Cavernous California loopholes

As voters prepare to ratify or reject the complex budget deals represented in the six propositions -- 1A through F -- on the May 19 ballot, there is one part of the budget deal they don’t get to decide on: huge new corporate loopholes. The last two budget agreements worked out by the Legislature and signed by the governor include provisions that permanently cut billions in revenue from the corporation tax -- with the state getting next to nothing in return.

Corporate tax attorneys are chuckling over the absurd deal in the last agreement that lets multistate and multinational taxpayers decide, each year, how much income they want to report to California. Because this was negotiated in private, with no hearings and no independent expertise brought to bear, the result is a giveaway and a national embarrassment, in a state that had prided itself on a fair, successful corporation tax.

Here’s how it works. Each state typically figures out what percentage of a large company’s business is done in the state, and then taxes that percentage of income. Historically, if 10% of a multistate company’s payroll, property and sales are located in the state, then 10% of its nationwide or worldwide income is subject to tax. In the budget deal, California changed the formula to allow companies to choose to make that percentage based only on sales in California.

Other states have used this so-called single-sales factor, so that out-of-state companies selling into the state could pay more in tax and in-state companies with lots of payroll and property but that sell around the world would pay less. The claim -- never proved to be true in any state -- is that such a formula helps economic development.

Companies that pushed heavily for this tax break -- e.g., NBC Universal -- will now be able to base their California income not on their total economic activity in California but only on the percentage of their sales done in California, which is a far smaller fraction of their income. This is “money for nothing” -- companies do not have to provide a single new job to receive a huge tax cut, which benefits their worldwide shareholders.

But here’s the worst part of the secret budget deal: The state provides multistate and multinational companies with a choice yearly of which formula they want to use when they file their taxes. So, depending on whether companies have losses or gains in a given year, they can choose to either attribute more losses or fewer profits to California, to minimize their taxes. The Legislative Analyst’s Office said this tax change will potentially cost billions per year, despite the lower projections given when it was enacted.

None of this manipulation helps smaller businesses and start-ups that operate only in California, and therefore pay tax on all of their income. But wait! If they invest outside the state, they too get to play the same games with their income reporting -- hardly an incentive to do business in California.

On top of all this, the previous budget deal last September put two other permanent loopholes in place, again without hearings or public examination. One allows corporations to get refunds for taxes already paid for losses in previous years -- so-called carry-backs. So they can now manipulate the formula to take larger losses in California and can get refunds based on that manipulation -- at a cost to every struggling program and taxpayer in California.

Another permanent loophole allows firms that receive generous tax credits but can’t use them all to share them with affiliated corporations, to shelter the income of their affiliate. After that, they can recalculate their taxes and decide how much income to attribute to California.

The justification for these new loopholes? The Legislature accelerated tax payments by corporations -- but only for two years. In exchange, the Legislature gave away massive, permanent revenue losses -- about $2.5 billion yearly for these combined loopholes, according to legislative estimates, beginning in 2011 and amounting to potentially 25% to 30% of the state’s corporation tax revenue -- without requiring that a single new job be created or even a sunset clause on the breaks in case the state doesn’t benefit from them.

The giveaways can only be taken back by a two-thirds vote, a virtual impossibility given the arrayed power of corporations in the Legislature and the GOP’s anti-tax stance. Or they can be taken back in an initiative, but voters would be barraged by a campaign about the “business climate.” No corporations can ever complain again about taxes in California, because they now can endlessly manipulate a system that was once a model for a fair corporation tax.