Davis Plan to Raise Taxes Doesn’t Hit Businesses

While calling on taxpayers to make sacrifices on many fronts, the budget unveiled by Gov. Gray Davis last week steers clear of any new demand on corporate income, one of the deepest pockets it could have tapped to help close the state’s revenue shortfall.

Under the Davis plan, wealthy individuals would give up more of their income and everyone would pay a higher sales tax on goods. Corporations would face no change in their historically low level of taxation, although they also would pay a higher sales tax.

Davis’ reluctance to tamper with business taxes reflects a nationwide shift away from fiscal policies that take more from the wealthy, a trend illustrated in President Bush’s proposal to drop taxes on stock dividends.

Caught between pressure from taxpayer associations that want business to pay a larger share and from business groups that complain about excessive taxation, Davis has opted to leave in place a series of tax breaks and tax rate reductions adopted since the 1980s.

The budget reflected Davis’ unwillingness to tamper with the tax burden borne directly by business at a time when the economy is foundering. He wants “to get people working, and adding additional taxes to businesses is not going to help us accomplish that goal,” said Davis spokeswoman Hilary McLean.

Those who think low-wage earners are overtaxed say corporations should bear the pain along with individuals.

“If we’re looking at increasing those taxes that would primarily affect low- and middle-income families, we should also look at the fact that corporations are paying a smaller share of their profits today than they were a decade ago,” said Jean Ross, a former Assembly tax consultant who heads the nonprofit California Budget Project, which studies the budget’s impact on the poor.

Combined with federal tax reductions, the changes mean California corporations are paying a far smaller percentage of their profits in taxes today than at any time since the 1950s. Actual corporate taxes peaked in 1981, when nearly one out of every $10 in net corporate revenue went to the state. Today the rate is about half that.

Corporation taxes have also declined both in total dollars and as a share of the state’s revenue. The slack has been taken up by a dramatic rise in personal income tax.

Using figures from the Franchise Tax Board, Ross calculates that a return to the peak corporate tax burden in 1981 would generate $4.7 billion in new revenue.

Critics of tougher corporate taxation question that conclusion. The reductions in corporate taxes reflect many factors that state policy could not touch, they say, including changes in federal law and economic trends such as greater borrowing and lower profit margins.

Many economists shy away from higher corporate taxation because of its potential to make California less competitive in attracting business.

“In general, I think economists are not big fans of state corporation income taxes because we view businesses as more mobile than individuals,” said Alan Auerbach, the Robert J. Burch professor of economics and law at UC Berkeley. “We worry about the incentives for business to locate elsewhere.”

Typically, taxes on business profits are attractive to Democrats because they fall most heavily on the wealthy.

But Davis signaled his sympathy for the competition argument when he declared in his State of the State address Wednesday: “My most immediate priority can be summed up as jobs, more jobs, and even more jobs.”

He reinforced the point by recommending extension of the manufacturers’ investment credit, a $410-million tax break that business is loathe to give up.

“This credit is widely recognized as creating hundreds of thousands of new jobs,” Davis said.

Overall, Davis knew that it would be a hard sell to raise business taxes and push for higher employment at the same time, said Richard Lehman, a business lobbyist and former state legislator.

“If he had gone the other way, it would have been contrary to his message of new jobs,” he said.

The Wine Institute, which represents more than 600 wineries involved in California’s $13-billion wine industry, was among those whose lobbyists made it clear to Davis that higher taxes would be political poison among its constituents, including the industry’s 145,000 employees.

“We’re very price-sensitive right now,” said Wine Institute President John De Luca, noting that his industry is fighting flat sales. “If you add to the cost of buying a bottle of wine in a store or in a restaurant, you can see how it depresses consumption.”

That doesn’t mean vintners and other businesses wouldn’t be hurt by Davis’ plan. That bottle of wine would still cost consumers more under Davis’ plan to hike the sales tax by a penny. (Combined with local taxes, state sales taxes now range from 7.25% to 8.5%.) And the impact could be felt most by industries making and selling big-ticket items such as cars, appliances and furniture.

“If you have a one percentage-point [tax] increase on a $25,000 vehicle, for some folks that’s a lot of money,” said Richard Costigan, chief lobbyist for the California Chamber of Commerce. “All tax increases have economic consequences.”

In his budget message Friday, Davis said he meant to balance tax increases on the wealthy with those borne mostly by wage earners. By not raising corporate taxes, Davis passed up an opportunity to shift the balance toward a more progressive tax structure, meaning that it takes more from the wealthy.

California has one of the nation’s most progressive tax systems, according to a report released last week by the Institute on Taxation and Economic Policy, a Washington, D.C., advocacy group for tax fairness.

The institute said, however, that state taxes generally are regressive -- placing the greatest burden on lower-income taxpayers -- and have grown more so over the last decade.

Some Democrats in the Legislature say the plan is unfair to the poor and are planning to put corporate taxes on the table when they consider Davis’ $96.4-billion budget proposal.

State Sen. Richard Alarcon (D-Sylmar) said he will ask for amendments that would deny the investment credit to corporations that cannot demonstrate their “corporate responsibility” in such areas as living wages and health benefits.

“I’ve heard that there are corporations that pay miserable wages and refer their employees to Healthy Families,” Alarcon said. “That’s not socially responsible.”

As for restoring a higher corporate tax rate, as Davis proposed on the personal income tax, there is little momentum.

“There’s been some discussion of that, but minimal,” said a Senate consultant who asked not to be identified by name. “It would certainly be difficult to get the two-thirds vote you need. The extreme ‘job-killer’ message would come out.”

For the moment, Republican lawmakers aren’t taking a position.

“I’m not going to debate the relative merits of raising this tax versus that tax,” said Senate minority leader Jim Brulte (R-Cucamonga). “I’m not going to support tax increases at all. I believe the core problem the state has today is on the spending side.”

Brulte is proposing a cap on state spending that he wants to put before the voters.

California’s current corporate rate of 8.84% is the nation’s 11th highest, according to the Tax Policy Center of the Urban Institute and Brookings Institution. Iowa’s top-tier rate of 12% is the highest, followed by Pennsylvania’s 9.99%. Several have rates of 5% or less.

However, business lobbyists say California’s tax system is uncompetitive with other states, and some economists agree. California is tougher than other states in apportioning the state’s portion of a corporation’s nationwide income and is more vigorous in closing loopholes, said Steven M. Sheffrin, director of the Center for State and Local Taxation at UC Davis.

“I feel we’re aggressive enough,” Sheffrin said. “I would be very cautious about increasing the tax.”

But the perception that business is not paying its fair share could prove a potent political argument, the Burch Center’s Auerbach said. He saw a possible compromise in the idea of a temporary tax, designed to expire after the crisis subsides.

“I guess if I were going to do it, I would do it as a tax surcharge rather than a change in the tax structure,” Auerbach said.