California’s CorporateTax Collection Lags

Published Sunday, Aug. 28, 2011

Month after month this spring, California officials cheered as personal income and sales taxes flowed into state coffers at a robust clip.
But one area repeatedly underperformed: taxes on corporate profits.
That occurred despite the fact that corporations have reported strong profits this year. More than 75 percent of S&P 500 companies beat earnings estimates in the second quarter, according to Bloomberg. California Department of Finance officials say their own indicators show corporate earnings are as strong as predicted at the start of the year.
It is hard to find concrete answers without reviewing corporate tax records, but fiscal experts suggest a strong possibility: Tax breaks California policymakers have approved are turning out to be more lucrative for corporations than once thought.
Lawmakers and then-Gov. Arnold Schwarzenegger negotiated the changes in previous closed-door budget talks and approved them with little public review. Forecasters considered those tax changes when they built their January projections. But analysts say they underestimated the cost of those tax benefits.
Through the first seven months of 2011, California received $708 million less in corporate tax revenue than the Department of Finance projected in January, or 10 percent. Over that same period, personal income taxes topped expectations by 15 percent, while sales taxes were slightly above target.
“What’s happening in our numbers is not really about corporate profits,” said Jason Sisney, director of state finance for the nonpartisan Legislative Analyst’s Office. “What’s happening now is all the effect of the policy changes we’ve had.”
Brad Williams, a private consultant and former forecaster at the analyst’s office, added, “The bottom line is we did a lot of things to the Tax Code, and there’s always a lot of uncertainty when you’re talking about something that’s never been done before. It’s quite possible one or many of the changes had a greater fiscal effect than anticipated.”
Business leaders blame the economy for corporate taxes falling behind projections. They suggest forecasters were too optimistic in their assumptions. Corporate tax revenues are 2.6 percent higher year over year, despite missing projections.
And corporate profits are up much more. In its July quarterly report, Mountain View-based Google reported a 36 percent increase in net income year over year. Cupertino-based Apple showed a 125 percent increase in profits.
Even if major corporations are reporting impressive numbers, business leaders say firms may have had less economic activity in California, where unemployment remains high.
“It depends on where your profits are and how much is attributed to the California economy,” said Allan Zaremberg, president and CEO of the California Chamber of Commerce. “Some companies like Google are reporting strong profits, but you don’t know if it’s all attributable to business in California.”
Starting this year, firms were allowed to ignore the amount of California property and employees they have when calculating their corporate tax liability. Instead, they have to pay only on their percentage of sales in the state, called the “single sales factor.” The change benefits California-based companies.
A union-backed measure to repeal the benefit failed on the November 2010 ballot.
Most other large states have moved to the single sales formula in an economic development arms race, hoping to attract companies by removing tax burdens based on property and payroll.
But in its switch, California became the only state besides Missouri to allow companies to choose annually between the single sales formula and the traditional one. That means companies with large sales in California but fewer employees or facilities can choose to pay less.
Gov. Jerry Brown called on lawmakers last week to eliminate that option and force all companies to use the single sales formula. That would raise an estimated $1 billion annually, mostly from out-of-state firms. He would then redirect most of that money to a sales tax exemption on manufacturing equipment.
The analyst’s office recommended last year that the state eliminate the two-formula option by 2013.
Business groups have lobbied to maintain two formulas to avoid creating winners who get tax breaks and losers who pay more taxes. They say forcing companies to pay $1 billion more would curb job growth.
“The state shouldn’t be in the business of shifting tax burdens from one taxpayer to another,” said Teresa Casazza, president of the California Taxpayers Association, which represents businesses. “There are companies not headquartered here who still have a lot of jobs here.”
The state also restricted use of various business tax credits in 2008 and 2009 to raise $1 billion over two years. In doing so, the state agreed to allow companies to share credits with affiliates starting in 2010, a policy that came with a projected annual price tag of $400 million.
The state could see another corporate tax reduction next year. Lawmakers agreed to restrict deductions for operating losses from 2008 to 2011, but expand their use thereafter. That has led to some one-time cash, but it is projected to cost the state $205 million starting next year.
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