Income, Business Tax Increases Looming as Budget Deficit Widens

Staff Reporter

Businesses, taxpayers and local governments could be in line for some painful financial hits as the deficit mounts in a state budget deep in the red.

With one-time borrowing gimmicks already used, state revenue-producing alternatives such as higher personal income and corporations taxes are now being considered. A reduction in state funding for local governments also is looming.

With the election over, state officials must turn to the task of fixing a budget, passed in September, that already is out of balance by $7 billion as revenues appear to have been overestimated once again.

The budget deficit for 2003-04 already is projected at $10 billion to $15 billion. If current trends hold, that puts the total hole at more than $20 billion.

What's more, the one-time gimmicks to postpone tough decisions like borrowing against future tobacco settlement monies are mostly gone.

"There's probably still some long-term borrowing that can be done, but there's no way now to avoid tax increases and spending cuts," said Ted Gibson, former chief economist for the state Department of Finance and now an economic consultant for Metropolitan West Financial LLC in Sacramento.

Given the severity of the budget crisis, newly re-elected Gov. Gray Davis is expected to call a special session of the Legislature to address the problem, probably concurrent with the actual start of the session in January. However, some Republicans said they believe a special session should be convened in December to begin sorting through proposals to plug the deficit.

The consensus among state government watchers and lobbyists is that without a "midcourse correction" in the next 90 days to reduce spending for the rest of the 2002-03 fiscal year, the state could face a cash crunch next spring. That, in turn, could force state officials to issue warrants or take out short-term loans while a budget package is being worked out.

Whatever happens, California businesses could see a double-whammy of tax hikes and the repeal of tax credits. Among the possible measures being considered:

- Raising personal income taxes on top brackets from the current 9 percent to 11 percent, which could bring in an additional $3 billion to state coffers. Statewide, 2 million partnerships, sole proprietorships and "sub s-corporations" pay taxes through personal income taxes, with most falling in the top tiers.

- Raising the bank and corporations tax from the current 8.84 percent to 9.3 percent (where it stood 10 years ago) or even higher. This would affect about 500,000 business entities; every percentage point hike brings in an estimated $600 million to $700 million.

- Splitting off business properties from assessment rolls subject to Proposition 13 limits on property tax increases. This could bring in $1 billion more each year.

- Reversing some or all of the recent cuts in vehicle license fees, which could add up to $3.5 billion to state coffers. Businesses pay about one-third of all vehicle license fees. Rental car companies would take the biggest hit.

- Raising the base state sales tax, which now stands at 7.25 percent. Every percentage increase brings in about $4 billion. As with VLF fees, business pays about one-third of sales taxes on business-to-business transactions.

- Reducing or temporarily postponing the manufacturers' investment tax credit, which costs the state $500 million a year.

- Extending the postponement of the net-operating loss carry-forward, which allows businesses that post losses in a given year to pay no taxes for that year and reduced taxes for the next 10 years. In the 2002-03 budget passed Labor Day weekend, this credit was suspended for two years, adding $1.2 billion to state coffers.

Finally, state lawmakers could turn to a host of fees on certain industries, either raising existing ones or adding new ones. In some cases, it's even conceivable that certain state programs particularly involving environmental regulation could be forced to enact fees on business or face elimination from the budget, according to Fred Main, senior vice president of the California Chamber of Commerce.

Even adopting a few of these measures could cripple many businesses that have seen their margins shrink during the economic slowdown, business lobbyists say.

"When it comes to generating revenues, one of the first places policymakers focus on is the business community, by raising taxes and fees," said Gino diCaro, spokesman for the California Manufacturers & Technology Association.

Uphill battle

DiCaro said the business community would vigorously fight these proposals. But he conceded that it might be an uphill battle, especially given the seriousness of the crisis and the expectation of an even more liberal, anti-business bent in the state Legislature.

However, Gibson said that intense business opposition would probably sink the repeal of the manufacturer's tax credit, the splitting off of business properties from assessment rolls, and increasing the bank and corporations tax.

"When you're talking about closing a $20 billion deficit, these don't bring in that much money and in my opinion, may not be worth the effort to overcome guaranteed intense opposition," Gibson said.

But business groups won't be the only ones objecting. Local governments are expected to fight any reduction in state funding. Local officials are still bitter over the Legislature's action 10 years ago to shift $3 billion a year in property tax revenues destined for local governments to state coffers.

Local government lobbyists say they fear a repeat of that action, this time with vehicle license fees, which the state collects on behalf of local governments. When those fees were cut by two-thirds in the late 1990s, state officials pledged to funnel general fund dollars to local governments to make up the difference. This "backfill" now amounts to $3.7 billion a year, about $2.6 billion going to counties and the remaining $1.1 billion to cities. In all, local government jurisdictions in L.A. County receive about $1.1 billion.

"Our biggest concern is the prospect of seeing the backfill reduced or eliminated it's the easiest mechanism they have at their disposal to close the budget gap," said Dwight Stenbakken, legislative director for the League of California Cities. "We're recommending that each community go through their budgets and come up with programs that they can cut. And if the entire $3.7 billion is cut, I can guarantee you that local governments will be cutting core programs, like police and fire."

Compromise possible

Gibson said it's unlikely that the entire $3.7 billion in state backfill for vehicle license fees will be cut.

"I would expect to see a package, in which a 50 percent hike in fees paid by car owners is combined with a 50 percent reduction in the backfill," he said. "That's probably the most politically palatable way of going about this, since that way everyone would share a bit of the pain."

While the loss of VLF funds may be the biggest single threat to cities and counties, local government lobbyists say it's far from the only one.

"Our greatest potential impact is on the program side, where the state can arbitrarily change the funding formula for health, welfare and other social programs," said Steve Keil, legislative coordinator for the California Association of Counties. "We call this the death by a thousand cuts."

Keil said the state could, for example, reduce its contribution toward administrative fees for MediCal programs, in-home support services, welfare caseloads and other social programs run by counties.

About the only bright spot, Gibson said, is that the situation could have been even worse.

"Back two months ago, when the Standard & Poor's 500 Index stood at 750, the drop in state revenues could have been even more catastrophic. We could have been looking at a revenue shortfall exceeding the $24 billion we saw with this year's budget," he said. "But the stock market has rallied a little and appears to have stabilized."

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