October 2001

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For The Record 

(Editor’s Note: Items in FOR THE RECORD include news previously reported in Caltaxletter, Cal-Tax’s newsletter that is published 40 times a year.)

It was not the best of years for business as verbal hostilities and unfinished work dominated the conclusion of the first half of the California Legislature’s 2001-02 biennial session. Legislators gave scant attention to business tax or regulatory issues for much of the year as they were preoccupied with reapportionment of their districts, the energy emergency and the looming budget crisis.

The Legislature approved a number of bad-for-business bills before quitting for the year on September 14-15, a week during which the terrorist attacks at the World Trade Center and the Pentagon made it difficult at best to focus on any issue in the California Legislature.

It was a bizarre windup to the first half of the session. Governor Gray Davis harangued the Senate for inaction on a bill to rescue Southern California Edison from the brink of bankruptcy. Senate President Pro Tem John Burton responded with expletives.

On September 27, the governor issued a proclamation ordering the Senate and Assembly back to Sacramento for a third “energy crisis” special session in less than 10 months. However, he canceled the order on October 2 when the California Public Utilities Commission (CPUC) and Southern California Edison reached a settlement designed to keep the investor-owned utility afloat.

Grabbing the headlines was an angry reaction from the governor when the Senate didn’t even give floor consideration to SB 78XX (Polanco), a bill touted by the governor and Assembly Speaker Robert Hertzberg as crucial to helping Southern California Edison regain financial footing and avoid bankruptcy.

Meanwhile, the state’s fiscal condition grew worse with a report from the governor on October 2 that revenues for the first three months of the fiscal year were $1.1 billion below the budget forecast, based on preliminary numbers. The already wobbly California economy was producing fewer-than-expected dollars before the September 11 terrorist attacks on the East Coast, and economists watching the California budget said they have never experienced so much uncertainty.

Governor Davis ordered his department directors to come up with proposals to cut their budgets by 15 percent for 2002-03, and he considered calling an “economic summit” to hear from business leaders and others on how to deal with the looming fiscal crisis, or even another special session of the Legislature.

Uncertainty was so prevalent that no one could predict how deep the budget hole will be. The minimum deficit appeared to be $5 billion in the current fiscal year ending June 30, growing to perhaps three times that number by the end of the 2002-03 fiscal year. For perspective, the largest state budget deficit since the Great Depression – about $14 billion – occurred in the early 1990s.

Legislative leaders planned emergency budget hearings before the session reconvenes in January. A budget deficit approaching $20 billion was seen by some if taxpayers are left holding the bag for billions of dollars in electricity purchases made by the state earlier this year to help keep the lights on in California.

Governor Davis and state Treasurer Phil Angelides were at odds with Senator Burton, a lopsided majority of the Legislature, and the CPUC over terms of more than $12 billion in revenue bonds that would be used to replenish the state treasury and pay contracts for electricity that were negotiated by the Department of Water Resources. The Legislature easily approved Senator Burton’s SB 18XX, strengthening assurances that the state General Fund would be repaid and requiring CPUC review of the contracts. The governor threatened to veto the bill. As of this writing, the governor had not acted on SB 18XX, and Senator Burton said it was purposely delayed during enrollment from the Senate desk because he wanted his bill to be considered separately from the hundreds of regular-session bills requiring action by midnight October 14.

Senator Burton has called on the governor to seek renegotiations of at least some of the contracts that would lock in higher prices for many years, but the governor has indicated that he wants to veto the bill rather than renege on the contracts.

The governor’s decision to cancel the October 9 special session came as it remained clear to most that he would not have the votes to pass any bill perceived as a “bailout” of Southern California Edison. After the governor called the Senate irresponsible, Senator Burton said he saved the governor from further embarrassment of a defeat at the hands of fellow Democrats as well as minority Republicans in the Senate.

Tax legislation. The Legislature also refused to pass two bills that seek to slap windfall profits taxes on generators of electricity if they charge too much for their product in sales to the state.  Still alive, however, for potential action in 2002 are AB 2XX (Corbett), and SB 1XX (Soto), although they’d have to be reintroduced if the Assembly joins the Senate in adjourning the second extraordinary session. Both houses have to quit the session for it to be adjourned, and the Assembly did not take such action in the early morning hours of September 15.

