Tax Commission:
Commission Submits Final Report, Governor Calls Special Session on Taxes

The Commission on the 21st Century Economy released its final report September 29, and there were no surprises in the recommendations. However, there was one big surprise in the report itself: Nowhere in the report is there a revenue estimate. Yet, the legislative counsel has ruled the package would be a majority vote bill. The plan calls for creation of a new tax on businesses' net receipts, coupled with an income tax reduction, elimination of the corporate and state sales tax and other changes (detailed below).

Governor Arnold Schwarzenegger joined Commission Chairman Gerald Parsky and the two primary authors of the proposal – Commissioners Christopher Edley Jr. and John Cogan – at a Capitol press conference to unveil the final report. Shortly after the hour-long press conference, the governor issued an executive order calling a special legislative session, beginning immediately, to consider the commission's report.

The report was signed by nine out of the 14 commissioners, but Chairman Parsky was careful to say that the commissioners who signed the report "endorsed moving the report forward," which seemed to be an indication that not all of them actually support the proposal as it is written.

Signing the report were Chairman Parsky, Ruben Barrales, Michael Boskin, John Cogan, Edward De La Rosa, Christopher Edley Jr., Monica Lozano, Becky Morgan and Curt Pringle. The five commissioners who did not endorse the report were Richard Pomp, Fred Keeley, George Halvorson, Bill Hauck and Jennifer Ito.

The commission's plan would:

· Establish a business net receipts tax (BNRT) – The plan would establish a new tax, not to exceed 4 percent, applied to the net receipts of businesses. Small businesses with less than $500,000 in gross annual receipts would be exempt from this tax. It appears that the 4 percent cap could be increased if revenues from the BNRT are insufficient to balance reductions. In fact, the draft language of the proposal does not specify the rate of the BNRT. This tax would have a much broader base than the sales tax (since it would apply not only to goods, but also to services and to sales into the state from businesses located outside the state). Chairman Parsky said this was a politically viable way to tax services, as opposed to expanding the sales tax to services. He said the BNRT is better than a sales tax because it does not tax "business inputs." A reporter pressed Chairman Parsky about whether the BNRT idea originated in the Governor's Office, and the chairman did not specify who proposed the idea.

· Reduce the personal income tax – The commission proposes reducing the number of tax brackets from six to two. The new tax rate would be 2.75 percent for taxable income up to $56,000 for joint filers ($28,000 for single) and 6.5 percent for taxable income above that amount. However, all itemized deductions except for mortgage interest, property taxes and charitable donations would be repealed. All tax credits, except for the credit for taxes paid to other states, also would be repealed. The standard deduction would be increased, however.

· Eliminate the corporation tax and minimum tax – In addition to eliminating the corporate tax, currently at 8.84 percent, the proposal calls for doing away with the $800 minimum franchise tax.

· Eliminate the state general purpose sales tax – The plan calls for eliminating the state sales tax, which will revert to 5 percent on July 1, 2011, with the exception of the sales tax on gas and diesel fuels, which would continue to be collected and dedicated to transportation. Elimination of the sales tax would be phased in over five years. Local sales taxes would remain, so a sales tax collection and appeals mechanism would have to be kept in place.

· Create an independent tax dispute forum – Under the proposed provisions, the forum would consist of gubernatorial appointees, not elected officials.

· Strengthen the state's "rainy day" fund – The plan would increase the target for the reserve from 5 percent of revenues to 12.5 percent, and would restrict the government's ability to use reserve assets so that the reserve is available to help fund services during recessionary periods.

The tax commission's full 425-page report, which includes extensive legislative language, is posted online at www.cotce.ca.gov, along with an outline and a press release.

During the press conference, the governor initially appeared to be avoiding endorsing the report in whole, but singled out the provision to create a stronger reserve for the state budget. Under the current system, he said, "nobody is willing to put any money aside for a rainy day fund" when times are good. When questioned by reporters, however, he said he would sign the commission's proposals into law if they are approved by the Legislature as is. "I want to get this done this year," he added.

Chairman Parsky stated that the plan was designed to be revenue-neutral, approved by a majority vote of the Legislature and phased in over a five-year period. He also said the changes were intended to "retain the overall progressivity" of the state's tax system.

Issues Left to Legislature

Based on the comments of the commissioners and governor at the hour-long press conference, there seemed to be an expectation that the Legislature will take the commission's report as an advisory statement, not a plan that will be kept intact and voted on without major modifications.

The chairman said there are many issues for the Legislature to study prior to enacting any legislation. He specifically mentioned research-and-development tax credits, treatment of net operating losses, and the impact of a business net receipts tax on financial institutions, employer-paid medical benefits and independent contractors.

