Riordan Administration Tackles City’s Tax Code

It is a tax code that defies logic and yet resists tinkering:

It imposes the same rates on doctors and lawyers as it does on gardeners. It is clumsy when it comes to emerging industries and often discourages executives from moving their companies to Los Angeles.

The city’s system of business taxes has few defenders and scores of critics. And yet, it has remained for decades, quietly growing more complex as special interests lobby for their loopholes and new inequities creep into the code. That code today can extract $30,000 a year from one- or two-person small businesses, but it caps motion picture company business taxes at less than $13,000 a year.

Now, a core group of top aides to Mayor Richard Riordan has embarked on what may prove to be one of the most challenging and controversial initiatives of his second term--overhauling the city’s business tax code. It is a task sure to rile some of Los Angeles’ most potent special interests--movie studios, health care providers and writers, among others.

That is not a mission that Riordan set out to fulfill when he first sought public office in 1993. In that campaign, Riordan pledged to hold down taxes but talked little, if at all, about realigning the tax code.

So-called “tax equity” emerged on the mayor’s radar only after he had held office for several years--the result of butting up against complaints from local business leaders and wrangling to convince other companies to come to Los Angeles. Word from those contacts was nearly unanimous: The city’s tax code was bad for business, not just because taxes were so high but because they were so haphazardly and confusingly applied.

“This is something they have to deal with now,” said Alan Kazden, a local CPA who works with many small businesses. “Small businesses here are getting hammered.”

As an example, Kazden cited a ticket broker headquartered in the city of Los Angeles. According to Kazden, the broker was being taxed based on the full cost of every ticket he sold rather than the markup for those tickets. The result, Kazden said, was that the broker stood to save $45,000 a year simply by relocating his offices outside the city limits.

“I had all these clients with huge assessments,” Kazden added. “I got to the point where I realized I couldn’t tell them not to move out of Los Angeles. This is unfair.”

Faced with complaints such as that one, tax reform has become a dominant challenge for Riordan in his final four years as the city’s mayor. His administration has set out not so much to lower taxes as to straighten them out, to create a rational basis for taxing one company at one level and another at a different one.

“The current code is incredibly overcomplicated,” Riordan said last week. “There are too many categories, and it doesn’t differentiate between companies.”

Riordan added that while he believes the overall business taxes are not too high, the code’s complexity and inequities discourage some companies from deciding to set up shop in Los Angeles.

The result: a process that could over the next few months affect virtually every one of the city’s 100,000 or so businesses, from multinational corporations to street vendors and shopkeepers. At stake is an important aspect of the city’s economic development and a vital source of tax revenue.

Business taxes account for about $290 million a year, and their impact is even greater because every business that operates in the city provides jobs and pays other taxes that contribute to the city’s overall economic health.

A Complex Web of Taxes

As it is, executives and city officials alike agree that the current tax code is a mess.

“This system just doesn’t work,” said Assistant Deputy Mayor Deborah J. La Franchi, one of the Riordan aides assigned to tax equity. “It doesn’t work for the companies, and it doesn’t work for the city.”

At the root of the problem is complexity. As the city’s tax code has grown and grown over the decades, it has become home to a complicated web of overlapping categories. For businesses, that can create dizzying ambiguities.

Take a simple example: Say a department store chain is considering opening a store in Los Angeles. Such a store would undoubtedly be considered under the retail sales tax category, which calls for businesses to pay $110.86 for their first $75,000 in gross receipts, plus $1.48 for every $1,000 after that. But if the same department store also sells wholesale items, those items would be taxed at a different rate. If the store sells firearms, it would pay a third rate on those sales. And if it also runs an automobile repair shop, that operation would be taxed by a fourth standard.

The system is even more complicated for firms that produce goods in Los Angeles but sell a portion of them here and a portion elsewhere. The goods sold here are taxed at one rate, while the goods manufactured here but sold elsewhere are considered separately.

“We have some businesses that qualify in up to 10 areas,” said Robin Kramer, Riordan’s chief of staff. “It is amazingly complex.”

And complexity is often the enemy of efficiency. Complicated tax laws mean that companies spend more on accountants and have less certainty about their bottom line. That discourages companies from relocating to Los Angeles, and encourages those that are here to look elsewhere for better deals.

In part, the Riordan administration discovered those problems as it attempted to lure multimedia companies to Los Angeles.

Those campaigns revealed a glaring problem with the tax code: Its 64 business categories did not include a place for multimedia firms, making some of those companies nervous about coming to the city because they were not sure what they would pay in local taxes.

