Governor Brown’s Anti-Growth Tax Ideas for California

Politicians have an uncanny ability to talk themselves into very foolish things. Jerry Brown, the governor of California, is in the midst of displaying this disturbing skill.

Consider the opening from a May 22 CBS/AP report: “Gov. Jerry Brown is pitching his proposal to raise the state sales and income taxes to an audience that traditionally opposes tax increases—members of the California Chamber of Commerce. The Democratic governor wants voters to approve the temporary increases in November as part of what he described as a series of steps to help California recover from the recession without deeper cuts to education and social services.”

Now, keep in mind how grossly noncompetitive California taxes already are. On the 2012 edition of SBE Council’s “Business Tax Index,” California ranked a pathetic 45th among the 50 states and District of Columbia.

As explained in the Index (which I author): “Each tax hits business directly or indirectly, distorts the workings of the marketplace, and diminishes economic efficiency by shifting resources from the private sector (guided by prices, profits and losses) into government (guided by politics and special interest pressures). But different taxes affect economic decision-making in different ways and impact the economy to differing degrees. For example, income taxes are the most damaging levies, as they impact incentives for working, investing and entrepreneurship. Property taxes affect decisions regarding investments in buildings and housing. And consumption-based taxes can divert and reduce consumer purchases. In the end, though, all taxes matter, whether imposed at the federal, state or local level of government. They matter to consumers, entrepreneurs, investors and businesses. They matter in terms of a state’s competitiveness. And they matter when it comes to economic growth and job creation.”

But Jerry Brown, and many other California politicians choose to simply ignore this Economics 101 observation on taxes.

Instead, Brown wants to make California’s state tax system even more non-competitive and costly.

Brown’s ballot initiative, which will be voted on in November, would jack up the state’s top personal income tax rate from 10.3 percent – which already is the second highest state rate in the nation – to 13.3 percent. For good measure, along with increases in state income tax rates, the state sales tax would increase from 7.25 percent to 7.5 percent.

Here’s a little tidbit of tax history: When Jerry Brown ran for president in 1992, he called for a flat federal income tax of 13 percent. Now, the same person wants to raise the state income tax rate in California to 13.3 percent. Go figure.

Considering that more than 92 percent of businesses file taxes as individuals (e.g., sole proprietorship, partnerships and S-Corps.), this personal income tax hike is a direct tax hitting the bottom lines of small businesses.

But keep in mind that the individual capital gains tax rate will rise to 13.3 percent as well. For innovative entrepreneurs looking to start up, expand, generate growth and create jobs, it will be much more difficult to find the capital needed, as an even higher state capital gains tax rate (California already has the highest rate), if approved, would create far greater incentives to invest elsewhere.

Keep in mind that nine states – Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming – impose no individual capital gains levies.

Jerry Brown wants to help California recover from recession. Unfortunately, his tax plan would accomplish the exact opposite. It would merely make an already inhospitable policy climate for entrepreneurship, business and investment even more inhospitable, thereby reducing the capital available for investment, and restraining risk taking and growth in the state.

_____

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His new book is “Chuck” vs. the Business World: Business Tips on TV.

"Amazon Tax" is a Bad Idea

Just in case you needed a reminder of how bad taxes are in California, the Golden State came in at a pathetic 45th among the 50 states and District of Columbia on the Small Business & Entrepreneurship Council's "Business Tax Index 2011," which ranks the states according to 18 different tax measures.

California's poor tax climate got worse when Governor Jerry Brown signed an "Amazon tax" into law in late June, with the tax taking effect on July 1. Brown reportedly called it a "common-sense idea." In reality, it is anything but common sense.

Amazon taxes force out-of-state retailers to collect sales taxes on purchases from in-state entities. The U.S. Supreme Court, however, in its 1992 Quill decision, made clear that a company must have a substantive, physical presence, or nexus (such as a store or warehouse), in a state before that state can require the firm to collect sales taxes. The online retailer Amazon.com has no such physical presence in California. California, and other states with Amazon taxes, are trying to get around this obstacle by claiming that out-of-state retailers that have contracts with "affiliates," that is, independent people and businesses within the state who post a link to the out-of-state business on their website and get a commission from any resulting sales, constitute nexus, and therefore state sales taxes must be collected.

