Tax Hikes to Hurt Climate For Business

Staff Reporter

As the state struggles to find ways to close its projected $35 billion budget deficit, businesses are certain to be hit with new or increased taxes and fees, a prospect that threatens to further damper California's already fragile business climate.

To be considered in the coming months will be increasing top-bracket personal income tax rates, hiking the sales tax and expanding its scope, raising business property tax assessments, new "sin taxes" on alcohol and tobacco, and higher car registration fees. Passage of any of these measures would increase costs for businesses already hit hard by skyrocketing insurance rates and energy bills.

"Businesses have already been hit by a rapid run-up in costs," said Michael Shaw, assistant state director of the National Federation of Independent Business, which represents 40,000 small businesses. "Increasing costs further may put them over the edge, forcing them to close down or move out of state."

Just the uncertainty over the prospect of new taxes or fees is likely to curtail business spending over the next six to nine months, further exacerbating the current economic lethargy. That, in turn, could compound the state's fiscal problems by further slowing tax receipts.

State officials say California is not alone in confronting budgetary problems: 41 states are running deficits so far this year. Like California, many of those states are likely to turn to revenue-raising measures on business.

"Businesses in California that may be looking to lower costs elsewhere should recognize that other states are looking to enhance revenues as well. We're not an anomaly," said Norman Williams, spokesman for the state Technology, Trade & Commerce Agency.

But unlike other states, California's business costs are already among the highest in the nation. And the size of the budget deficit dwarfs anything ever seen in any state.

While some clarity in the budget picture may emerge on Jan. 10 when Gov. Gray Davis unveils his 2003-04 budget, both sides of the Legislature are likely to clash for some time over taxes. Any budget package will need some Republican votes to get the two-thirds majority needed for passage.

The Republican leadership is holding to its line of no new or increased taxes, while Democrats insist that the budget deficit is so huge that some tax increases will be necessary to close it.

This past summer, Democrats and Republicans deadlocked for two months on the taxation issue when faced with a smaller, $23.6 billion deficit for the 2002-03 fiscal year. That deadlock ended on Labor Day weekend when four Republicans in the Assembly agreed to back the budget package, which largely eschewed new or increased taxes in favor of one-time measures like borrowing against tobacco settlement dollars.

GOP gains leverage

Thanks to GOP gains in November, at least six Republicans in the Assembly and two in the Senate must support the 2003-04 budget package in order for it to pass. That gives Republicans more leverage than they had last year.

"Colleagues on my side of the aisle will not support any tax increases," Assembly Republican Leader David Cox said. "Any new taxes will be a detriment to the business climate in California."

Cox said there are levies that Democrats will seek to redefine as fees requiring only a simple majority vote. These include raising the vehicle license fee, instituting a levy on alcoholic beverages or raising the taxes on cigarettes. "Anything the Democrats will try and do themselves, without Republican votes, I'm sure will get done," Cox said.

Democrats, meanwhile, say that the budget deficit is too big to close simply with spending cuts or short-term borrowing.

"We risk jeopardizing California's future by decimating our public education, public safety and fragile public health systems if we make $20 billion to $30 billion in cuts," said Assemblywoman Jenny Oropeza, D-Carson, who chairs the Assembly Budget Committee.

What's likely to emerge is a package of tax increases alongside steep spending cuts and extensive borrowing.

On the revenue side, most likely to happen is reversing recent decreases in the vehicle license fee. Repeal of the decreases requires a simple majority vote in both houses of the Legislature. If that's the case, increasing the VLF back to previous levels which could bring in $4 billion to the state's depleted coffers only needs Democrat support.

Some form of increase in state sales taxes is also in the offing. Several proposals are in circulation around the Capitol:

-Increasing the base sales tax rate 0.5 percent, which would bring in between $1.5 billion and $2 billion to state coffers.

- Expanding the sales tax to include services, such as lawyer and accountant billings. This could raise between $1 billion and $12 billion, depending on what services are added.

- Instituting a nickel-a-drink tax on the sale of liquor at the wholesale level, which could bring in $500 million.

-Increasing the tobacco tax by anywhere from 50 cents to $3 per pack of cigarettes. A hike of 50 cents would bring in $475 million, while a $3 hike could bring in as much as $2 billion.

- Increasing the gas tax by 5 or 10 cents, which could raise as much as $1.5 billion for transportation-related projects.

-Extending the sales tax to Internet purchases, which could bring in anywhere from $200 million to $1 billion.

Of these, the "sin taxes" on tobacco and alcohol are viewed as most likely to pass, especially the tobacco tax. But the real money is in expanding the sales tax to cover services.

"The economy has moved from manufacturing-based to service-based, yet we're still taxing as if it's all still manufacturing," said Sen. Gil Cedillo, D-Los Angeles. "We have to fish where the fish are, and now, the fish are in services."

But such a move is likely to encounter a sharp backlash from politically powerful constituencies, like doctors and attorneys.

"This would not be a mere half-cent hike in the sales tax," said Fred Main, senior vice president of the California Chamber of Commerce. "You're talking about going from zero to a pretty sizable surcharge all at once. I would bet the lawyers and all the other impacted parties will squawk very loudly on this one."

Hiking income taxes

Another major battle is expected over whether to reinstate the top income tax rate of 11 percent on upper-level income earners, who now pay 9.3 percent. The Democratic leadership, led by Senate President John Burton, argues that people who earn more than $150,000 can afford to pay a few more dollars in taxes to keep essential state services flowing.

But the idea is meeting predictable resistance from Republicans and business groups, who note that many small business owners pay personal income taxes on their business revenues.

It's also meeting some resistance in Democratic quarters for another reason: it increases the state's reliance on the fortunes of the small cadre of upper-income earners. Roughly the top 10 percent of earners pays 80 percent of the state's income taxes. More than a quarter of the current budget debacle can be traced to the loss of stock options and declining stock market prices among this segment of taxpayers.

"Everyone recognizes the over-reliance of the budget on upper-income earners and there's a reluctance to exacerbate that," said one Democrat budget committee consultant.

Another revenue raising measure, splitting off business property taxes from the ranks of Proposition 13-protected property tax rates, would raise up to $1 billion in the first year. In the past, the business community has strongly opposed any move in this direction, as it has almost every tax increase that has been proposed.

This year, though, things may be different. The budget hole is so huge that many business leaders recognize that closing it entirely through cuts could cause long-term damage to the economy.

Instead of opposing all tax and fee measures as it has in the past, the business community this year is taking a different approach: it is pushing for repeal of recent measures it views as strongly anti-business. Chief among them: the increase in workers' compensation benefit rates passed last February.

"If the state needs to raise revenues on business, then other anti-business costs on employers that don't flow into state coffers need to be stopped entirely or reduced," said the Chamber's Main. "We view this as a tradeoff."

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