well, with Sen. Tom Harman, R-Huntington Beach, asking for more detail. Parsky said that the range of adjusted gross income would be 2.75 percent for taxable income up to $56,000 (for joint filers), and 6.5 percent for taxable income above that amount.

The governor’s office analysis states that the proposed tax reductions would reduce the amount of income tax by 29 percent for tax payers.

Harman asked Parsky, “Shouldn’t everyone pay something?” and then asked how the commission arrived at the income numbers and base income to be taxed. Parsky said that many members of the commission agreed that everyone in the state should pay some income tax, but because they couldn’t achieve a majority of members on the issue, they did not recommend it.

The issue of the state planning to tax business services was discussed. The more broad-based Business Net Receipts tax applies to services such as legal and accounting services, even landscape services and nanny care. Harman was concerned that health care services would also be taxed, and asked if the tax would be on the total, or original cost of the health service, or on the negotiated amount agreed to by the insurance company.

Phil Spilberg, also with the Department of Finance, explained “the tax is when money changes hands.” Several legislators questioned his answer, so Spilberg explained again, “When the bill is due… the amount of the discounted price.”

Harman asked how the state could possibly track services, and properly tax them. No one on the panel was able to answer Harman. Parsky said implementation has not been resolved yet.

Assemblyman Chuck DeVore, R-Irvine, said that at least 10 other states did similar tax reform, and that reducing tax rates on corporations resulted in dramatic revenue increases. DeVore named Tennessee and Kentucky as two of the states to successfully reduce corporate taxes.

Other taxes were discussed as well. Parsky said the vehicle license fee and oil severance taxes were addressed in the commission’s report.

Parsky said however, that the top 1-percent of income earners still pay over 50 percent of the state’s revenues. “Higher tax rates have the most to do with business decreasing,” added Parsky. “And, some are much more attractive in a state neighboring California where rates are lower.”

Mac Taylor, the Legislative Analyst for the state, offered his analysis of the commission’s report, and warned legislators about exempting industries and businesses from the net receipts tax on services.

Taylor said the biggest change in the taxing structure is the tax to services. Calling it a “transaction tax,” Taylor said it still has businesses pay taxes on transactions. “Clearly businesses don’t pay higher taxes – they pass them on to consumers,” said Taylor.

Someone in the audience rather loudly said, “What about supply and demand?” which usually dictates what costs businesses can pass along to the consumer.

Taylor warned that the number of permits in the state may triple, in order to collect taxes.

The legislative counsel for the state’s sales tax collection agency, Margaret Shedd, boasted that the Board of Equalization “has 900,000 taxpayers registered,” as if they were a client base. Shedd said, “Household services such as dry cleaning, sprinkler repairs, car repairs, and sporting and event tickets are all subject to the service tax.”

The challenge for the taxing agency, according to Shedd, was how to collect on services like accounting, advertising and legal work. There was an audible grumble from audience members. Shedd said that national corporations that produce multi-state advertising campaigns, or perform legal work or accounting services, would have great difficulty knowing where to pay the tax.

Assemblyman Calderon said, “It would be enormous to shift the tax base to a service economy, and not an effective use of our time.”

The many groups presenting public comment mostly included business associations and anti-tax groups in opposition.

The California Taxpayers Association spoke in opposition to the taxation of services and said, “taxpayers need more predictability. We want to focus on real solutions to the budget.” Explaining its opposition, the taxpayers association Web site fact sheet states, “Some estimate that a broad sales tax on services could generate as much as $45 billion annually in new revenues. However, the real question with regard to taxing services is whether expanding the base would result in an overall benefit to the General Fund and whether that benefit would outweigh the natural but likely unintended, consequences that would flow from such an expansion.”

Jean Ross, president of the California Budget Project, has long been an advocate of raising taxes on the wealthy, and states on the Web site, “A CBP analysis shows that increasing taxes on higher-income families is the best choice for closing the budget gap when the economy is weak.” Ross spoke in favor of expanding taxes to include services and said, “We should have doe this in the 1960s, because we’re not going to get a lot of growth in this.” Ross said that the tax cuts enacted by former President Bush caused the “slowest employment growth,” and after the Reagan tax cuts, “16 million jobs were lost.”

Other opponents of the commission’s recommendations warned of ramifications for California’s underground economy. A representative of landscape workers said, “Underground economy businesses have no workers compensation or other insurances. This is only an incentive to greatly expand the underground economy.”