In California, the tax man cometh

Jumpin’ Jehoshaphat, is there ever going to be a gale force of oratorical wind expended in the next few months over taxes.

Primarily because convincing Californians to keep paying $9.2 billion of “temporary” taxes for five more years is the lynchpin of Gov. Jerry Brown’s January budget proposal.
The Democratic governor aims to put this question to voters at a June special election. So figure between now and then there might be almost as much attention riveted on state tax policy as Oprah’s discovery of her half sister, Patricia.

Tax breaks. Tax incentives. Tax increments. Tax relief. Tax burden. “Don’t tax me, tax the guy behind the tree.”  That’s just a smattering. And, as with most things in politics, one person’s “economic stimulus” is another’s “corporate welfare.”

So what’s the Rosetta Stone for illuminating what the state refers to as its “tax expenditure programs?”

Updated December 2010, it’s the Franchise Tax Board’s scintillating California Income Tax Expenditures Compendium of Individual Provisions. At 99 pages, it’s more like a compendium-and-a-half. Bedtime reading – no matter what time of the day.

The board’s Economic and Statistical Research Bureau lays out the various exclusions, exemptions, deductions and credits offered by the state, both those conforming to federal tax law and those that don’t.

There are 80 in all, according to the table of contents. Everything from the “clergy housing exclusion” to a “reforestation expenditure amortization,”  the “transportation of donated agricultural products credit” and the “percentage resource depletion allowance deduction.”

Some inequities exist. Why a “cafeteria plan benefits exclusion” but nothing for smorgasbords?

Of these tax expenditure programs, 14 cost the state $1 billion or more annually.

In fact, the 14 represent $27.7 billion in lost revenue – enough to erase the projected budget shortfall and have a couple billion in mad money left in the kitty.

Of course, businesses would vehemently object to ending the write-off for contributions to their employees’ health plans. And big-hearted Californians would grouse about losing their $1.8 billion worth of charitable contributions deductions. They’d probably be almost as angry as Social Security recipients seeing their monthly checks taxed  – even though it would save the state $2.6 billion.

Ah, politics.   

Although updated in December, the statistics in the board’s compendium of how much money the state loses and how many Californians avail themselves of these tax programs come from the 2007 tax year.  In addition, the 80 tax reducers examined are only found in the state’s personal income tax and corporate tax codes. Sales tax is the bailiwick of the Board of Equalization.

However, an equally spellbinding Tax Expenditures and Revenue Options, prepared by the redoubtable Legislative Analyst in April 2008, lays out the big ticket sales tax exemptions.  
“There are two primary policy motivations for adopting tax expenditures,” say the Deep Thought Thinkers of the Franchise Tax Board.

“The first is to move towards a more equitable tax system by providing relief to taxpayers facing a monetary cost due to their circumstances in life.” Like a lot of the characters in Charles Dickens novels.  

“The second is to provide taxpayers with incentives to alter their behavior.”

Ok. Then where’s the join-a-gym, ride-a-bike, walk-the-golf-course credit?

In weighing the efficacy of these tax expenditures, policy makers should be aware that paying for them might “necessitate an increase in taxes” or a spending cut, the board says. Based on the empirical evidence, policy makers are painfully aware of that.

Tax expenditure programs might also “induce undesirable behavioral reactions from taxpayers,” perhaps akin to the villagers at the end of Frankenstein descending on the good doctor’s pad with a lot of attitude and plenty of pitchforks and torches. Sadly, the board uses a less vivid example: the Renter’s Credit. This credit was designed to lessen the tax burden for renters who do not enjoy the ability to write off mortgage interest.

At a projected $5.2 billion for the current fiscal year, mortgage interest deductions cost the state $1.6 billion more than the second highest write-off, employer contributions to pension plans.

As to the renter’s credit, the board says it actually encourages renters to keep renting, undermining the mortgage interest deduction and other tax expenditures designed to encourage home ownership.

It’s unclear how much undermining really occurs. Single tax filers with income less than $34,412 can get a $60 credit. It’s $120 for joint filers with income not exceeding $69,824. Not exactly a down payment on a home in Brentwood. Or Coalinga, for that matter.

Another downside to tax expenditures, the board says, is the possibility they provide “expensive windfalls to some taxpayers without furthering the intended policy goals.”

The board does not consider the state’s research and development expenses credit a “windfall.” Or if they do, they’re not talking.

There might be a benefit in allowing firms to receive tax credits for some of their R&D expenses – $1.5 billion worth in 2007 – if it causes a company to locate in California, in turn, luring support industries and creating an “agglomeration economy,” the board says. Agglomerations like Silicon Valley or filmmaking In Hollywood.

The board cautions though that ”because of the complexity of agglomeration economies, the extent to which the California R&D credit has encouraged the development or growth of any agglomeration economies is not known.”

What is known is that in 2007, 8 percent of the 3,771 income tax and 2,184 corporate tax returns claiming the credit were companies with gross receipts greater than $1 billion. Those companies received 84 percent of the credits.

Manufacturers accounted for 55 percent of the returns and got 72 percent of the credits.

The state is not required by the federal government to use what’s called the “water’s edge election” to calculate California taxes paid by multinational corporations. Doing so will cost the state $800 million in the fiscal year beginning July 1, the board estimates.  

In 2007, the board reports that corporations with gross receipts of more than $1 billion represented 6 percent of the water’s edge returns.

Those corporations received 76 percent of the benefit.

Unlike income taxes and – supposedly – corporate taxes in which the more money earned the more taxes are paid, the sales tax is the same for everyone. Warren Buffet pays the identical rate as a family of four living below the federal poverty level.

That leads to another word, which will be bandied about in the coming tax debate: “Regressive.” The word will almost always be used in conjunction with the sales tax.
“Base broadening” should also get a good workout. Again, this phrase goes hand-in-hand with the sales tax and is shorthand for saying sales taxes should be expanded to include services like accounting, auto repair, lawyers and theater and amusement park tickets.

This idea has been trotted out before in the Legislature and picked apart. Like carrion by a pack of vultures.

The idea likely will be raised again and be, just as ruthlessly, picked apart.  

Abandoning the notion of base broadening, which actually is sound tax policy based on Californians’ spending habits, rivaling the mortgage deduction as the biggest giveaway is the sales tax exemption on food. That cost the state an estimated $3.8 billion in 2009, the Legislative Analyst says.

Not applying a sales tax to gas, electricity, water and steam  –  a $2.2 billion hit on the general fund.

California loses $1.8 billion by not taxing prescription drugs. That number is only going to increase as more Baby Boomers turn 65. The state Department of Finance says over the next five years the number of Californians over age 65 will grow by 17 percent.

Maybe they could use their state Senior Exemption Credit — $98 for each taxpayer over age 65 – to cover the added nut. They already receive a $1,400 exemption from the federal government just for making it to 65. Everyone needs to share the pain, according to Brown, a septuagenarian. And if tax expenditure programs are designed to modify behavior then instead of a join-a-gym credit, tax candy and snack foods and generate $350 million.

Might as well keep the exemption for bottled water, particularly that chi-chi fizzy kind pumped from artesian springs in the Black Forest by specially trained dwarves.

What the hey? It’s only a $64 million revenue loss.