Weighing the Economic Benefits of the “Single-Sales Factor”

Three times through July 16, Gov. Arnold Schwarzenegger has publicly touted a study praising the economic benefits of a change in tax law favoring businesses operating in multiple states that was enacted as part of the February 2009 budget.

The study by Charles Swenson, a Marshall School of Business professor at the University of Southern California, assesses the impact of a tax break Republicans demanded in return for providing Democrats with enough votes to reach the two-thirds majority required to pass a budget.

Swenson concludes that the change in tax law will create at least 144,000 new jobs and increase state revenue by $411 million. The state Franchise Tax Board says the law change will cost the state $900 million in lost corporate taxes in the fiscal year beginning July 1, 2012.

For companies doing business in more than one state, California currently uses a formula comparable to that of 33 of the 46 states that have a corporate income tax. Taxes that multi-state businesses pay are based on a combination of the sales, property and payroll located in each individual state.

Different states weigh the three factors differently. California has a “double-weighted” sales factor, which means sales account for 50 percent of the company’s taxable California income while property and payroll represent 25 percent.

Under the new law change, starting in the 2011 tax year companies will be given the choice of either basing their taxes on sales alone or the current mix of the three criteria.

Among the supporters of the tax change are Silicon Valley companies, biotech firms, drug makers and media conglomerates like Time Warner and Walt Disney.

A group called California Competes, which includes many of the beneficiaries of the change in tax law, commissioned Swenson’s study.

Such a shift in tax calculation will “stimulate business and industrial growth in the state as measured by increased employment, help attract business into the state, help retain and expand business and industry and create increased job opportunities for all Californians,” Swenson concludes.

Schwarzenegger, who proposed postponing implementation of the move to what’s called a “single sales factor” in his January budget if California didn’t receive enough federal money to close its cash shortfall, abandoned the idea in his revised budget in May.

Now, he’s an avid supporter of keeping the law as is. When the report was issued, the GOP governor said this:

“As budget negotiations move forward, it is vital that the Legislature continues to recognize the importance of the economic stimulus measures adopted last year because California’s private sector is the key to our economic recovery,” Schwarzenegger said in a statement when the study was released.

“The single sales factor makes it easier to do business in California and will play an integral role in encouraging companies to locate, invest, create jobs and generate revenue right here in California.”

On July 15, the governor’s press secretary, Aaron McLear, sent out the June 24 press release again with a note saying:

“Today marks one month past the Legislature’s deadline to pass a budget and so far all we’ve seen is a two-page outline of possible solutions from Democrats. “While we wait for a plan from the Democrats, I wanted to remind you of this study about the jobs created by the Governor’s economic stimulus measures, which they have proposed to eliminate.”

The budget plans proposed by legislative Democrats do not eliminate the elective shift to a single sales factor; they propose to postpone its implementation date by two years because of the state’s fiscal condition.

On July 16, Schwarzenegger mentioned the study again in a statement regarding California’s 12.3 percent unemployment rate in June.

“A recent USC study found that just one of the bipartisan economic stimulus measures passed in last year’s budget – the single sales factor – will create nearly 144,000 jobs. That, and incentives such as the sales tax exemption on green tech manufacturing equipment are the sorts of efforts that will encourage employers to hire and move our recovery forward. I encourage the Legislature to remember this as they negotiate the budget.”

Swenson’s study is based on the experience of five other states that now use a single-sales factor in calculating the taxes of firms doing business in multiple states. Those states are: Georgia, Louisiana, New York, Oregon and Wisconsin.

Unlike California, in those states the single sales factor is mandatory, not elective.

In an interview, Swenson said that while his study only considers use of the single sales factor as mandatory, California’s elective system would have even more economic benefit.

“If it’s mandatory, some companies benefit and others don’t,” Swenson said. “If you go to an elective system where no firms are going to be hurt and don’t have to shed jobs, you’re actually going to see more job growth than what I have in my report.”

At the end of his executive summary, Swenson cites a May 26 Legislative Analyst’s Office assessment of shifting to a single sales factor. Of the analyst’s report, Swenson says:

“They noted that the (single-sales factor) promotes job growth and that the absence of a (single-sales factor) would put California firms at a competitive disadvantage.”

Swenson does not say that the Legislative Analyst recommends making the single sales factor mandatory, in part because it reduces the corporate tax revenue loss to the state and because the ability to choose which formula is most beneficial “arbitrarily favors firms with disproportionately high or low California sales relative to property and payroll.”

Being able to switch formulas from year to year depending on whether they have a net profit or loss means those companies would pay less taxes than a multi-state business with a more even division betweens sales, property and payroll and businesses that operate only in California, the analyst says.

As Senate Democrats propose, the analyst recommends pushing off implementation for two years given the state’s cash-poor fiscal condition – one year longer than Schwarzenegger proposed in his January budget.

Searching for Swenson’s study on the Internet, it is most easily found at the website of the opponents of Proposition 24, a measure on the November ballot that would repeal the single sales factor shift and two other business tax breaks from the February 2009 budget.

Opponents of the proposition, most of whom benefit from the tax change, include a number of members of California Competes, which paid for Swenson’s study.

Proposition 24 has so far been bankrolled largely by the California Teachers Association. The constitution guarantees public schools at least 40 cents of every $1 flowing into the state general fund.

“Save Our Schools: Close Corporate Tax Loopholes!” is how the proposition’s supporters frame the issue.

A reduction in corporate tax collections of $900 million, the estimated impact of full implementation of the elective single sales factor change, means a loss of $360 million in potential support for public schools.

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