(February 13, 2009) Following is the testimony prepared by Kyla Christoffersen, policy advocate for the California Chamber of Commerce, for her presentation yesterday to the Commission on the 21st Century Economy.

My remarks today will focus: 1) first upon our belief that the economy should be a principal consideration of this commission in formulating recommendations; and 2) second, on the detrimental impact several tax proposals raised before this commission would have on job creation and the economy.

Strong Economy is Key

Commission Principles

Among the five principles set forth in the Governor’s executive order that are to guide this Commission’s ultimate recommendations, we believe the most important are those related to ensuring the strength of California’s economy over the long term, including:

• “Promote the long-term economic prosperity of the state and its citizens”; and
• “Improve California’s ability to successfully compete with other states and nations for jobs and investments.”

Nonetheless, much attention has been given to two other guiding principles for the commission: 1) addressing volatility; and 2) ensuring the tax structure adequately reflects the 21st century economy.

Care should be given to considering whether these aspects of the tax system are actually “broken,” before prescribing remedies. We believe neither issue need be a focal point of this Commission, for the following reasons:

• Volatility. With respect to volatility, there is no doubt about our tax system’s volatility, especially in relation to the state’s personal income tax. This, in combination with poor fiscal decisions, contributes to budget crises. A proposed solution is already pending, however. Both the Governor and Legislature have approved for public vote at the next statewide election, a “rainy day” fund which is designed to address volatility. The proposal “smoothes” revenues by requiring that “peaks” be saved to be spent during “troughs.” It seems logical that this proposal be tried and tested before considering more radical options.
• 21st Century Economy. Many of the complaints about California’s tax system are couched in terms of whether the system is “reflective of the 21st century economy.” However, we submit California’s tax system is generally reflective of the economy, because data shows that it generally rises and falls with the economy. For the past 30 years, the amount of revenues raised by General Fund taxes in California has generally ranged between 6 and 7 percent of personal income.

Since volatility can be addressed without changing the tax system, and since the tax system seems to be reflecting the economy, then the major criterion for examining whether and how to change the tax system should be improving the state’s economic climate and competitiveness.

California’s Current Tax Climate

Thus far, a range of perspectives have been offered as to the burdensomeness of California’s taxes and our ability to compete with other states for jobs under the current tax structure.

While a state’s tax climate is not the only factor a business considers in determining whether to locate, maintain, or expand jobs in California, it is a significant factor. The Tax Foundation observes that the defining characteristic of today’s marketplace is the mobility of capital and labor. California, more than ever, is competing both nationally and globally for workers and companies.

From the perspective of businesses, the state’s job-creators, California’s tax structure is one of the most burdensome and hostile in the nation:

• The non-partisan Tax Foundation’s 2009 national study confirms that California has the sixth highest state and local tax burden, the highest income tax rate, the 10th highest corporate tax rate, and a sales tax rate above the national median. Only the property tax is considered slightly below the national average.
• California’s high income tax burden is particularly harmful to small businesses. Many taxpayers in the top income tax brackets are small businesses such as sole proprietorships which pay the individual income tax rate rather than corporate.
• With respect to the sales tax, virtually no other state besides California taxes both business inputs (manufacturing and research assets) and business outputs (the products from the utilization of these assets).
• Moreover, in a cross-section of national tax climate rankings, California consistently ranks near bottom:
• In the Tax Foundation’s 2009 State Business Tax Climate Index, California ranked 48th out of a worst of 50.
• In the 2008 Small Business Survival Index, out of the 50 states and D.C., California’s tax system ranked 48th out of a worst of 51.
• In CFO magazine’s 2007 State Tax Survey, California’s tax environment ranked as the very worst in the nation.

California’s dismal tax climate means there is room to make our tax system more attractive for jobs and investments, but a tax system for the 21st century economy should above all do no further harm to California’s economy and competitiveness.

Harmful Tax Proposals

This leads me to the second part of my remarks, which is to specifically address a few of the pending tax proposals which we believe will only exacerbate the suffering economy and California’s competitiveness problems.

Services Tax Would Be a Tax on Jobs

CalChamber believes a tax on services would impede sustained economic recovery and burden already-struggling California businesses. A tax on services is a tax on labor, which will mean service-based companies will ultimately be unable to provide as many jobs.

A services tax, whether broad or targeted, would mean a sudden, nearly 10 percent price increase on services such as repairs, entertainment events and veterinary care. We have no doubt that such an increase would result in substantially less business and in turn fewer jobs at repair shops, attendance at entertainment events, and care for ailing pets. Small businesses in particular would be disproportionately impacted by this sudden cost increase.

And under a broad-based services tax, further job loss is likely to result from changes in behavior. Businesses may be incentivized to hire out-of-state professionals for services, such as accounting and legal. In addition, more businesses may be inclined to move in house work currently contracted out to other businesses. Thus, a services tax will create more jobs for out-of-state competitors and harm in-state businesses.

Targeted Taxes Discriminatory and Unfair

Another type of revenue proposal that has repeatedly surfaced in the context of this state’s fiscal challenges are unfair and inequitable tax increases that propose to single out a specific industry or profession to shoulder billions of dollars of permanent tax burden. These industry-specific taxes kill good jobs and harm industries unique to California.

For example, the often-proposed new tax on oil production in California will ultimately make California oil more expensive than that produced in foreign countries and harm our state’s competitiveness. It won’t change the amount of oil used in California, but it will result in loss of high quality jobs in the industry, increased imports to the state and increased prices at the pump.

Likewise, another common proposal—singling out the alcoholic beverage industry for a tax increase—will directly affect our important wine industry and beer production facilities, costing high quality jobs in both sectors.

E-Commerce Taxation Harms Competitiveness

Some policymakers in California and a number of other states are concerned about potential lost tax revenues as more and more consumers purchase products such as music and videos through digital downloads rather than in tangible form.

The CalChamber and many in the business community, however, believe this disregards characteristics and challenges unique to e-commerce that would cause taxation to be counterproductive for both the state and industry and could ultimately lead to fewer tax revenues. Digital media industries are highly mobile and can reach California consumers from outside the state’s borders as easily as from within.

A related trend in the e-commerce taxation context has to do with nexus, which is the requirement by the U.S. Constitution that a state have a sufficient physical connection, or nexus, to an out-of-state company before it can force a company to collect the state’s sales tax.

Because of the expanding number of out-of-state sellers in the online marketplace, there has been a growing interest in adopting new and unconventional ways to establish nexus with them. California currently has a clear nexus standard which helps California web-based companies compete globally for customers. If California were to muddy its standard, California companies would be at an immediate competitive disadvantage with companies in states with clear and certain nexus standards.

E-commerce taxation issues are better left for resolution at the federal level so that any changes would apply uniformly and not create competitiveness issues among the states. 

Conclusion

CalChamber believes the solution to California’s revenue problems will only come from robust economic growth and job creation. Accordingly, any changes to the tax structure should take into account not only the need to maintain necessary government programs but the need to foster our state’s economic growth. Any changes to the tax system should be undertaken primarily with the health of the economy in mind.