Desperate for jobs and revenue, cities have long offered tax breaks to lure companies to set up shop inside their borders or to stop employers from leaving. But in recent years, municipalities have increasingly been getting caught in tax-break bidding wars over the firms they’re trying to woo, as online companies take advantage of California’s arcane sales tax rules to extract ever more lucrative deals. Those arrangements shortchange local residents $1 billion in tax revenue a year.
Here’s typically how the game has been played: Cities agree to generous tax-sharing agreements to persuade companies to build warehouses or sales offices in their jurisdictions, rather than locating somewhere else. These agreements allow companies to keep a sizable chunk — in some cases more than half — of the local portion of the sales tax revenue attributed to the facility. That’s money that could have been spent on public safety, street repairs, affordable housing and other government services.
For example, to lure Ulta Beauty to build an online-order fulfillment center in their city, officials in Fresno agreed to pay the company 75% of the local sales tax revenue generated from the warehouse, according to an investigation by Bloomberg Tax. Sacramento County gives Macy’s 50% of the sales tax revenue produced by its distribution center there. Ontario lets home shopping giant QVC keep 55% of the sales tax it generates from its distribution center in the city.
Why would local governments agree to forfeit so much money? Because California law allows retailers to attribute the sales taxes they collect from online purchasers anywhere in the state to the jurisdiction where their warehouse or sales office is located, not to the cities where the buyers live. A warehouse for a big online retailer can thus bring with it not just jobs, but also far more sales tax revenue than a brick-and-mortar retailer that’s just selling locally. A city council may be happy to part with more than half of that revenue, considering how much it would still collect.
These arrangements have created winners and losers when it comes to sales tax proceeds. Traditionally, sales tax revenue has been spread broadly across cities with brick-and-mortar shops. As more people shop online, that revenue is becoming increasingly concentrated in cities with fulfillment centers.
That makes these warehouses tremendously valuable for the host cities, and online retail companies are using their leverage to play cities against each other to score the biggest tax break. The League of California Cities estimates that about 10% of cities and counties have made tax-sharing agreements, which collectively siphon about $1 billion a year from public coffers to corporate profits.
Proposals to change California’s sales tax law to reflect the shift in consumer behavior have gone nowhere. But Gov. Gavin Newsom could still help stop the tax break arms race by signing Senate Bill 531, which would ban new tax-sharing agreements between local governments and companies.
The bill, by Sen. Steve Glazer (D-Orinda), has faced pushback from cities that use tax-sharing agreements. They argue the ban on new deals would hurt their ability to draw jobs and private investment to economically challenged communities. Proponents argue that receiving 50% of something is better than 100% of nothing.
But that assumes companies wouldn’t come without the tax break, which is far from certain — after all, for many of these retailers, the main point of building fulfillment centers is to put their products closer to their customers in California. It also assumes the kickbacks are creating new economic activity, rather than just moving it from one California city to another.
The bigger problem here is that individual cities — hungry for tax revenue and economic development — are hard-pressed to take themselves out of the competition while their neighbors continue to woo warehouses, and while other states continue to offer generous incentive packages to lure companies from California. That’s why state leaders need to intervene and stop the cities’ race to the bottom. While they’re at it, California leaders should work with neighboring states on an armistice or interstate compact in which they collectively refuse to offer such generous tax breaks so companies can’t goad cities and states into offering bigger, pricier subsidies.
Another proposal, Assembly Bill 485 by Assemblyman Jose Medina (D-Riverside), would require that cities disclose more information, including how much tax revenue a project is expected to generate and how many jobs it would create, before approving new tax-sharing agreements. While transparency is better than nothing, AB 485 does little to address the unhealthy competition created when companies go shopping for tax breaks.