Also becoming two-year bills were AB 934 (Hertzberg), the business-backed bill to allow trial de novo in local property tax appeals, and AB 81 (Migden), which seeks to return assessment authority of power plants of at least 50 megawatts to the State Board of Equalization.

Assembly Speaker Hertzberg, a lawyer with first-hand experience of representing taxpayers before county assessment appeals boards in a system that he said was tilted against taxpayers, maneuvered AB 934 through the Assembly and the Senate Local Government Committee. However, Senator Burton, as chair of the Rules Committee, refused to allow the bill to be heard in the Senate Revenue and Taxation Committee or the Senate Appropriations Committee before the interim recess. A parade of county assessors lobbied against the bill, unwilling to give up an obvious advantage over property owners in a legal system that prevents the taxpayer from introducing additional evidence in appeals to the Superior Court level.

Major pro-labor bills. Sent to the governor’s desk by the Democratic majorities in the Legislature were SB 71 (Burton), increasing workers’ compensation insurance benefits, and SB 40 (Alarcon), increasing unemployment insurance benefits. The governor, as expected, vetoed SB 71, the third straight year he rejected labor-backed workers’ comp legislation. He signed SB 40. The business community did not oppose improved benefits for UI and workers’ comp, but lobbied for reforms to make both systems more efficient.

Despite strong arguments that the UI Fund could run out of money without substantial employer tax increases, the governor signed SB 40 on October 1, providing $100-a-week increases in UI benefits starting January 1.

The governor had vetoed a similar bill last year. This bill increases the maximum weekly UI checks to $330, with additional increases of $40 a week each year until 2005, when the maximum UI check reaches $450 a week. At the governor’s request, the author dropped a provision of the bill that would have continued providing benefit increases in line with increases in the cost of living.

Critics said that while the UI Fund has a surplus, with which the system was designed to operate, the benefit increases would all but wipe it out in two years, requiring large increases in employer payments starting in 2004 ($160 million), and reaching $782 million in 2005. This amounts to a 32 percent increase in the UI tax paid by employers.

The governor had sent out signals that he would again veto a workers’ comp bill that lacked reforms of the system. In his veto message, he urged all parties to negotiate a compromise bill that could be considered when the Legislature returns in January. He said it should provide needed benefit increases, contain costs of effective medical care and target benefit dollars to achieve the best outcomes for injured workers. The business community has complained that lawyers and medical professionals are getting fat off the system at the expense of dollars for injured workers.

Furthermore, the governor said the net impact of SB 71, along with another vetoed workers’ comp bill, AB 1176  (Calderon), would damage the fragile economy.

Senator Burton and labor interests have threatened to mount an initiative campaign for the November 2002 ballot that would raise workers’ comp benefits even more, and contain no reforms. “It is shameful that injured workers of this state got caught in the governor’s paddling to the right in his consideration of the workers’ comp bill,” said Senator Burton. “I believe it is important to help injured workers; I believe the governor believes it is important to help the Chamber of Commerce.”

UI system experts noted that while California’s benefits are comparatively low among states, California’s eligibility benefits are among the most generous. The business community argued that enhanced benefits should be accompanied by measures that would guard against fraudulent claims and assure that those truly disabled from job-related injuries are adequately compensated.

Internet Tax Freedom. Governor Davis on September 25 signed SB 394 (Sher), extending California’s Internet Tax Freedom Act to January 1, 2003 (or January 1, 2004, if certain conditions are met). The bill bans local taxes on access to the Internet and does not prevent collections of sales taxes on Internet transactions under existing law. If the new California Commission on Tax Policy in the New Economy issues its report prior to December 1, 2002, the act will be extended to January 1, 2004.

