I’ve criticized the city of Los Angeles for the way it treats businesses. It says it wants companies to call the city home, then it all but cudgels, kicks and chases businesses out of town.
But I must admit that I’m pleased to see a proposal from Councilmen Richard Alarcon and Greig Smith that, if passed, may be a modest help to lure businesses here or allow them to get started here.
The proposal would temporarily expand the waiver on the gross receipts tax on businesses. Basically, new businesses or ones that relocated to Los Angeles would not have to pay the tax for three years.
The measure is accompanied by a study from Charles Swenson, a professor at USC’s Marshall School of Business. The report says the exemption would modestly spur job growth, creating perhaps 55,000 jobs eventually, and result in a small increase in city tax revenue.
The reason for the job growth is easy enough to understand – that would result from businesses that moved or got started here.
The reason for the increase in city tax revenue may be a little trickier to understand, at least for those who don’t grasp the dynamic effect that tax policy has on the real world. That is, if the new exemption results in a net increase in companies that get rooted here, then the multiplier effect would kick in. Those new companies and their employees would buy at least some of their goods and services from other local companies. And that increased economic activity will generate tax income for the city.
In other words, if the city would cut the tax, the city would get more tax revenue.
This is an old principle, of course, and it’s been proved accurate a number of times. What’s amazing is that at least some members of the City Council seem willing to understand and accept that premise. The usual response from elected types around here is “We need money. Let’s raise taxes.” So it’s good to see at least a couple of councilmen say, “We need money. Let’s cut taxes to help business locate here and grow.”
The issue may come before the council in a month or so. Now let’s see if the entire City Council gets that.
Actually, the idea of giving the break to incoming and startup businesses is particularly good. That’s because the gross receipts tax is onerous for young businesses as the tax is on revenue, not profits – and profit margins are usually slim for new businesses.
Swenson’s report provides a good hypothetical. The tax rate varies, depending on the type of business, but let’s say a business pays a gross receipts tax of $4 per $1,000 in revenue. A well-established business with a nice 10 percent profit margin will pay a tax equal to only 4 percent of its profits, or $4 for every $100 in profits. No big whoop.
But if that same business is young and makes only a 1 percent profit margin, suddenly the tax is 40 percent of its profits, or $4 for every $10 in profits. That’s huge, and it’s enough to make many young-and-struggling business operators look outside of Los Angeles to start or relocate a business.
And that business would have many options where to plant its flag. As Swenson noted, gross receipts taxes are not assessed by many cities; San Francisco and Santa Monica are about the only other California cities with substantial ones.
Actually, the city’s gross receipts tax does more than impede startups. It can hurt established businesses. You may recall within the past year how some companies that sell over the Internet were upset with their gross receipts tax classification and threatened to move out of Los Angeles until the city lightened up on them.
Cities fight to lure businesses, and L.A.’s gross receipts tax puts the city at a decided disadvantage in that competition. This may be a good opportunity for the city to show some courage and do another study – one that looks at the effect of rolling back or even killing the gross receipts tax and maybe some other taxes. A proposal that’s not so modest but bold.
Such a study may show what some elected people here seemed so unwilling in the past to accept: If done right, a big cut in tax rates can lead to a much more attractive and far healthier business climate. And that, in turn, could lead to an increase in tax revenue.
Charles Crumpley is editor of the Business Journal. He can be reached at [email protected].
