California Against the World


California is so large and important in the world economy that it is sometimes referred to as a nation itself. It’s a delicious thought but sometimes a self-defeating one.

Such is the case with the state’s effort to maintain the option of taxing foreign companies that have branches here according to the so-called “unitary” tax rule. This assesses a foreign company’s state tax as a percentage of its total worldwide revenue. The procedure has its defenders--some economists prefer its simplicity; but it is a source of great annoyance to foreign trading partners.

They argue that the unitary system is at variance with the basic tax philosophy of international tax and trade agreements, which rely on a different system, called “arm’s length” or “water’s edge.” That system generally results in less taxes. California now offers that tax-paying option to foreign companies here, but those that wish to use it have to pay a premium.


Foes of the unitary rule argue that it ought to be dropped entirely. European governments, and some U.S. multinationals, contend that the unitary method is unfair and contributes yet another burden on business activity here. Perhaps if the unitary method were the standard approach, the argument against it would collapse and California could keep it.

But Washington needs to be able to negotiate international trade and taxation agreements. Sacramento’s declaration of independence tends to undermine the federal government’s constitutional right to negotiate treaties, including those on trade. Preceding U.S. administrations have opposed California on this; Clinton campaigned on behalf of the state’s position.

The U.S. Supreme Court has been asked to intervene, in the case of Barclay’s Bank International vs. California Franchise Tax Board. It wants the new Administration to state its position clearly.

Alas, the Barclay’s suit involves billions in alleged back taxes. An ideal--if difficult-to-imagine--Supreme Court ruling would be one that strikes down the unitary rule as unconstitutional but that somehow permits some retroactivity, thus allowing this state the billions in disputed taxes. Such a Solomonic solution could defuse this potential tariff-war-creating issue without digging this state into an even deeper fiscal hole.