State hunts for cash, but tax loopholes still abound

Cash-starved California needs money but foregoes billions of dollars each year because of provisions in the tax code that allow some people and companies to shift their bills to the public.

The issue is not new: Tax breaks for some, however justified as an expression of social policy or conformance with federal rules, mean a heavier burden for others. Who wins and who loses is determined in the Capitol, where lawmakers are pressured by an array of special interests demanding special treatment. It is the Capitol’s oldest political fight – except for water.

But it is generating new debate as a weakened economy, jitters in the wake of the debt-ceiling debate and an increasing possibility that a looming budget “trigger” will be pulled in January as yet another round of economic deterioration takes hold. Privately, there is a feeling among some fiscal experts that a trigger may get pulled. Officially, it’s too early to tell.
A key to the new budget debate, then, may focus on what loopholes can be closed in return for easing the burdens of the personal income tax.

“The grand bargain could be a reduction in the personal income tax rate or something with other corporate taxes, then perhaps part of the agreement would be that other loopholes would go away,” said Sen. Lois Wolk, D-Davis, the chair of the Senate Governance and Finance Committee. It requires a two-thirds vote, but it might be successful.”

In the end, tax breaks – called “tax expenditures,” “tax loopholes” or “tax incentives,” depending on who’s doing the labeling – total nearly $50 billion in a state with a $85.9 billion General Fund, according to the governor’s budget-writing office. Put another way, for every $8.50 collected by the state, another $5 goes uncollected because of the existing tax rules – enough to balance the state’s books many times over.

Closing the loopholes is difficult: there are fewer cows in the Capitol more sacred.

“Nobody wants to pay more taxes, but it’s always a question of priorities. It’s hard to talk about them in the abstract. It the public is asked the question, ‘What do you value, subsidizing vacation homes or providing basic services to our children?’ the answer is a no-brainer – when the question is framed that way,” said Assemblyman Bob Blumenfield, D-Van Nuys. “But the reason we haven’t been able to tinker with these tax deductions is because of the two-thirds vote requirement,” he added.
That rule requires a two-thirds vote to raise taxes, and closing loopholes is raising taxes.

There are many to choose from. Allowing offshore tax havens, for example, costs the state some $150 million annually. Allowing homeowners to deduct the interest in a vacation-home mortgage costs $750 million. A recent tax rule allows corporations that report losses to get tax refunds from prior years – a break worth more than $200 million a year. Another rule enabling some companies to decide each year how to calculate their income tax – a provision that Gov. Brown sought unsuccessfully to close this year – is worth about $1 billion, part of some $5 billion in corporate tax expenditures.

“He tried to close it, but couldn’t. It’s absolutely ridiculous and they did it so wrong before that it’s embarrassing, and it costs the state $1 billion a year,” said Lenny Goldberg of the California Tax Reform Association, which is financed largely by labor.  

Tax benefits for property residential and business properties include limits on increases, breaks for commercial property transfers and breaks for agricultural property held from development. There are tax breaks for businesses for research and development, breaks for companies locating in economically depressed areas and breaks for so-called “mom and pop” corporations or Subchapter S companies – a tax benefit enjoyed by more than 372,000 California companies – and incentives for investing in low-income housing.

But by far, the biggest loophole-riddle zone in the state tax code relates to the personal income tax, totaling about $31 billion, or nearly two-thirds of the total tax-break price tag.

Of some 85 categories of tax loopholes, the most crowded single category relates to personal income taxes, including mortgage interest deductions, investment income on annuities, medical care deductions, inherited property, child care costs, new home credits, scholarship income, cancelled mortgage debt, renters’ credits, lottery winnings, and many more.

There are tax breaks, little known by the public but cherished by the industries they affect, for the sale of aircraft components, motion picture leases, linen supply rentals and custom computer program sales, among others.

One significant tax break – requiring online retailers to collect sales taxes – was just closed to recoup $200 million but faces a legal fight in the courts and a likely referendum on next year’s ballot.

Because there are so many of them and many have been part of the state’s tax structure for so long, sorting out what is and what isn’t a loophole is not easy.

“There is no absolute rule for defining tax expenditures,” noted the latest report by the Department of Finance, “and the concept of a ‘tax expenditure’ can be defined in several different ways.” One way is to call it a “credit, deduction, exclusion, exemption or any other tax benefit as provided by the state,” a broad description that nevertheless isn’t all-inclusive, the report added.

Anti-tax advocates view the fundamental issue in devising an equitable tax code not as a question of generating revenue but of eliminating waste.  A March 2010 report by the California Taxpayers Association identified some $18.9 billion lost through state government mismanagement and abuse during the previous decade, a figure it said was derived through government audits and media reports.

“The task that policymakers now face is how to solve this problem and provide services to Californians with the money already available…,” Cal-Tax added.

That, however, will become even more difficult if so-called triggers approved in the 2011-12 budget get pulled. Those ”triggers” force automatic cuts if incoming revenues dwindle.
If the state gets between $3 billion and $4 billion of its projected revenue, then the triggers stay inactive.

But if only $2 billion to $3 billion comes in, then some $600 million in automatic cuts will kick in, with about two-thirds of the cuts hitting higher education and social services, plus an $80 million hit on public safety programs. If less than $2 billion comes in, then up to $1.9 billion in cuts could be ordered, about three-fourths of that in K-12 schools alone.

California’s state and local tax burden of 11.8 percent is above the 9.8 percent national average, although the state’s tax-burden ranking dropped to sixth place in 2009. It had been in fifth place for decades, according to the National Tax Foundation. The state’s individual income tax rate is the nation’s third highest and its sales tax rate is the highest. Its corporate taxes are the highest in the West and its business climate ranks 49th overall – a statistic often cited by anti-tax activists – sandwiched between New York at 50th and New Jersey at 49th.  California’s unemployment rate is about 11.8 percent, about 2.5 percent higher than the national average.

And the money isn’t going as far as it used to: California receives less in federal funding than the average state, and for every dollar the state sends to Was
hington, it gets back 78 cents.

Within the state, tight-fisted voters have adamantly opposed paying new taxes, even though such critical programs as education and health care have experienced Draconian cuts. Voters, for example, in November rejected paying $1.50 per month to keep the state’s parks open.

In next year’s primary election, probably in June, voters will be asked to raise cigarette taxes by $1 a pack and boost levies on other tobacco products as well.

But the chances of the tax’s passage are problematic. Voter turnout in primary elections is uneven, and while presidential primaries draw more people to the polls, it is unlikely there would be a sufficient surge in pro-tax advocates – Democrats – to get the tax approved, not to mention the multimillion-dollar campaign against the tax mounted by tobacco companies.

Moreover, the same ballot is likely to contain a referendum to overturn the online sales tax, which pits Amazon and other online retailers against stores with a physical California presence, such as Wal-Mart and Target. In one measure, then, business will be arguing in favor of a tax, while in the other they will be arguing in opposition.