Prop 39 and AB 1500: A taxing alliance

August 20, 2012

By Katy Grimes

The passage of AB 1500 by the Assembly last week demonstrates the gargantuan disconnect California Democrats have with elementary economics, as well as the economics of education.

AB 1500 would raise taxes on businesses and employers who operate inside California, but are headquartered out-of-state. Unlike the previous versions of the legislation, the bill was remodeled to create a favorable sounding “Middle-Class Scholarship” for California’s public college students, in an attempt to make the bill more palatable.

But businesses aren’t able to make any long-term plans or investments in California because the Legislature keeps changing the rules from year to year on tax policy, fees, and increasing regulations.

“We don’t have a lack of students going to the University of California and California State University — we have a lack of jobs when they come out,” Assemblyman Curt Hagman, R-Chino Hills, said, putting the issue into perspective. “Until we make California competitive again, we will have that problem.”

The bill

Assembly Speaker John Perez, D-Los Angeles, calls the tax credit a “loophole.”

AB 1500 restores the level playing field for California businesses,” Perez has said at each of the hearings on AB 1500.

“Leveling the playing field” is always code language for how government imposes taxes on successful businesses.

Perez has defiantly insisted that the “money saved by closing this loophole, approximately $1 billion annually, will be used to fund the Middle Class Scholarship.” Perez said the $1 billion in additional tax money will be used to cut student fees by two-thirds for UC and CSU students whose families earn less than $150,000 per year, and includes $150 million to increase affordability at the state’s community colleges.

But as I’ve written before, the bill is light on details about that scholarship. Now according to legislative staff, there appears to be an issue with the state’s mandatory Proposition 98 education funding, which requires a 43 percent minimum percentage of the state budget to be spent on K-12 education.

Covering all bases

Not leaving the failure of this big tax increase to chance, Democrats have also taken AB 1500 language and put it into Proposition 39, which would eliminate the “loophole” and use the tax money to fund green energy projects, and the general fund.

Prop. 39 is just another retread of the 2010 Proposition 24, designed to undo the Single Sales Factor tax calculation, used by out-of state businesses currently doing business in California.

However, if Pérez’s bill passes the Senate, and the governor signs it into law, Prop. 39 sponsors say that their campaign is over. But don’t count on it. The “Yes on 39” campaign has invested $23 million in the initiative. Thomas Steyer, the money man behind the opposition to Proposition 23, which would have suspended AB 32, the “Global Warming Act of 2006”, has taken that win and decided to try his hand at pay-to-play politics again.

The ‘loophole’

The word “loophole” to describe the tax deal has been bandied about carelessly by AB 1500 supporters, and by Perez. In 2009, state law was agreed to and changed by both Democrats and Republicans to allow the use of the single sales apportionment factor to be used by businesses. The corporate tax break, imperative for stimulating any business in the state, allows businesses to choose whether to have their income tax based on the proportion of their total sales within California — or on a combination of their total sales and operations, which includes payrolls as well as property.

In a legal document filed with the state Superior Court about Prop. 39, Lenny Goldberg, the executive director of the California Tax Reform Association, wrote, “I have worked closely with the Yes on Proposition 39 campaign and with the authors of the Argument in Favor and the Rebuttal to the Argument Against. Those ballot materials use the word ‘loophole’ as a reference to the ability of multistate businesses to make a yearly election. The word ‘loophole’ does not refer to potential formulas themselves. An apportionment formula is not a loophole, as that is simply a methodology by which income of multistate corporations is ascribed to a state.

“The loophole is the yearly election between apportionment formulas, which has never been justified from a policy perspective, nor can it be.”

Invoking the big-business card

In each of the legislative hearings about AB 1500, Perez has used biotech and technology companies Qualcomm and Genentech, “which employ thousands of Californians,” as examples of companies which support the measure “because they are put at a competitive disadvantage” by current law.

But Perez has failed to acknowledge that Genentech has laid off hundreds of employees in California, as has Cisco, which terminated 1,300 California employees in July, and has announced that layoffs will continue through December.

Perez claimed at the most recent hearing that 40,000 jobs would be created in the state with passage of AB 1500.  But “40,000 jobs will not appear because of the money,” according to Dorothy Rothrock, with the California Manufacturers and Technology Association.

Rothrock said that AB 1500 will raise taxes on employers. Rothrock explained at the hearing that a version of the three-factor formula for corporate income tax apportionment, which AB 1500 seeks to eliminate, has been in place since 1966. In 2009, the Legislature provided the option for Single Sales Factor and kept the existing policy because they recognized that it is a legitimate method to apportion income to California.

“The campaign rhetoric continues as Prop. 39 proponents say they are only raising taxes on ‘out of state’ companies, ignoring the taxes they already pay and the significant contributions they make to California’s economy,” Rothrock said. “They have many employees and investments of property, equipment, and facilities in California.  They would pay higher taxes under the single sales factor simply because they have sales in the state that are relatively large in comparison.”

Under AB 1500, students who might qualify for Perez’s ‘Middle Class Scholarship’ may see tuition and fees decreased by $4,000 annually for California State University schools, and approximately $8,100 for University of California schools. The tax hike and drop in tuition would take effect immediately.

Out-of-state businesses would pay California income tax based on the percentage of their sales income in California, if AB 1500 is signed into law, instead of basing their taxes on property and payroll, which can sometimes result in a lower tax bill for businesses with operations primarily out of state.

According to the manufacturers association, “the companies are imposing no additional burden on government services, nor will they be able to avoid the tax increase through reasonable in-state investments and/or hiring. The business model for many companies does not allow for massive in-state investment to overcome the disadvantage caused by SSF. For those companies, SSF is actually a disincentive to invest in California.”

The unholy alliance

“The ink is hardly dry on the 2009 legislation,” the CMTA explains. “Prop 39 is another example of the increasing uncertainty and unpredictability of the tax climate in the state.  Taxes in California are high enough — current law imposes a tax burden on companies that ranks the state 48th (2012 Tax Foundation Business Tax Climate Index).  Prop 39 will further erode California’s ability to attract and compete with other states for business investment and hiring.”

Both AB 1500 and Prop. 39 ignore the taxes that out of state businesses already pay, as well as the massive contributions they make to the California economy. Businesses employ many California residents and invest in California property, equipment, and buildings in California.  Businesses would end up paying much higher taxes under the Single Sales Factor merely because they have sales in California that are significant. And they apparently are in the sites of the California Legislature, which views private business revenue as potential state income.

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