The gross receipts tax that Los Angeles imposes on businesses is like a parasite that's embedded itself deeply into the body of its host. Everyone wants to remove it, but no one wants to go through the pain. That's understandable — eliminating a tax that generates close to half a billion dollars annually could blow a gaping hole in the city budget. But for city leaders to pretend they can do it without feeling a pinch doesn't help anyone.
Unlike the typical business tax, a gross receipts tax is assessed on every penny of revenue collected within the jurisdiction — regardless of whether the business made gangbuster profits or lost its shirt. This approach became popular during the Depression because a low rate could still generate a large amount of money for cash-strapped governments, but it fell out of favor because it violates a fundamental principle of good tax policy: The size of the tax bill is totally unrelated to a business' ability to pay it. Making matters worse, Los Angeles' top tax rate — 0.5% — is almost 10 times higher than the average in other California cities that still impose a gross receipts tax. And perversely, the city imposes its highest rates on the sorts of businesses that would have the least trouble moving their operations out of town.
A tax on businesses' profits, such as those imposed by the federal and state governments, would make a lot more sense, which is why so many candidates for City Council are touting it. Unfortunately, state law doesn't allow cities to go that route. Instead, Mayor Eric Garcetti has embraced the proposal from the Business Tax Advisory Committee to phase out the gross receipts tax completely. The committee's assumption is that the tax cut would pay for itself through faster economic growth — where have we heard that one before? — but just to be on the safe side, it would implement the cut in three stages and halt further reductions if revenues fell short.
As poorly designed and uncompetitive as the tax is, city leaders shouldn't try to transform it with wishful thinking. The most credible study of the committee's plan showed that eliminating the tax would improve the local economy, but would still leave city coffers nearly $400 million short per year. With that admonition in mind, the City Council agreed this month to a modest cut in the top tax rate, phased in over three years. The administration could track the effects of that cut for a few years and see whether it demonstrably increased the amount of tax dollars collected, in which case it could try further cuts. Or if it were really serious, it would pair a proposal to eliminate the current business tax with a package of spending cuts and/or tax increases large enough to fill the ensuing gap. The gross receipts tax is such bad policy, the city can put up with some pain to remove it.