This is anything but a true nexus, and when this issue finally gets to the U.S. Supreme Court, these Amazon taxes should get struck down. But in the meantime, politicians greedy for more revenue will grab it where they can - the heck with the Constitution, and oh yes, the heck with their state's taxpayers and economy.

California is projected that the state and localities will rake in some $317 million from this new tax. However, as is always the case with tax increases, revenue realities rarely live up to revenue expectations. As the Christian Science Monitor recently reported: "In North Carolina and Rhode Island, tax revenues actually decreased after similar laws were enacted, according to the Tax Foundation in Washington."

Why would that be the case? Consider a few reactions to Amazon taxes:

• The Los Angeles Times reported: "Amazon and online retailer Overstock.com Inc. told thousands of California Internet marketing affiliates that they will stop paying commissions for referrals of so-called click-through customers. That's because the new requirement applies only to online sellers based out of state that have some connection to California, such as workers, warehouses or offices here. Both Amazon in Seattle and Overstock in Salt Lake City have told affiliates that they would have to move to another state if they wanted to continue earning commissions for referring customers... Many of about 25,000 affiliates in California, especially larger ones with dozens of employees, are likely to leave the state, said Rebecca Madigan, executive director of trade group Performance Marketing Assn. The affiliates combined paid $152 million in state income taxes last year, she pointed out."

• The Christian Science Monitor noted: "‘We're going to have to leave the state,' says Keith Posehn, who operates a website with his wife in San Diego... Mr. Posehn is one of at least 25,000 local affiliates affected by the new law. In 2008, he and his wife created Zorz.com - a website that helps clients develop online advertising campaigns. Until now, when his business referred a customer to an online retailer like Amazon or Overstock.com - and the customer made a purchase there - he was paid a commission. But now the online retailers are cutting off such payments, in a bid to erase their connections to California. Posehn says that 35 percent of his business is evaporating without the commissions. Looking for a state that is friendlier to tech-firm start-ups, Posehn says his next stop is Washington, Texas, or Utah. ‘We can either stay here and remain a target for a state that is hostile to the core of its own economy, or go to a state that is more supportive and open to tech and small business,' he says."

• Writing in Forbes magazine, Steve Forbes puts the issue this way: "That California, where modern high-tech industry was born, should wage war against Internet-based entities is bizarre. It demonstrates the madness of its political class. California faces a budget shortfall of $10 billion. This new tax might collect $200 million from Amazon and others. That's hardly a drop in the bucket. More fundamentally, it will force Amazon to sever its relationships with thousands of its affiliates. This new tax law will hurt other online retailers and their affiliates, which will damage the state economy by considerably more than that $200 million."

But is there some hope in California?

Well, a movement is under way to gather signatures in order to put a referendum on the ballot that would kill the state's new Amazon tax. The petition drive is being led from the www.jobsnottaxes.com website.

The effort is summed up: "The More Jobs Not Taxes committee has been formed to oppose the recent sales tax law passed by the Legislature that would hurt small businesses, kill jobs and undermine chances for any economic recovery in California. At a time when unemployment is over 11% in California, we need to be creating more jobs and fostering economic growth, not passing tax legislation that undermines small businesses."

That's right on target. While high-tech is so important to the California economy, the state's elected officials take the industry for granted, as is clearly illustrated by the Amazon tax, as well as a wide array of other taxes and regulations. If the voters say no to this misguided, anti-entrepreneur, anti-small business tax, will the politicians finally start listening?

_______________

Raymond J. Keating serves as chief economist for the Small Business & Entrepreneurship Council

A Tax Win in California

San Diego tried to get around California’s requirement that voters approve all tax hikes by imposing a so-called “fee” on the collection of a rental tax on property owners. Are they kidding?

California’s Fourth District Court of Appeals correctly ruled this week that this was an unconstitutional tax on rental property owners.

