(February 7, 2005) The California Chamber of Commerce is warning state policymakers that increasing taxes on businesses will not resolve the state’s budget woes.

This is in response to state Treasurer Phil Angelides, who last week reiterated his proposal to resolve the state’s continued spending crisis with new taxes on California businesses.

The Chamber is pointing out that attempting to balance the budget on the backs of businesses will harm California’s economy, thereby reducing state revenues and hampering the state’s efforts to stabilize its budget.

Key points the Chamber wants lawmakers to consider include the following.

Taxes Matter to Business
California businesses begin to generate revenue for the state before they even open their doors for business. Licensing fees, permitting fees and environmental fees are just a few of the costs businesses must incur just to operate in this state.

In addition, California businesses must grapple with a long list of taxes (such as property taxes, sales taxes, income taxes, utility taxes and employment taxes).

Competition forces businesses to routinely search for more tax-friendly environments, and businesses generally view California’s tax system as one of the most aggressive in the nation.

Individual and corporate taxation make up 50 percent of California’s revenues (billions more are paid to local governments). California’s corporate tax alone — which as of December 31, 2003 stood at 8.84 percent — is higher than the tax rate in a majority of states, according to the State Business Climate Index released in October 2004 by the Tax Foundation.

Incentives Not Loopholes
The state treasurer has called for the rollback of seven economic incentives — most of which were enacted by the state Legislature. These economic incentives include, among others, the Subchapter-S corporate election, the water’s edge election, sales tax exemptions for agricultural machinery and fuel used in farming activities.

The treasurer is mischaracterizing these and other measures as “unjustified corporate loopholes” that unfairly shift the tax burden to individual taxpayers.

The reality is that there is no tax shift. California has a highly progressive income tax structure with the top 5 percent of taxpayers paying more than 60 percent of the personal income tax collections and the bottom 40 percent paying less than 1 percent of taxes.

Moreover, corporate and individual taxes represent half of California’s tax collections, according to a recent report commissioned by The Pew Charitable Trusts, “Grading the States 2005.” The next “significant revenue source,” according to the report, are sales taxes, which represent 40 percent of total tax collections.

Corporate tax revenues are expected to total $8.7 billion in 2004-05 and increase to $9 billion in 2005-06. Taxable profits are estimated to increase by 16.8 percent in 2004-05 and 7.1 percent in 2005-06, according to the Governor’s Budget Highlights for 2005-06.

Rather than lessening the burden on individual taxpayers, the treasurer’s proposal to roll back economic incentives will instead hinder economic growth.

• Subchapter-S. Take for example the Subchapter-S election. A corporation first pays taxes on its income. If any revenue is distributed to its shareholders, they are then taxed on the amount of income received. Thus, corporate revenue is taxed twice — at the corporate level and at the individual level.
  
  The Subchapter-S election eliminates the double taxation of corporate income by allowing corporations (that qualify and voluntarily chose the election) to pass income through to their shareholders, who report the income on their tax returns. There is no tax avoidance — corporate income is still taxed.
  
  The Subchapter-S election helps small businesses that do not have a large number of shareholders. It encourages entrepreneurship by relieving the double tax typically imposed on large corporations.
  
  Eliminating or altering the Subchapter-S election will place many small corporations at a disadvantage and put California out of conformity with federal law. Moreover, double taxing Subchapter-S income leaves less money for small businesses to reinvest in expanding operations within the state.
  
  
• The water’s edge election was enacted by the Legislature in 1986 to provide corporations with the ability to choose between being assessed either on a worldwide unitary basis or on business activity within the territorial waters of the United States.
  
  This policy was the culmination of intense international pressure that included foreign diplomats coming to California to argue in favor of a more equitable tax levy that alleviated the unfair burden on foreign corporations doing business in California.
  
  In 2004, a proposal sponsored by the treasurer failed in the Legislature — an indication that the Legislature was not prepared to undo a law that was the product of such intense negotiations.
  
  
• The sales tax exemption for farm machinery and fuel used in the farming industry will help sustain a struggling agriculture industry and ultimately help the economy.

The sales tax exemptions for equipment and fuel used in agriculture are not unique to California. The majority of states have similar exemptions. If California wants to continue to have a strong agriculture industry, it must stay competitive with other states. Preserving the state’s agriculture industry is also a matter of preserving consumer safety and choice.

California has among the most strenuous environmental regulations in the nation. They are designed to ensure that California produces the safest foods in the world. The proposed tax changes will drive the agriculture industry out of business, thereby eliminating the ability for consumers to purchase California-grown food.

The special resource deductions for gas and oil companies and the sales tax exemption for timber machinery also are important to the economy.

Tax Hikes Lead to Job Loss
California’s economy is on the road to recovery, but still has a long way to go. The Chamber strongly believes that increasing taxes on businesses will ultimately stifle economic growth and force businesses to relocate to tax-friendly states.

If costs go up, a business has three choices: raise prices, reduce jobs or relocate. For many businesses, relocation begins to look more attractive because the Internet and other new technology makes many business operations much more portable than they were 10 years ago, giving business owners greater flexibility in choosing their location.

A state with lower tax costs will naturally be more attractive to business investment. If higher taxes and costs push California businesses to move elsewhere, the state will suffer a decline in jobs and revenues, which will only hinder California’s efforts to balance its budget.

Ultimately, an important budget-balancing strategy for California must focus on curbing spending and retaining businesses rather than targeting corporations for higher taxes. A strong economy will do more to generate revenues than anti-business tax policies.

For more information on the 2005-06 budget or Chamber-supported tax incentives, please visit the Chamber website at www.calchamber.com.