Thoughts on the California/SF Tax Related Propositions for Tuesday

San Francisco – Proposition E: replaces SF payroll tax, which is based on the number of employees, to a gross receipts tax

• Favor: the payroll tax makes hiring people more expensive (since employers have to pay more taxes for every new hire). Many economists think that employers pass on a lot of the payroll tax burden onto workers in the form of lower wages. For instance, if I run a coffee shop and have to pay 5% more to hire you due to the payroll tax, I could just lower the salary I’m willing to offer you by ~5%. Thus, removing the payroll tax (and replacing it with a more efficient sales based measure) could increase employment and wages in SF.

CA – Proposition 30: increases taxes on earnings over $500K for 7 years and sales taxes by 0.25 for four years to fund education. Estimated to raise ~$6B per year

• Favor: this raises marginal rates for joint filers who earn $500K by 1 to 3%. Marginal  rate increases of this magnitude are unlikely to have substantial economic impacts in terms of job or output growth. Moreover, the share of state funds going to higher education has been decreasing and is actually now lower as a share of the budget than spending on corrections as shown below [higher ed is blue, corrections is green]. Support for the UC system helps build a strong economic foundation for California.
  Source: CACS.

CA – Proposition 38: increases income taxes across the board for 12 years to support K-12 schools and early childhood programs

• Oppose: While there is good evidence that good teachers and early childhood support can be very beneficial, broad-based tax increases are costly. Revenue could be raised in better ways (as done in Prop 30 and 39).

CA – Proposition 39: requires multi-state businesses to pay income taxes based on the percentage of their sales in California (rather than using an apportionment method that allows them to pick the least costly apportionment option). Estimated to raise $1B per year. Dedicated revenues for 5 years to clean/efficient energy projects.

• Mixed views: Good tax policy, but don’t love the dedicated spending (that amounts to roughly half the revenues raised) for green projects.
• Tax part: When companies operate in many states, their state corporate tax bill is determined by figuring out how much activity they have done in each state. “Activity” is often measured in 3 ways: payroll, property and sales. A company that operates in multiple states besides California, as I understand it, will have to figure out what share of its payroll is in CA, what share of its property & equipment is in CA, and what share of its sales are in CA. Historically, many state corporate tax rules simply averaged those shares equally so if the payroll share in CA was 6%, property was 3%, and sales were 12%, then the apportionment formula would say this firm’s activity in CA is (1/3)6% + (1/3)3% +(1/3)12% = 7%. As described above in my commentary on the SF proposition, the payroll based tax is bad policy since it makes hiring more expensive relative to sales-based measures, which are less distortionary. What this proposal says is that instead of letting companies pick whether they want to determine their level of activity in CA using something like the weight-based method (ie 7%) or sales only (ie 12%), we’ll make them use the sales based method. This will prevent states from simply picking the lower number and will make a sales-based method the way corporate taxes are raised in CA.  The bottom line is that this is good tax policy. For a given level of state corporate tax rates, it’s better to raise money using sales based measures.
• However, there are likely better ways to spend state money than for these projects, so ultimately I think I’ll vote in favor but would be more enthusiastic about that if the proposition only included the tax part.

See Kevin Drum for helpful commentary on the other propositions. Also, here is Brad Plumer on the controversial Prop 37 about labeling genetically modified foods.