Joseph Henchman, tax counsel for the Tax Foundation, who wrote a friend-of-the-court brief in the case, issued a statement:

“All over the country, politicians are increasingly trying to label taxes as ‘fees’ in an effort to get around voter-approval requirements or otherwise discreetly raise revenue. This case, Weisblat v. City of San Diego, shows that we’re making progress in clarifying those definitions. The purpose of a tax is to raise revenue, while the purpose of a fee is to cover the cost of providing a service. In San Diego’s case, money raised from the so-called ‘fee’ on rental property owners provided no services to the landlords, but simply went into the city’s general fund to help fill a revenue shortfall. Mislabeling what are really taxes as ‘fees’ is problematic for a number of reasons, which the Tax Foundation outlined in its amicus brief. Other than being unconstitutional under a state law that requires voter approval for tax increases, blurring the line between taxes and fees also conflates the purposes for which the revenue may be used. Clearly identifying taxes as taxes and fees as fees increases government transparency and helps taxpayers understand where their money is going. It’s only under that kind of a system that voters and policymakers can make sound, informed choices.”

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

Who Will Win the Nevada-California Battle for Businesses?

The July 17 New York Times an article titled “Nevada Sees an Opening in California’s Troubles.”

It tells the latest chapter in the war between the two states over where businesses should locate. It was reported:

The president of the nonprofit Nevada Development Authority, A. Somer Hollingsworth, donned a tinfoil hat for part of a speech in which he told local business executives and politicians that California’s excessive government had led to its near-bankruptcy.

“Nobody’s really working there — everybody’s a recipient of some kind of state program,” said Mr. Hollingsworth, whose organization’s mission is recruiting companies to the Las Vegas area and whose talk was entitled, “California Has Lost Its Mind and Las Vegas Is Providing Psychoanalysis.”

After reciting Nevada’s favorable attributes — no personal or corporate income tax, lower sales taxes than in California — he asked, “Why would you not move?”

Indeed.

While both states are having serious economic troubles, the mess in California is far worse than in most places in the nation. And the basics in terms of tax and regulatory policies coming into the current situation was far more favorable in Nevada than California.

On the latest edition of SBE Council’s “Small Business Survival Index,” which ranks the states according to their policy climates for entrepreneurship and small business, Nevada ranked second best. Meanwhile California was second worst among the 50 states.

Who is winning and will continue to win the battle for business between Nevada and California? It’s not really close.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

Targeting California

The February 13 Wall Street Journal has an interesting story (“State Recruit Worried Californians”) about how various states are trying to lure individuals, corporate executives, venture capitalists and manufacturing firms away from California during that state’s latest budget crisis.

The article specifically mentions Colorado, Arizona, Nevada, Oregon and Utah.

Indeed, entrepreneurs, investors and business executives might want to take a peek at where California comes in compared to these and other states on SBE Council’s “Small Business Survival Index,” which ranks the states according to their public policy climates for entrepreneurship and small business.

• California: 49th, with only New Jersey and the District of Columbia ranking worse

• Oregon: 32nd

• Utah: 15th

• Arizona: 13th

• Colorado: 10th

• Nevada: 2nd best

Indeed, even prior to the current budget mess, a business in California could move to almost anywhere else in the nation – except New Jersey and the District – and improve the public policy environment in which it operates.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

Getting Tough in California, or Maybe Not

California is in midst of a huge budget mess, and various parties involved in the debate are getting tough. Well, that is, except apparently for some state business groups.

Noting that the state faces a budget gap of about $40 billion through July 2010, the following was reported in the February 3 Sacramento Bee:

• “A top GOP official has submitted a resolution for the Republican Party's convention later this month to formally censure any Republican who votes for new or higher taxes in a state budget deal. ‘If the Republican party loses the ability to say that we're the party against higher taxes, then we've been dealt a grievous blow,’ said Jon Fleischman, author of the resolution and a Southern California vice chairman in the California Republican Party.”

