Can taxes on multinationals ease CA’s budget deficit?

from Dan WaltersCalMatters

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The chronic deficit of the state budget between revenues and expenditures — 125 billion dollars in the last few yearsaccording to the Legislature’s fiscal adviser — have left Gov. Gavin Newsom and lawmakers scrambling for ways to clean up the state’s finances.

Newsom has so far avoided new taxes to close the gap, even trying to deflect a tax on billionaires’ assets which may appear in the November newsletter. Union advocates say it would generate about $25 billion a year for four years, about the size of California’s projected deficit, with the proceeds going mainly to health care.

While Newsom may not want to raise taxes as he prepares for a presidential campaign, his fellow Democrats in the Legislature and the myriad interest groups to whom they owe allegiance increasingly see tax increases as the only way out of the twin dilemmas of the budget deficit and recent cuts in federal aid.

Thus, some form of taxation that can pass political scrutiny is sought, especially if the wealth tax is diverted. The search focused on California’s system of taxing multinational corporations.

For many decades, California imposed these taxes on a so-called “uniform” basis. Corporations had to report their global income and a formula determined what percentage would be taxed by California.

The system was very controversial and strongly opposed to foreign companiesespecially those based in Japan and the UK. Their governments pressured California, directly and through diplomatic channels, to abolish the system.

Finally, in 1986, Republican Gov. George Deukmedjian and Democratic lawmakers threw in the towel and ruled that corporations could either continue the unitary approach or adopt so-called “water’s edge” calculations that only count activities in the United States.

Critics have since said the water’s edge option was a gift to corporations because they could use creative accounting to shift profits to subsidiaries in other countries and thereby minimize their California tax bills.

This criticism is renewed by advocates of a return exclusively to the unitary system.

Assemblyman Damon Connellya Democrat from San Rafael, introduced a uniform taxation bill. On Wednesday, the taxation committees of both legislative houses held a hearing to get input from advocates and opponents.

Advocates such as UC-Davis law professor Darien Shanske argue that corporations have benefited from recent federal tax changes and California should use their profits to prop up vital government services threatened by cuts.

Opponents, such as Jared Walczak of the California Tax Foundation, have warned that a return to the single system would complicate tax compliance and potentially renew international opposition.

The claim by unitarians that the water’s edge option is a loophole that has eroded corporate tax revenue is shaky. California has the nation the third highest corporate tax rate in the state8.4%, and since the option was passed 40 years ago, corporate tax revenues are increased 9 times from $4.8 billion annually to $43.5 billion, slightly less than the growth rate of personal income taxes.

It’s also doubtful that the flat tax would make much of a dent in the state’s chronic budget deficit, much less replace federal cuts. Two state agency tax experts told lawmakers that estimating revenue gains is virtually impossible. The left-leaning California Center on Budget and Policy estimates it could raise another $3 billion a year, while Shanske suggested $4 billion.

Government deficits are about $20 billion a year, and projections for future deficits are in the same range. Truly closing the gap would require increases in the proposed wealth tax rate indefinitely — and replacing the federal cuts would require even more.

It’s yet another reminder that making promises without the revenue to back them up is a reckless approach to public finances.

This article was originally published on CalMatters and is republished under Creative Commons Attribution-NonCommercial-No Derivatives license.