Proposition 39 fixes a mistake, not a ‘loophole’

The official name of the commmittee backing Proposition 39 is “Yes on 39 - Californians to Close the Out-of-State Corporate Tax Loophole.” And much of the coverage of the proposition, which would change the way multistate businesses calculate how much they owe California’s tax-meisters, has used the same “loophole” shorthand.

The only problem is, there is no loophole in state law. Instead, there’s a bad policy that lawmakers adopted in 2009, evidently without considering the incentive they were giving companies to expand and hire in other states.

It’s hard to understand the measure without knowing something about the history of how states have taxed businesses that operate inside and outside their borders. In the 1950s, officials from states across the country agreed on a three-part formula designed to apportion a multistate corporation’s profits among all the states where it did business. The goal was to avoid having multiple states tax the same profits twice, or having some profits not taxed at all. The percentage of a corporation’s profits subject to taxation in each state would be based on the percentage of sales made and payroll paid to residents there, as well as the percentage of its property located in the state.

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Over the years, though, some states tinkered with the formula to make themselves more attractive to companies looking to expand or relocate. Two dozen states, including New York and Texas, now base their tax only on the percentage of a company’s sales made in that state (an approach called “single sales factor”). That shift attracts companies away from states that continue to base corporate taxes on the percentage of in-state employees and assets.

California lawmakers proposed to make the same leap in 2009. But in a deal cut to spur passage of a new budget, they agreed to let companies choose whether to pay taxes under the current three-part formula or using the single sales factor. The result was a break for companies that have a lot of employees and property in California, who collectively saved about $1 billion a year by switching to the new formula. Meanwhile, companies with high sales but relatively few employees and little investment here could continue to pay taxes under the three-part approach that was more favorable to them.

It’s hard to call a formula that’s been in place for half a century a “loophole,” which implies an exception or wrinkle that accountants discovered. Instead, consider the change made in 2009 to be a giveway to certain corporations that should have been offset by higher taxes on other multistate businesses, but wasn’t. It was a deliberate choice by Sacramento, and it was a bad one.

You could argue that the change helped keep companies that had made major investments in California from uprooting themselves. But by leaving the current formula in place as an option, lawmakers gave out-of-state companies no reason to expand their investments here. Instead, they could go on treating California as a place to sell, not make, their wares.

Granted, there are plenty of other things the state does to deter companies from locating or expanding here, such as heavy regulatory burdens and a comparatively high corporate tax rate. Ideally, the Legislature would have addressed some of those things as part of a measure to require all multistate companies to use the single sales factor. Instead, we’re left with Proposition 39, which would mandate the shift and dedicate half the revenue temporarily to energy-efficiency projects at public buildings.

Just for the record, The Times’ editorial board has repeatedly called for the state to require all multistate corporations to use the single sales factor, and it has endorsed Proposition 39.

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