The $4-Billion Misunderstanding

A series of natural disasters has sent shock waves through California’s economy in recent years. Now the state may be facing a severe financial test stemming from a U.S. Supreme Court decision.

In one of the most important business cases of the court’s current term, Barclay’s Bank vs. California Franchise Tax Board, the justices will consider the constitutionality of the state’s so-called unitary tax rule, which taxes foreign corporations based on their worldwide revenues.

One now has the ominous sense that not only will California lose in the high court but that it will lose big. The justices could decide that the state will have to give back $4 billion in previously collected taxes to multinational corporations. This at a time when the state’s economy is in its worst shape since the Great Depression.

Granted, California has been in the wrong about unitary taxes. Its practice of assessing a foreign company’s state taxes as a percentage of its worldwide revenues is bitterly opposed by multinational companies, even many of those headquartered here in the United States.

California’s method differs from that of the vast majority of the states, most of which levy taxes on the “arms length” or “water’s edge” basis.

These other states may collect less in taxes, but they don’t hamper Washington’s ability to negotiate international trade and taxation agreements.

Some might argue that unitary taxation is simpler, but a much more compelling argument is that California should not march alone in its taxing methods.

Recently the Legislature revised state tax policy to offer multinationals an option to file their state returns either way--unitary or water’s edge. Even so, petitioners including Barclay’s Bank and Colgate-Palmolive Co. are seeking monetary compensation for past taxes under the unitary method. That’s too bad for California. The hope was that Sacramento’s recent action would make the issue moot.

The Justice Department has recently filed a friend-of-the-court brief, erroneously supporting California’s arguments in favor of unitary taxation but rightly arguing that the state should not have to refund billions in back taxes to corporations. That’s fulfillment of a campaign promise of President Clinton, but it’s a muddled position at best.

Washington must be free to negotiate international tax arrangements as an aspect of foreign policy. And California wisely has stopped insisting on a unitary tax alone. There the matter should end. The Supreme Court should not put such a huge loan on a state already so burdened by recession and nature’s wrath.