Proposition 39: Should Corporations Choose How They Are Taxed?

During the recent recession, when state revenues were at their lowest level as a share of the economy in more than three decades, lawmakers quietly passed a set of significant tax cuts that benefit a small number of large corporations at a cost of more than $1.5 billion a year to our state budget. Proposition 39, one of the measures on the November 6 ballot, singles out the largest and most costly of these tax cuts for public scrutiny. The CBP recently released an analysis of the measure, which would end the state’s current policy of allowing multistate corporations to choose the more favorable of two methods for determining their California income tax.

Under a system known as “optional single sales factor apportionment,” in effect since 2011, multistate corporations operating in California are allowed to choose the more favorable of two methods for determining what share of their income will be subject to state tax. Proposition 39 would change the law so that nearly all multistate firms would be required to calculate the share of their income subject to the state’s corporate income tax the same way: based on the percentage of their total sales that occur in the state. The proposed new system, called “mandatory single sales factor,” has been adopted by almost half of all US states.

Starting in 2013, Proposition 39 would result in an estimated $1 billion annually in additional state revenues, an amount expected to grow over time. From 2013-14 through 2017-18, half of these dollars would be used to fund energy efficiency and clean energy initiatives. After 2017-18, all the dollars would be deposited in the state’s General Fund. Proposition 39 is also expected to increase school funding because significant growth in General Fund revenues tends to boost the state’s minimum funding guarantee for K-12 education and community colleges.

The current system for taxing multistate corporations neither encourages firms to locate in California nor offers an incentive to hire Californians. Instead, it provides an arbitrary tax break for multistate firms by letting these corporations choose the most advantageous formula for calculating their annual tax bill. Currently, California is one of only two states that allow corporations to choose each year between single sales factor and another tax apportionment formula based on the firm’s property, payroll, and sales in the state. All other states that have adopted single sales factor have made it mandatory – either for all corporations or for certain categories of firms. States that have adopted the mandatory approach provide both a “carrot” and a “stick”: the carrot of lower taxes for firms that locate in-state and export out-of-state and the stick of higher taxes for firms that sell to the state’s market without locating a proportionate share of property and payroll there.

In the CBP’s analysis of Proposition 39, we find that the largest firms would provide the majority of Proposition 39’s new revenues. Firms with gross annual receipts over $1 billion would provide approximately 70 percent of the revenues. In a given year, only about 2 percent of all corporations doing business in California would likely be affected by the tax change.

Proposition 39 has its drawbacks: It includes an exception that specifically favors cable companies, and it dedicates a share of its revenues to specific, inflexible uses (namely, renewable and clean energy projects). Voters will need to weigh these concerns against the fact that Proposition 39 would revoke a sizeable and unnecessary corporate tax break and bring in $1 billion a year in new revenues, helping to stave off deeper cuts to California’s vital public systems and programs.

— Hope Richardson