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New Budget Proposal Creates Permanent Tax Increases

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Key Tax Changes

A permanent tax rate increase of one percentage point for every personal income tax (PIT) bracket except the top bracket. This increase in PIT rates would be for the 2010 tax year, so in effect would be retroactive to all income earned this year, even though it would be implemented in the fourth quarter. Also, the one-quarter percentage point "temporary" increase in PIT rates enacted in 2009 would be made permanent.
A permanent increase in the vehicle license fee of one-half percentage point. The rate would rise to 1.65 percent and would remain at that rate permanently, rather than dropping back to its 0.65 percent rate as contemplated by the 2009 "temporary" tax hikes.

The state sales tax would be reduced by three-quarters of a percentage point in October and another three-quarters percentage point the following July. Added to the expiration of the temporary one-cent increase, the state sales tax rate would drop from 6 percent today to 3.5 percent in 2011-12. Local sales taxes levied by cities, counties and transportation districts would not be affected.

The effect of this "tax swap" would be to increase net taxes by $1.7 billion this year, which would steadily increase so that by the 2015 fiscal year, the net permanent tax increase would be $3.3 billion. Democrats point out that federal deductibility of state income and vehicle taxes would reduce the aggregate net tax increase on taxpayers; translating to a savings this year and next, and a net increase after federal deductions of about $140 million by 2015.

Corporate Tax Increases

Other tax increases are focused on corporate taxpayers:

• Impose a new severance tax of 10 percent on the value of oil produced only in California.
• Continue suspending the use of net operating loss carry forward deductions and postpone the new net operating loss carry back deduction for another two years.
• Suspend for two years the new ability of unitary groups to fully utilize certain tax credits by sharing them with their affiliates.
• Suspend for two years the new tax incentive for companies to add jobs and facilities in California, also known as the Single Sales Factor (SSF) formula, in calculating corporate income tax apportionments.
These business tax increases would amount to about $2.7 billion in new revenues for this budget year.

Negative Impact on Jobs

California Chamber of Commerce President and CEO Allan Zaremberg issued a statement saying "Any budget proposal enacted during an economic downturn must, first, do no harm. The illegal oil severance tax and elimination of the SSF, both proposed in the Democrat plan, would have an adverse impact on California jobs.

"Imposing a new tax on California oil will make ours the highest taxed oil in the country, leading to job loss in those communities that produce oil in our state and higher gasoline prices for all Californians. These proposals would clearly put California at a competitive disadvantage and kill jobs.

"Secondly, any proposed budget proposal enacted during economic hard times must do everything possible to improve the private sector job climate. Taxing investment in California by eliminating the SSF and increasing the price of oil extracted only in California would be yet another set of roadblocks for employers to overcome here. Allowing the SSF to go into effect, as negotiated and voted on during last year’s budget solution, will create much-needed investment in people and property.

"We must be looking for ways to reduce costs and burdens on job creators so that we can generate the revenue needed to pay for vital government services going forward."

Creates Tax Amnesty Program

The proposal also includes a provision that would establish a new tax amnesty program related to "abusive tax avoidance transactions" along with severe penalties that build on existing penalties in state and federal law that could harm innocent taxpayers. The provision is similar to that contained in AB 2498 (Skinner; D-Berkeley), which was bottled-up in a Senate committee last month.

Imposing a series of complex new definitions, standards and penalties would leave taxpayers unaware of their responsibilities related to the amnesty program, create confusion that would ensnare unwitting, law-abiding taxpayers and expose California employers to exorbitant and duplicative penalties.

Out-of-State Sales Tax

Another provision in the package being finalized by the conference committee this week seeks to commandeer out-of-state retailers to collect sales tax on behalf of the state. The approach here mirrors that included in ABX3 17 (Evans; D-Santa Rosa) from last summer, which targeted Internet retailers who advertise and sell through California-based websites.

While the Franchise Tax Board estimates the proposal will generate approximately $100 million annually, outcomes in other states like New York that have already adopted similar laws suggest that the state may actually lose revenue from harm to in-state Web businesses that will be dropped by retailers seeking to get around the law.

There also are serious constitutional issues raised by the proposal, and similar laws are being litigated in several states. ABX3 17 was vetoed by Gov. Arnold Schwarzenegger after a large Internet retailer threatened to sever all of its advertising relationships with California websites if it became law.

Continuing Bad Habits

In addition to the $4.7 billion in tax increases in the budget proposal, the proposal also makes what it claims is $8.3 billion in budget cuts, assumes $4.1 billion in federal fiscal relief, assumes an improved economy will boost existing revenue streams by another $1.4 billion, borrows and shifts revenues from other sources by $2.7 billion and suspends the application of the Proposition 98 school funding guarantee to free more than $3 billion for other General Fund purposes.

Zaremberg said, "Finally, it is troubling to see legislators, once again, proposing to use one-time money to fund ongoing programs. Even if the federal money they are counting on comes through, using this strategy, we will find ourselves in the same predicament next year."

The state budget is now 37 days late.

HG Makelim Co
HG Makelim Co
Naylor, LLC
Naylor, LLC