October 19, 2004

Revise California’s Tax Code

(This articled appeared in the San Francisco Examiner October 19, 2004)

Despite campaign rhetoric about “Benedict Arnold CEOs” sending jobs overseas, Californians are sweating about a jobs threat much closer to home: low-tax U.S. states poaching California’s businesses.

The threat of tax competition between states for jobs is old hat to state lawmakers. Within America’s 50-state free-trade zone, every change in a state’s tax code affects its competitiveness with its neighbors.

But California’s recent budget woes and high tax rates have made the state an unusually ripe target for opportunistic governors. Nevada recently posted ads to lure California employers, and Gov. Arnold Schwarzenegger retaliated with pro-business promises. But in today’s economy, Nevada isn’t the only jobs threat.

Unfortunately when it comes to tax competition, most states get it wrong. The temptation is to lure sexy employers like sports teams and corporate headquarters with short-term tax boondoggles. But this strategy almost always backfires — a lesson Schwarzenegger should remember as he responds to job threats.

Consider Columbus, Ohio, a city addicted to money-losing tax bonanzas. Local officials lured a moving company with a five-year package of tax goodies back in 2000. Four years later? The company not only failed to add 100 jobs as promised, but actually fired 98 employees, sending lawmakers into a panic to yank the final year of tax breaks.

What went wrong? Short-term tax lures are a politically attractive way to “create” jobs. But those expensive giveaways send a damning message about a state’s tax friendliness. To new companies, they signal that only special bonuses can make the state’s flawed taxes attractive. And to existing companies they’re an economic face-slap, treating current employers as dupes who’ll pick up the tab for newcomers.

The real way to lure long-term jobs? Streamline California’s tax code to be permanently business-friendly to all companies.

The Tax Foundation recently released its guidebook on business tax-friendliness, the “State Business Tax Climate Index.” It ranks the business tax climates of the 50 states, rewarding tax codes that are neutral, have low and flat rates, are simple and transparent, avoid double taxation, and have statutory restraints that keep tax burdens low.

The 10 most business-friendly states this year are South Dakota, Florida, Alaska, Texas, New Hampshire, Nevada, Wyoming, Colorado, Washington and Oregon — a list that includes several of California’s neighbors.

This year California ranked 38th in the nation, putting California at a competitive disadvantage with nearly every state in the West.

The main culprit? High tax rates. For corporations looking to relocate, California’s 8.8 percent corporate income tax is the highest in the West, and only 10 states have a higher rate.

However, many small businesses — sole proprietorships, partnerships and so on — pay individual income taxes rather than corporate taxes. California’s top rate of 9.3 percent kicks in for just over $39,000 of income for singles, $78,000 for couples. At those income levels, no state has a higher rate. And on top of that is California sales tax, the nation’s highest at 7.25 percent.

Overall, California’s tax code isn’t exactly a welcome mat for employers.

California companies can’t be blamed for accepting tax boondoggles from competing states. Blame lawmakers in Sacramento who’ve steadily marched toward high tax rates in recent years with no concern for state competitiveness.

There is a way out for California: tell Gov. Schwarzenegger to lead the way toward a more neutral and job-friendly tax code. If you do, the jobs will stay.

Scott A. Hodge is president and Andrew Chamberlain is a staff economist at the Tax Foundation in Washington, D.C.