• “The proposed censure comes less than a week after one union leader threatened recall campaigns against any legislator who votes to roll back labor protections as part of a budget deal.”

• “For months, Democrats and Schwarzenegger have proposed a combination of tax hikes and spending cuts to close the budget deficit. So far Republicans, many of whom signed pledges to never raise taxes, have refused to go along.”

However, the Bee also noted: “Business groups are advocating new broad-based taxes, instead of none at all, and GOP lawmakers are signaling a willingness to talk.”

A January 17 Bee report noted:

“Key groups are now focusing their tax opposition on proposals that impact specific industries while remaining open to broad-based charges such as a temporary sales tax or vehicle license fee increase… California Chamber of Commerce President and CEO Allan Zaremberg said this week that his group is ‘not opposed to all taxes’ in the current budget environment.

“‘There's going to have to be a combination of revenues and real spending reductions,’ Zaremberg said. ‘But there are certain taxes that are going to hurt the economy worse than others, and those are targeted taxes that impact one industry disproportionately.’

“Zaremberg said the state chamber, which represents 16,000 businesses, opposes a proposed 9.9 percent tax on each barrel of oil extracted in California. It also opposes extending the sales tax to a number of services that the state currently does not charge, such as veterinary care, car repair and amusement parks. Zaremberg and other business leaders have said any new taxes should instead be broad in nature.”

That’s called surrendering. Unfortunately, I’ve seen too many state-based business groups over the years give up the fight, and open the door to higher taxes. Politicians then raise taxes, and later, those same business groups complain about how high taxes are in the state.

But the January 17 Bee story also noted: “Some groups remain opposed to all taxes, however. The Howard Jarvis Taxpayers Association continues to fight against any new tax increase, and its president, Jon Coupal, said ranking taxes is ‘academic’ because all hurt the economy.”

Quite correct.

And keep in mind how wildly non-competitive California already is when it comes to its public policy climate. On the latest edition of SBE Council’s “Small Business Survival Index,” which ranks the 50 states and District of Columbia according to their policy environments for entrepreneurship and small business, California ranked apathetic 49th.

Whether a Republican, a Democrat, a business owner or an employee, raising taxes still further in California will only inflict more economic damage.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council

California's Recession, and the Rest of Us

The October 9 Wall Street Journal featured a front-page story titled “First Into Recession, California Shows Possible Future for U.S.”

The article is a grim, sober account of what’s gone on in California – how it’s once-juiced up housing market came unwound before the rest of the nation; how the state’s economy has been suffering; and how it might signal woes for the overall U.S. economy.

For example:

• With its export businesses, manufacturing sector, professional services and big retail employers, California looks like many other U.S. states, only more so. California's $1.8 trillion economy -- twice the size of India's and accounting for about 15% of the U.S. gross domestic product -- is powerful enough to have ripple effects nationally.

• California was also at the leading edge of the nation's recent housing bubble, which is where its current problems started. Home prices in California rose higher and faster than in most of the U.S., and started weakening earlier, in 2005. Some mortgage-holders defaulted. Others struggle along under a mountain of debt. The problems spread to the state's financial sector, which was heavily exposed to local real estate. As Californians cut their spending, job losses spread from the housing sector to retail stores and auto dealers. Now the state's unemployment rate is 7.7%, among the highest in the nation.

The article closes by mentioning the impact on California’s governments. It is mistakenly asserted that government “spending can offer a buffer during times of economic weakness.” And the report mentions tax revenue shortfalls and budget deficits.

The article missed the fact that government spending sucks resources away from more productive private sector undertakings, and ignored the important point that California’s tax and regulatory structure are downright hostile to entrepreneurship, investment and economic growth. In fact, California’s tax rates on personal income and individual capital gains rank highest among the states, along with very high corporate tax rates. That’s not a positive combination for the state’s economy.

In order to revive the California’s economy in the short term and boost it over the long run, the state needs a dramatic change in policy direction – away from spend-tax-and-regulate and toward providing relief form the burdens of big government.

Raymond J. Keating
Chief Economist
Small Business & Entrepreneurship Council