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Senate report warns of rising cost of tax breaks

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As Gov. Jerry Brown heralded a last-minute tax deal yesterday, a Senate report warned of the unexpected ballooning costs of corporate tax breaks.

Brown and a couple of legislators announced bipartisan agreement in the state Assembly on a plan to tighten corporate tax calculations, generating an estimated $1 billion in new revenue. The money would be funneled back into tax breaks for individuals, small businesses and startup manufacturers.

"By closing a corporate loophole that only benefits out-of-state corporations, we’re providing real and permanent tax relief to Californians," Assemblyman Nathan Fletcher, R-San Diego, said at a press conference with the governor.

The future of the deal, which also maintains a special break for cable companies, is uncertain in the Senate, as the legislative session ends today. Senate Republican Leader Bob Dutton of Rancho Cucamonga urged Brown to call a special session on tax reform instead of "trying to jam through a proposal on the last day of session without transparency or input from the public and tax experts."

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At the same time, a new report by the state Senate Office of Oversight and Outcomes warned of the unintended consequences of past tax deals. The report [PDF] said some tax breaks have turned into "blank checks," costing the state much more in lost revenue than originally predicted. It found that major tax breaks to businesses cost the state $1.3 billion more than expected in the last fiscal year and $6.3 billion over the last decade.

"Unlike direct government spending, most tax expenditures are not capped or reviewed by lawmakers when they write budgets," the report states. "While spending programs are subject to annual review in the state budget, the foregone revenue from tax expenditures can swell far beyond initial projections with little notice."

The report noted that tax breaks often are drafted in last-minute deals, with projections that rely on old data, and it can be hard to foresee how businesses – armed with tax consultants – will take advantage of them.

"To me, the Senate report is the argument against the (governor's) tax deal," said Jean Ross, executive director of the California Budget Project, which focuses on the working poor. "I fear that the provisions in the deal announced today could very well end up with the same kind of cost overruns that the Senate report documented."

Kris Vosburgh, executive director of the Howard Jarvis Taxpayers Association, said he doesn't support corporate tax breaks at the expense of other taxpayers. But he questioned the reliability of the Senate report.

"Senate reports tend to be self-serving," Vosburgh said. "Anytime a body that is so dominated by one party produces a report like that ... it cuts into the credibility of the report, no matter what it says."

The Senate report recommends creating a commission to annually review the costs, impacts and public policy value of tax breaks. Report author John Hill also suggested that tax credit provisions include time limitations.

"My research showed that when you have caps or you have sunsets or dollar amounts that you’re not going to go beyond, that you don’t have this problem," Hill said.

The biggest unexpected loss of state revenue, according to the report, was a tax credit meant to encourage companies to spend more on research and development. The R&D credit is one of the most generous in the nation, but its effectiveness is unknown, the report states.

The California Chamber of Commerce, on the other hand, supports the R&D credit and has pushed for expanding it, arguing that it helps California compete with other states and stimulates the economy.

The Senate report also details the unexpected result of a 1993 tax formula called the "double-weighted sales factor." The formula, which was meant to benefit companies with operations in California, gave more weight to sales, as opposed to payroll and property, in calculating corporate tax liability. While the changed formula was projected to boost tax revenue by $15 million a year, it ended up costing the state an average of $200 million annually, according to the report.

That policy was replaced by another, which went into effect this year, allowing multi-state companies to chose how to calculate their tax burden, using either a multi-factor formula or what's called the "single sales factor," which calculates taxes based only on California sales.

That policy, said Hill, is potentially another "big blank check."

"It’s open-ended," he said. "Nobody’s quite sure how businesses will respond to it or how they’ll maximize their use of it."

Brown calls the current policy a "toxic tax loophole" that he is seeking to close by making the single sales factor mandatory.

The state Department of Finance projects $1 billion in additional state revenue from the change, which would be used for other tax breaks. The new breaks would include increasing the standard tax deduction for individuals, cutting taxes on small businesses that file as personal income taxpayers and offering a sales tax exemption for manufacturing.

Brown, in announcing the tax deal before securing the necessary votes in the Senate, maintained his sense of humor, saying, "We celebrate small victories."

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