Public sector unions are in full-throated panic over proposals to cut state and local spending programs. The defeat of Proposition 1A (which many of them opposed) has created a broad political consensus that tax increases should not be on the table, and instead, billions in real program cuts affecting thousands of unionized state and local public employees are likely to be adopted within the next several weeks.
The unions have responded with a barrage of tax increase proposals:
· The American Federation of State, County and Municipal Employees (AFSCME) proposed a six-page list of tax increases totaling more than $30 billion, demanding that Democratic legislators sign a pledge to support it.
· The Service Employees International Union (SEIU) has launched a $1 million statewide television advertising blitz calling for new taxes to help balance the state budget.
· Various unions and their allies are touting ballot initiatives to repeal the 2/3rds legislative vote requirement to raise state taxes, and to repeal several tax incentives adopted by the Legislature earlier this year.
· Unions and their legislative allies are dusting off a proposal to raise taxes – which they are re-purposing as "fees" – with a majority vote of the Legislature. The Governor has vowed a veto should this approach be taken.
The latest volley was a letter delivered yesterday by a coalition of unions and liberal organizations demanding the repeal of three tax incentives that bolster the state’s competitiveness or improve tax fairness.
On the chopping block is an important change to the way multistate companies calculate their corporate taxes. Known obscurely as the single sales factor (SSF) apportionment formula, this change will make California more attractive for growth and investment. The Legislature agreed to provide a tax incentive for many companies to invest in new facilities and new jobs in California by reducing the weight that those two factors contribute to calculating a company’s tax liability. The current law creates the perverse situation where companies that simply invest in more jobs or property in California can see their tax bills increase.
The second change conformed California law regarding tax losses to common practices by the IRS and other states. Taxpayers pay taxes on income (profits) and can write off losses. But for many business taxpayers, their business cycles do not conform to the arbitrary dates of a tax year. Federal tax law has long recognized this fact of economic life, and has allowed taxpayers to write off losses going back two tax years and forward up to 20 years. (The latter is particularly helpful for businesses with long gestation periods, like biotech firms.) To ameliorate this enormous tax increase – affecting businesses suffering losses in the midst of an economic contraction – some budget negotiators are suggesting that California conform completely to federal law by allowing a two-year carryback.
The third change would allow companies to broaden the application of certain tax credits to their corporate income, making it more likely that they would participate in the behavior being incentivized by these laws: investing in enterprise zones or in more research and development, for example.
Lost in the faux outrage over improving the tax climate for employers is the fact that last year’s budget was predicated on nearly $6 billion in new or accelerated taxes on California businesses and investors. When it comes to taxing California’s employers, they gave at the office.
· A two-year limit on the ability of businesses to use most business tax credits, including research and development, capping those credits at one-half of the taxpayer’s tax liability, costing businesses about $900 million. This tax credit limitation will result in increased taxes for companies currently relying upon California’s only remaining statewide investment incentive tax credits, research and development and enterprise zone credits.
· Suspends for two years the ability of businesses to deduct net operating losses, costing businesses $1.6 billion over two years. This change will directly affect marginally profitable businesses attempting to emerge from losses.
· Business taxpayers must pay more of their estimated taxes earlier in the year, which will raise about $2.3 billion. This will reduce cash flow for independent contractors and other businesses, small and large, in the first half of the year.
· Limited liability companies (LLC) must pay their annual fees at least six months earlier this year, and will suffer a 10% penalty if they underestimate their fees, costing these companies $360 million. The new fee deadline will result in a double payment of the fee in the early part of 2009, which may pose a hardship for small companies with limited cash flow.
· A new 20% strict liability penalty in addition to all existing penalties, which applies to "understatements" of tax liability of $1 million or more, which is estimated to raise $1.5 billion from businesses. Unlike most existing state and federal penalties, there is no "reasonable cause" exception, which makes this penalty applicable even to reasonable tax payer behavior where there is no culpability. This will force companies to overpay their taxes by May 2009 and subsequent years to include amounts reasonably in dispute, in order to ensure no 20% penalty.
The public employee union strategy is two-fold: gaining support for tax increases this year to offset program cuts and related reductions in government staffs, plus their holy grail of fiscal policy – repealing the requirement that state tax increases achieve two-thirds approval of the Legislature. But that is merely a recipe for more economic deterioration. The long term fiscal health of the state will be resolved only by turning around the state’s economy. A strong economic recovery will add billions to the treasury without increasing taxes, but will only occur if the Governor and Legislature are committed to increasing our state’s competitiveness and ensuring California is a welcome environment for job creation.