Tax Break for Insurers Is OKd

SACRAMENTO -- Brushing aside the recommendation of its own legal staff, a lame-duck State Board of Equalization voted Wednesday to give the insurance industry a tax break that will cost California’s financially troubled state government about $220 million in revenue.

The unanimous decision of the five-member board -- three of whom will leave office in January -- was a victory for companies that write workers’ compensation policies and a slap at a sister state agency, the Department of Insurance, which had recently assessed the tax.

Shortly after the vote, Insurance Commissioner Harry Low issued a statement saying he believed that the board had erred in its decision and would urge Commissioner-elect John Garamendi, who takes office in January, to appeal it.

The importance of the decision was heightened by an announcement from Gov. Gray Davis an hour before that the severity of the state’s fiscal condition has worsened dramatically. A revenue shortage believed to be about $21 billion had climbed to about $34.8 billion.

But equalization board members said they could not condone a tax that was being imposed on the industry retroactively and without a public hearing.

“They should not just be hit with this cold,” said board member Johan Klehs. “It seems there is something inherently unfair about that.”

The core of the dispute is an arcane tax of 2.35% -- called the gross premiums tax -- that insurance companies pay on the premiums they collect for providing various coverage. It became an issue for state officials when a 1995 law allowed workers’ compensation carriers -- those who provide coverage for injured workers -- to offer cheaper policies to businesses that agreed to reimburse them for claims up to a specified amount.

Larry White, senior staff counsel for the department, said at the time that then-Commissioner Chuck Quackenbush was advised by his legal staff that these reimbursements made by businesses to insurance companies should be taxed as part of the premium. But, he said, Quackenbush decided not to impose that portion of the tax.

After reviewing the law, Low, a former appellate court judge who succeeded Quackenbush, concluded that the full tax should have been imposed and advised insurance companies that they owed the additional tax retroactive to 1997.

The department estimated that the revenue from the retroactive tax payments would provide $220 million to the state to help pay for such things as schools, prisons and social services. In future years, it would bring the state about $50 million in additional revenue.

The industry immediately filed a protest with the Board of Equalization, an elected body that administers several of the state’s taxes and hears appeals on tax issues.

Many large businesses joined insurers in urging the board to overrule the Department of Insurance.

“This change in tax policy could not have come at a worse time for California businesses and employees,” a vice president for Dallas-based Southwest Airlines wrote the board.

“The proposed change will significantly increase the financial burden of doing business in California,” the executive added.

Richard Martland, a lawyer for Wausau Business Insurance Co., argued that the Legislature never intended for the industry to pay a tax on the reimbursements and warned the board that any additional tax imposed on insurers would be passed on to businesses and corporations like Southwest Airlines that already are reeling from a sluggish economy.

“This is a real hit on the employer, which I don’t think the Legislature intended,” he said.

The board’s legal staff disagreed, saying that its analysis of the law showed that it should rule against the industry.

“We conclude the ... reimbursements are part of gross premiums and subject to tax,” its legal staff advised in a nine-page recommendation.