Before the Legislature is the most dramatic state tax plan in decades, crafted by a bipartisan commission after months of hearings, selected leaks, voluminous testimony and internal bickering. Assailed by the left as an assault on the poor, by the right as an assault on the service and retail industries and by just about everybody as a perilous leap into the unknown, the plan now goes to lawmakers – who are likely to dismantle it in a special session called immediately by the governor.
Essentially, it would eliminate corporation income taxes and statewide sales taxes, and dramatically cut personal income taxes. It would recoup the lost money with a new tax on business’ activity, services and consumption.
“Sometimes crisis can serve as a catalyst for real reform,” said Gerald Parsky, chairman of the California Commission for the 21st Century Economy, noting the state’s dire economic straits. The panel’s members were appointed by the governor and Legislature.
The release of the commission’s report also was a textbook case on the impact of PR and communications. Much of the information, including analyses by individual commissioners, had been available for weeks – months – on the commission’s Web site, and what wasn’t available had been leaked from within the commission by critics, shaping an early, negative spin that took root as the report’s release date was pushed back.
On the day of its formal unveiling, the drumbeat of criticism was strong from anti-tax advocates, tax-reform activists and big and small business. Perhaps the most exhaustive, independent study of the commission’s proposals was conducted by the California Budget Project at http://www.cbp.org.
Nine of the commission’s 14 members, liberals and conservatives, endorsed the proposals. Parsky described the plan as a “true bipartisan compromise,” and commission member Christopher Edley Jr., the dean of the Boalt Hall Law School, called it a search for the “pragmatic center.” Gov. Arnold Schwarzenegger said that if the plan came to him in the form of a bill, he would “sign it immediately.” He added, however, that he had abandoned his plan to present it to the Legislature in one piece for an up or down vote; rather, he said, lawmakers could “tweak it” and “move things around.”
The head of the state Chamber of Commerce, which uses the term “job-killer” to apply to virtually any legislation it opposes, said the “impacts and potential unintended consequences have not been studied adequately” and “could drive jobs out of California.”
Pushing back, the Schwarzenegger administration compiled positive reactions that included statements from former Assembly Speaker Bob Hertzberg, a Democrat and now the head of the nonprofit political reform group California Forward, and former Gov. Gray Davis, a Democrat who Schwarzenegger ousted in the 2003 recall. Hertzberg said the commission “showed the courage to consider ideas as big and bold as California itself,” while Davis said “California needs to end its feast or famine budget cycle.”
Ironically, some of the anti-Davis political sentiment during his years in office stemmed from spending he approved during the state’s boom. Former Speaker Willie Brown, another Democrat, called the commission’s work “big and promising.”
But while its survival is in doubt, the debate over the long-awaited plan is alive and kicking: The commission’s blueprint shakes California’s tax system to its core, and it represents the most profound taxation change since voters approved Proposition 13 of 1978.
Two things guided the commission’s deliberations, one was to lessen the state’s reliance on the volatile personal income tax, in which about a tenth of taxpayers pay more than half the tax and which fluctuates erratically with the economy, leaving revenues uncertain. The second was to devise a plan that would be “revenue neutral” – that is, not cost more, but not lose money, either. The only way to do that was to find other tax sources and move the burden around.
What the commission came up with is a top-to-bottom rearrangement of the state tax system.
The proposals would completely eliminate billions of dollars worth of income taxes on corporations, the minimum franchise tax – which brings in about $800 million annually – and the statewide sales tax. They would eliminate four of the six brackets on personal income taxes, and limit that levy to 6.5 percent on taxable income above $56,000. Those filing jointly with less than $56,000 would be taxed at a rate of 2.75 percent. The changes would give six-digit savings – or even more – to the wealthiest taxpayers and scant savings to those at the lowest end. By one estimate, it would create an annual shift of $7.6 billion in tax liability from the wealthiest 3 percent of the population and spread it around everyone else. Overall, the income tax would be reduced by about 29 percent. Those with taxable incomes of $1 million or more have an average reduction of $109,000.
To make up for the state’s lost money, the commission proposed a Business Net Receipts Tax, or BNRT, of up to 4 percent. This is a tax on a company’s fiscal activity – in effect, on services and consumption, and this is the proposal that has generated the most controversy. This has never been tried, at least on this scale, although a similar, 1 percent levy is in effect in Michigan, where results are mixed.
“You take your gross receipts, everything you’ve paid out to other firms or companies or people, then you subtract all the costs for the materials, anything you’ve contracted out or bought from other companies or people, and then you’re taxed on the net. You can’t subtract what you pay for labor or health insurance,” said Lenny Goldberg of the California Tax Reform Association, which opposes the BNRT. Because labor costs can’t be deducted, labor-intensive companies would be hit hard, he added.
In effect, the BNRT would tax services – as applied to law, consulting, lobbying and architectural firms, for example – but could exempt out-of-state and international companies doing business in California. The push for the BNRT was unclear. Capitol insiders believe the plan originated with Schwarzenegger’s inner circle, although Parsky said the idea developed on the natural during the commission’s hearing and deliberations. Companies with $500,000 in revenues or less would be exempt from the BNRT.
The tax proposals can be approved by the Legislature in a simple majority vote. The final piece of the plan, to increase the state’s “rainy day” emergency reserve from the current 5 percent to 12.5 percent of the general fund, would require voter approval.
The new plan would be phased in over five years beginning in 2012, and would be monitored in real time by a special panel, Parsky said. During the transition, remnants of the existing system would be in place as the new provisions kicked in – a recipe for potential confusion.
Numerous tax issues were not included in the proposed overhaul, including a long-standing proposal to tax residential and business property differently – the so-called “split roll” – and an oil-severance tax, among others.
“Ultimately, the report suggests that California take a complete shot in the dark,” Goldberg said.