Mr. Cogan also said the Legislature should consider changing the commission's BNRT proposal to find a way to tax non-profit and for-profit entities the same when they are in competition, such as in the health care field. Under the commission's BNRT, non-profit agencies would not be taxed, he said.

Mr. Edley agreed that the Legislature should "study this carefully," but he noted that if exclusions to the BNRT are allowed, the rate likely would increase to maintain the same amount of revenue.

Split Roll Studied and Rejected

Los Angeles Times columnist George Skelton asked the commissioners, "Why didn't you look at the property tax?" Chairman Parsky said: "A split roll was on the table and considered by this commission. There was a lot of public testimony about it. The commission decided not to recommend a change on how commercial property is evaluated."

During the commission's public hearings, Lenny Goldberg of the union-affiliated California Tax Reform Association gave two presentations in support of a split roll, and other advocates of the idea also voiced their support. Cal-Tax President Teresa Casazza testified against a split roll and provided a report showing that there has been no shift of the property tax burden onto homeowners under Proposition 13.

Stability of the Property Tax

In a section of the report on the property tax, the commission confirmed what Cal-Tax has been saying about the stability of the property tax under Proposition 13. According to the commission: "Revenue generated by the property tax tends to be the most stable of the major state and local sources. The tax is levied on a limited measure of wealth – largely real property, which tends not to fluctuate as much as other tax bases in response to business cycles. Nor does the tax exhibit the levels of volatility seen in certain other taxes, most notably the PIT. The passage of Proposition 13 likely increased the stability of the tax by limiting significant increases and decreases in the tax base."

Cal-Tax Statement

Cal-Tax President Teresa Casazza issued the following statement to the press:

"Taxpayers appreciate the hard work performed by this bipartisan commission, and we agree with its goal of reducing revenue volatility. We are encouraged that after studying proposals for a new gas tax, oil production tax and split roll property tax, the commission decided not to recommend these proposals. These tax increases would not help our state, and in fact would increase volatility.

"The commission's proposal of a new business tax would send us into unchartered territory. There are still many unanswered questions surrounding its impact on the state's business climate and future stream of revenues.

"The commission's recommendation for an independent tax forum is very concerning, because tax appeals should continue to be heard by an elected board that is accountable to the people, rather than by judges appointed by politicians. This proposed change would provide less public oversight and input and would result in a less responsive government.

"Our constantly evolving tax system has been very generous to state government. Over the last 60 years, general fund revenues have grown at an average annual rate of 9.0 percent, while general fund expenditures have grown at an average annual rate of 9.2 percent. The solution is better fiscal management, refrain from using one-time peaks in revenue for ongoing programs, and establish a solid rainy day fund to tap into in times like these."

Reaction Less Than Positive

Art Pulaski, California Labor Federation executive secretary-treasurer, said: "The recommendations released today by the Tax Commission are a profound disappointment, offering no solutions to better support our state's middle class. The proposals are a step backward, shifting the tax burden from the wealthiest taxpayers to middle- and low-income families at a time when we can least afford it. If enacted, these proposals would entomb California in perpetual recession. … It's befuddling that the commission's recommendations do little to address the state's ongoing budget crisis, ignoring sensible revenue streams that a majority of Californians support. Closing corporate tax loopholes would save the state billions of dollars every year and would create a more fair and equitable tax structure. Additionally, common-sense taxes on oil extraction, tobacco, and digital downloads and Internet commerce must be considered if we are to address the state's alarming revenue shortage and bring our tax system into the 21st century."

Lenny Goldberg of the California Tax Reform Association, called the report "a failure." He said it relies entirely for its reforms on a completely unknown and untried tax, the BNRT. There are huge legal and economic problems with this tax, he added.

Alan Zaremberg, president of the California Chamber of Commerce, said: "The recommendation today from some members of the Commission on the 21st Century Economy is fatally flawed. The centerpiece of their proposal – the Business Net Receipts Tax (BNRT) – requires serious review and analysis before it is ready for prime time. The BNRT would represent a tremendous change in the way the state taxes businesses and the impacts and potential unintended consequences have not been studied adequately. Business representatives from a variety of industries told the Commission during workshops that the BNRT could drive jobs out of California. That's the last thing we need as the state attempts to pull out of this recession."

Jon Coupal, president of the Howard Jarvis Taxpayers Association, wrote: "We have concerns about the business net receipts tax. First, it is unclear what the rate of the tax will be. This could easily be a multi-billion dollar tax increase. Second, this has some of the indicia of a European-style value added tax. The problem, of course, is that such taxing schemes effectively hide the true scope of the tax burden from the ultimate consumer." He added that the changes in the income tax are worthy of consideration.

The Assembly Revenue and Taxation Committee will hold informational hearings on October 8-9 to discuss the recommendations of the tax commission.

Cal-TaxReports, October 5, 2009

© 2009 California Taxpayers' Association. All Rights Reserved.