“Tax Entitlements” on the California Ballot

The California ballot this November 2 features Proposition 24 along with eight other voter initiatives. Prop 24 cancels a package of California business tax breaks that were legislated in 2008 and 2009 as part of negotiations to close budget deficits. In short, the provisions allow for the the reduction in taxable income using three methods:

   1. Net operating losses could be applied against tax liabilities incurred in the previous two years (“carry back”, currently disallowed) or future profits (“carry forward”) more flexibly than current law allows. Carry forwards could be applied up to 20 years forward instead of the current 10 years.
   2. Multi-state companies would have more flexibility in what sales-based formula they use to determine their taxable income
   3. Business “groups” would get more options on how they share tax credits among members

The state legislative analyst estimates full enactment by 2012-2013 would reduce annual state revenues by $1.3 billion.

The composition of the two sides in the election holds few surprises. The opponents are “pro business” groups that are labeling Prop 24 a job killing tax hike (It’s actually the repeal of a tax reduction). Proponents include those under threat by the cuts necessary to shrink the $18 billion deficit: public employee, recipients of government services and their advocates.

The job-killer description for Prop 24 is in sync with the many-decade narrative which tags California as a high tax anti-business environment. On closer examination California doesn’t seem to have an exceptionally hostile tax code. A Los Angeles Times article of October 25 included a list of California tax features that challenge the anti-business reputation, at least as far as taxes are concerned:

   1. According to a study by the Council on State Taxation, the state’s tax share of  gross state product (gsp) is 4.7%, which is also the national average. Maybe surprisingly, the California rate is lower than for New York (5.5%) and Texas (4.9%). Two of the states usually held up as magnets for disgruntled California employers have higher rates: Arizona (4.8%); Nevada (4.9%).
   2. California’s research and development tax credit provision (15% of R&D expenditures over a specific base level) is considerably more generous than the national median of 6.5%.
   3. The well known Proposition 13 (1978) that caps real estate tax rates and annual increases favors business taxation since business ownership of commercial real estate changes far less often than for residential properties and is therefore less exposed the full tax adjustment triggered when deeds change hands. As a result, the business share of property taxes has declined steadily. In Los Angeles County, the residential share has climbed from 53% in 1975 to a current 69%.

More generally, the business share of California and federal income tax revenues has declined for decades. Business taxation rates expressed as a fraction of either profit or state or national gross product has not been increasing, this is particularly true for larger corporations. Through tax credits and other favorable “tax entitlement” the tax burden has steadily shifted to individuals and smaller businesses.

The tax and revenue systems of our respective states are complex and largely unfamiliar to citizens and journalists alike. So it would seem reasonable to make public the favors dispensed by the government. In California’s case such disclosure should be a prime candidate for the recently installed but seriously underused transparency-in-government efforts.

In California, Assembly Bill 2666 was passed by the state legislature and finally vetoed by the governor this summer. In the words of the legislative floor summary AB 2666 “requires the Franchise Tax Board (FTB) to compile information on tax expenditures claimed and reported by publicly traded companies and requires the State Chief Information Officer (CIO) to publish this information on the Reporting Transparency in
Government Internet (RTG) Web site.”

Tax expenditures, or what I prefer to call tax entitlements, are shrinking the tax base, shifting the burden to those who don’t have the political wherewithal to extract favors from their respective legislative bodies. This continuing trend restricts the deficit debate to a choice between cutting government spending and raising “job destroying” tax rates.

In California’s case, none of the tax breaks referred to in Prop 24 are aimed at or justified on the basis of job creation - except in the claims of the campaign literature. However, they clearly enhance after-tax income.

The California decision on Prop 24 distills the abstract national debate over whether cutting business taxes creates job down to a yes/no vote on a single proposition. The contexts are different but the question is really the same.

In testimony (Policies for Increasing Economic Growth and Employment in the Short Term) before congress in February 23, 2010, CBO Director Douglas W. Elmendorf offered the following: “increasing the after-tax income of businesses typically does not create much incentive for them to hire more workers in order to produce more, because production depends principally on their ability to sell their products.”