The governor named William J. Rosendahl of Mar Vista, regional vice president of operations for Adelphia Communications in Southern California, to serve as commission chair. Also named to the panel were Sean O. Burton of Los Angeles, a vice president of AOL Time-Warner Brothers Online; Morgan Hill City Council Member Larry Carr, director of education and workforce preparedness for the Silicon Valley Manufacturing Group; William Dombrowski of Davis, president of the California Retailers Association, and San Diego City Council Member Scott Peters, former partner in an environmental issues firm.

Davis Signs Property Tax Reform Bill. Significant reforms in property tax administration were enacted by the governor’s approval of AB 645 (Horton) on September 5. The bill extends the deadline for filling property tax bills in most counties from September 15 to November 30. It also gives all taxpayers identical appeals rights after a property tax audit.

Extending the deadline for property tax appeals has been a taxpayer priority for a number of years. With a September 15 deadline, most taxpayers did not get a notice of their assessment for the year until they received their tax bills in November, after the deadline to appeal. Changing the appeals deadline was an important component to Cal-Tax’s 1995 tax reform bill, but was amended out due to opposition.

AB 645 extends the deadline in all counties that do not notify taxpayers of their assessed value prior to August 1. Only five counties – Alameda, Orange, San Luis Obispo, Santa Clara and Sutter – send such notices and will not be covered by the deadline change.

Tax Cut Measures Fizzle. The governor’s proposed sales tax holiday for back-to-school shoppers fell by the wayside. So did his proposed 1 percent increase in the manufacturers investment credit (MIC), a casualty of the May revise when there were increasing signs of slumping revenues. The business community backed a Republican-authored package of $150 million in tax cuts: Besides the MIC increase, the package sought to increase the net operating loss carryforward, increase the research and development tax credit from 15 percent to 16 percent, and expand the sales tax break for commercial space launches.

Necessary Republican votes for the $101 billion 2001-02 state budget bill were recruited by majority Democrats who agreed to let voters decide in March whether to provide constitutional protection (ACA 4, Dutra) for the dedication of sales tax on motor vehicle fuel to pay for transportation improvements. The GOP failed to get repeal of a 0.25 percent sales tax as part of the bargain. This is the tax imposed in 1991 that was temporarily lifted in 2001 because of back-to-back budget surplus years and was due to be reimposed in 2002 due to declining revenues.

Farmers and Seniors. Two budget trailer bills, AB 426 and AB 440 by Assembly Member Dennis Cardoza, provided incentives for Republicans, especially from the Central Valley farm belt, to vote for the budget. The bills include increases in property tax and rent relief for senior citizens and disabled Californians, plus sales tax exemptions benefiting purchasers of farm and timber-harvesting machinery, diesel fuel used on farms and in food processing, and liquefied petroleum gas used in qualifying residences and in agriculture.

New Tax Name. An omnibus tax committee bill signed by the governor changes the name of the state’s Bank and Corporation Tax Law to the Corporation Tax Law.

Meanwhile, the State Board of Equalization was in the news during 2001, to wit:

Power Plant Taxing Authority. State BOE members who have clamored to take over local power plant assessment jurisdiction have found they have a tiger by the tail. At a September 26 board meeting, the proposed changes to Rule 905 noticed for a public hearing came under fire from a diverse group of opponents. Board Chair Claude Parrish sought to pull the issue off the agenda after getting a thick stack of faxes, including continued opposition from cities and new complaints from the union representing firefighters and a fire protection district.

On September 28, board staff presented recommendations that the board back away from the proposal to regain jurisdiction. Staff also strongly recommended that the board not become involved in local tax allocation disputes.  After taking testimony during the first week of October, the board scheduled another hearing on October 24.

Controller Kathleen Connell and Board Member Johan Klehs have urged the board to regain assessment authority that the board ceded to county assessors in the wake of deregulation efforts. They contend that the power plants should be assessed at higher values as a result of the energy crisis. As locally assessed property, the plants are covered by Proposition 13’s limitations.

