Capitol Alert: California Senate report says tax breaks are 'bleeding cash'

As Gov. Jerry Brown and legislative leaders dicker over a package of business tax incentives aimed at boosting the state's stagnant economy, an oversight office created by Senate President Pro Tem Darrell Steinberg has concluded that previous corporate tax breaks cost many billions of dollars more than anticipated.

The report, issued Thursday by the Senate Office of Oversight and Outcomes, provides ammunition for tax reformers who have called for closing corporate loopholes to raise state revenues and who are leery of opening new ones.

Brown has proposed to change the way multistate and multinational corporations are taxed to raise revenues, then use the proceeds for targeted tax breaks to spur job-creating investment. But with the 2011 legislative session in its final hours, he's encountered resistance from Republicans whose votes would be needed for the tax swap.

Meanwhile, Steinberg's investigators, who are mostly former Capitol reporters, have concluded that "some California tax breaks are acting as blank checks, costing the state billions of dollars more than anticipated when they first were put in place..."

They estimate that over the last decade, 10 major corporate tax breaks have cost the state treasury $6.3 billion more than estimates when they were enacted, including $1.3 billion more in 2010-11.

"How could the costs to the state escalate so far beyond expectations?" the report asks. "One explanation is that those who prepare estimates at the state's tax boards must use economic and demographic data that is already three years old. Economic forecasting is by nature an inexact science. Some tax expenditures have been passed at the last minute to cement deals on the state budget, giving analysts little time to assess the potential impacts on the state treasury.

"But other factors play an even larger role. Taxpayers change their behavior to maximize the financial advantage of tax breaks, moving into an enterprise zone, for instance, or figuring out ways to increase reported revenue generated outside of California, reducing their in-state tax burden. Consider this statistic: California accounts for about 12 percent of the national economy. Yet, in 2008 state tax returns, multi-state companies report only 5.4 percent of total national sales in California. Under the double-weighted sales factor, in-state sales drove up a company's tax liability, giving them an incentive to minimize the ratio of sales they reported within California.

"For some tax expenditures, consultants advise businesses how to reap benefits that they may have overlooked when they first filed their tax returns, offering to amend the returns for a share of the savings. Lastly, courts and tax boards may broaden the application of tax expenditures beyond what was envisioned by those who made the original estimates of foregone revenue."

Although California is aggressive in reporting on what are called "tax expenditures," the report says, the data of their costs are not folded into the annual state budget process, as some other states do, nor is there a systematic effort to determine what tax breaks benefit the state's economy and which do not. It recommends the creation of a commission, similar to one in Washington state, to annually review tax expenditures and recommend repeal or changes of those whose costs outweigh benefits.

The Legislature has already sent two tax expenditure bills to Brown's desk. Senate Bill 364 by Sen. Leland Yee, D-San Francisco, would impose penalties on any business with more than 100 workers that used a tax credit and in ensuing years had a 10 percent drop in the number of employees. Senate Bill 508 by Sen. Lois Wolk, D-Davis, would sunset any new tax credits after 10 years. Business groups are urging Brown to veto both.

The full report, entitled "Bleeding Cash," is available here.