The state budget’s chronic gaps between income and outgo — $125 billion over the last few years, according to the Legislature’s fiscal advisor — have left Gov. Gavin Newsom and legislators scrambling for ways to clean up the state’s finances.
Newsom has so far shunned new taxes to close the gap, even trying to sidetrack a tax on the assets of billionaires that may appear on the November ballot. Union advocates say it would generate about $25 billion a year for four years, roughly the size of California’s projected deficits, with proceeds going mainly to health care.
While Newsom may not want to raise taxes as he gears up for a presidential campaign, his fellow Democrats in the Legislature and the myriad interest groups to which they owe allegiance increasingly see tax hikes as the only way out of the twin dilemmas of budget deficits and recent cutbacks in federal aid.
Thus, the hunt is on for some form of taxation that could pass political muster, particularly if the wealth tax is sidetracked. The search has landed on California’s system of taxing multinational businesses.
For many decades, California levied those taxes on what was called a “unitary” basis. Corporations had to report their global incomes and a formula determined what percentage would be taxed by California.
The system was very controversial and bitterly opposed by foreign-based companies, especially those based in Japan and Great Britain. Their governments pressed California, directly and through diplomatic channels, to do away with the system.
Finally, in 1986, Republican Gov. George Deukmejian and Democratic legislators threw in the towel and decreed that corporations could either continue the unitary approach or adopt what was called “water’s edge” calculations, which counted only activities within the United States.
Ever since, critics have said the water’s edge option is a giveaway to corporations, because they could use creative accounting to shift profits to subsidiaries in other countries and thus minimize their California tax bills.
That criticism is being revived by advocates of returning exclusively to the unitary system.
Assemblymember Damon Connolly, a San Rafael Democrat, has introduced a unitary taxation bill. On Wednesday, the taxation committees of both legislative houses staged a hearing to get input from advocates and opponents.
Advocates, such as UC-Davis law professor Darien Shanske, argued that corporations have benefited from recent federal tax changes, and California should tap their profits to support vital state services threatened with cuts.
Opponents, such as Jared Walczak of the California Tax Foundation, warned that returning to the unitary system would complicate tax compliance and potentially renew international opposition.
The contention of unitary advocates that the water’s edge option is a loophole that has undermined corporate tax revenues is shaky. California has the nation’s third highest state corporate tax rate, 8.4%, and since the option was adopted 40 years ago, corporate tax revenues have increased 9-fold from $4.8 billion a year to $43.5 billion, slightly less than the growth rate of personal income taxes.
It’s also doubtful than unitary taxation would make a serious dent in the state’s chronic budget deficit, much less replace the federal reductions. Two state agency tax experts told legislators that estimating revenue gains is virtually impossible. The left-leaning California Budget & Policy Center estimates that it could net another $3 billion a year, while Shanske suggested $4 billion.
State deficits have been running about $20 billion a year, and projections of future shortfalls are in the same range. Truly closing the gap would require increases of the proposed wealth tax’s magnitude indefinitely — and replacing the federal reductions would require even more.
It’s another reminder that making promises without revenues to back them up is a foolhardy approach to public finance.
Dan Walters is a CalMatters columnist.
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