Cities complain that they wouldn’t receive millions of dollars in property taxes if the state takes over the assessments. Representatives of the North Monterey County Fire Protection District and the statewide firefighters’ union asked the BOE to hold off on the Rule 905 change and to ask the Legislature to deal with allocations when it reconvenes in January. They said loss of property tax revenue to the fire protection district that serves an area including the Moss Landing power plant would result in a layoff of firefighters. (Editor’s Note: See For The Record in the September Cal-Tax Digest for earlier coverage of this issue, including the BOE’s unanimous decision on June 20 to begin the process of regaining assessment authority.)

Satellite Taxation. The BOE in September unanimously approved Property Tax Rule 206 to prohibit county assessors from going after satellites that are permanently launched into outer space. The action was prompted by board staff advice that Los Angeles County Assessor Rick Auerbach could assess the multi-million-dollar satellites produced by Hughes Electronics. This prompted the board to withdraw the staff advice and adopt the new rule.

Controller Connell said she first thought it was a joke when she heard L.A. County was planning to tax orbiting satellites. “No one owns God’s space and it shouldn’t be taxed,” she said. Cal-Tax voiced support for the new rule.

Tobacco Taxes. The BOE’s controversial decision in June to impose huge tax increases (as much as 490 percent) on snuff and chewing tobacco was at least temporarily blocked in Sacramento County Superior Court (Core-Mark International, Inc., California Association of Retail Tobacconists and U.S. Smokeless Tobacco Company v. BOE).  The board had voted to increase the tax rates on these products last June, effective July 1, breaking 12 years of tradition in which one rate applied to all tobacco products, including cigarettes. That rate is 52.65 percent for this fiscal year.

The plaintiffs argued before the board in June and again in court that a state law requires the board to set a single rate for all tobacco products, while the board contends it has legal latitude.

The board’s 3-2 vote in June also called for the automatic reduction to 52.65 percent for snuff and chewing tobacco if the board’s decision was overturned by the courts, and it was felt by the board majority that the higher rates would apply pending a final ruling in the courts, which could take years. That would have happened had the court not issued a preliminary injunction, making the board subject to contempt-of-court issues if it maintained the higher rates, according to BOE Chief Counsel Tim Boyer.

Mr. Boyer said the board has authorized an appeal that was being prepared for filing with the Third District Court of Appeal in Sacramento.

Meanwhile, the board announced on October 5 that the tax rate for all taxable distributions of all tobacco products is 52.65 percent as of September 10, the date of the preliminary injunction, with the higher rates in effect from July 1 through September 9. However, if the board successfully appeals the ruling, the higher rates would be reimposed.

Dennis Maciel, chief of the BOE Excise Taxes Division, said that if an appeal succeeds, the court would decide whether the higher rates would be applied from that date forward or be retroactive to September 10. “It’s really up in the air. The court would decide. It really puts the distributors in a very awkward situation,” Mr. Maciel said.

Automation Project. The BOE refused to approve a $28 million automation contract for a scanning and imaging computer system, despite a staff report that the state would save millions and that a new system is critical to the board’s mission of accurate and timely allocation and distribution of local taxes. Board Member Dean Andal and Dr. Connell were the lone votes to proceed with the project over the objections of public employee union officials. The board, at its June meeting, denied the contract, which had been three years in the making, and ordered that the procurement process be restarted – along with renewed talks with labor. An angry Mr. Andal said union leaders stood in the way of badly needed board improvements because their sole interest was a desire not to lose 148 entry-level positions “that pay dues” to the union.

Reapportionment. The reapportionment of state BOE districts for 2002 elections essentially maintain the status quo: Two districts favoring Democrats and two favoring Republicans.

The District 2 seat, now held by termed-out Dean Andal of Stockton, was changed to include the San Bernardino residence of veteran legislator Bill Leonard, who has announced his candidacy for the Republican nomination. The District 1 seat, with a San Francisco Bay Area base, will be open as Johan Klehs is termed out. It was changed to pick up coastal Santa Barbara County and all of San Luis Obispo County, making it easier for Democrat Assembly Member Carole Migden of San Francisco. Conservative areas of extreme northern California are moved from District 1 to District 2.

District 3, mostly Los Angeles County, and District 4, including Orange, Riverside and San Diego counties, remain the turf of incumbents John Chiang (Democrat), and Claude Parrish (Republican), respectively.