As they had when faced with previous ambiguities, city administrators decided that multimedia firms were best defined as “professions and occupations businesses,” the same group that includes doctors, lawyers, barbers, dentists, automobile mechanics and gardeners, among others. That meant multimedia companies would pay at the city’s highest tax rate--a rate far higher than they faced in adjacent areas such as West Hollywood, Culver City and Beverly Hills.

The experience of reforming the city’s tax laws for multimedia firms was sparked largely by DreamWorks, which was interested in locating in Los Angeles but was at first deterred by the tax situation. Ultimately, the Riordan administration succeeded in winning City Council approval for a multimedia tax reform, one that persuaded DreamWorks to commit to Los Angeles and that now applies to all other such companies in the city.

Although critics have accused Riordan of giving away too much in the discussions with DreamWorks, the mayor’s staff and supporters stress that the deal was not targeted specifically to that company but rather was the result of an overall change in the tax structure. And that change, they say, has contributed to the dramatic growth of multimedia employment in Los Angeles, which today has more of those companies than any city in the United States, twice as many as Northern California and New York combined.

The dramatic effects of that exploration into the tax code were reinforced by another source. Since its creation, the mayor’s business team--devoted to luring new industries and convincing others not to leave--has run up time and again against the wariness many harbor for the city’s tax structure.

“Once the business team was established, we were constantly hearing about this,” said La Franchi. “Our tax code hasn’t adjusted to a modern economy, and businesses are the ones feeling that.”

Still, support for tax reform is wide but shallow. Council members, the Chamber of Commerce and the Central City Assn., among others, have expressed their support for a simplified tax code that allows businesses to plan with more certainty.

But it is easier to support the idea of tax simplification when there is no concrete proposal on the table than it is to back an actual proposal. After all, any proposal is likely to have winners and losers, and losers--particularly ones with political influence--are not likely to go away quietly.

Zeroing In on Entertainment Firms

City Councilman Richard Alatorre, who chairs the council’s Budget and Finance Committee, said he expects some companies to end up with higher taxes once the reform process is complete. In particular, he and other officials warned that the city’s entertainment industry, whose firms long ago won a tax cap that limits them to less than $13,000 a year in business taxes, stands potentially to feel the pinch of a new tax system.

“These people in the entertainment industry, they squawk,” Alatorre said. “There is a concern that they have. Is it justified? Yeah, I think it’s probably justified.”

Movie studios successfully lobbied for the business tax cap in the 1930s and have tenaciously clung to it since. They still have a strong argument in that the industry supplies Los Angeles with thousands of jobs, but any overhaul of the city business tax code undoubtedly will raise questions about the production company exemptions.

“I’d be worried if I were them,” said one city official familiar with the tax reform efforts.

Alatorre, whose political success has never relied on entertainment industry support, said opposition from that quarter would not discourage him from pressing ahead. “We have to provide some equity,” he said.

In the mayor’s office, the tax simplification effort is being spearheaded by La Franchi and Deputy Mayor Rocky Delgadillo, both of whom are working with the Milken Institute, the economic think tank established by onetime junk bond kingpin Michael Milken. The institute has designed a model to test various tax reform proposals in order to assess their impact on overall tax collection.

The goal, La Franchi said, is to whittle down 64 tax categories to five or so and to put every business in the city into one of those broader categories. Companies would no longer be designated in overlapping categories but rather by the single category that best describes their business.

The new classifications, supporters say, are intended to be “revenue neutral,” meaning that tax simplification is not intended as a stalking horse for tax increases.

Trying to Encourage Compliance

Some observers are worried that the reforms may not go far enough. Kazden, for instance, warned that merely simplifying tax categories will not necessarily make Los Angeles competitive with surrounding areas. The city’s emphasis on taxing a company’s gross receipts--and its definition of that term--is cumbersome for many firms, Kazden said, urging officials to address that problem as they overhaul the code.

Nevertheless, Kazden and others said they hope that simplicity will have another effect, that of encouraging compliance. City officials today estimate that 20% to 40% of Los Angeles businesses are not complying with their tax requirements. “That’s punishing companies who do pay their taxes,” Kazden said.

Although Riordan aides acknowledge that political opposition to tax reform may mount as the proposal takes shape, La Franchi said the administration is determined to press ahead with tax reform in this term--and to do so quickly.

Administration officials hope to begin presenting reform scenarios next year, completing that process by June and then introducing legislation that would implement the new tax system.

“This is my No. 1 priority,” La Franchi said. “This is something that badly needs to be done.”