By Marc Salomon, guest editorial
November 30, 2009
Jobs, jobs, jobs. That’s what’s on everyone’s mind as the economy struggles to find its new level after the bubbles have popped, real unemployment hits 20 percent and a “jobless recovery” sets in. What can San Francisco do now to retain and create jobs?
We’ve seen flash-in-the-pan public initiatives that would try to position San Francisco to take advantage of each fashionable “Next Big Thing,” but those have been about as ephemeral as the bubble economy from which they arose. City technocrats have tried to craft an economic development plan, but like every planning effort in San Francisco, by the time the plan is complete, the assumptions upon which the plans are based are no longer valid.
San Francisco needs to look no further than the business tax structure to find a relatively simple way to encourage job creation and retention while providing a greater degree of certainty to businesses and stability to the City’s revenue stream than current arrangements offer.
Until 2001, San Francisco had a dual business tax structure where a firm was required to pay the greater of a payroll tax or a gross receipts tax. Under the advice of then City Attorney Louise Renne, and over the objections of progressive attorneys on the Board of Supervisors at the time, Matt Gonzalez and Gerardo Sandoval, as well as Chris Daly, the City settled a lawsuit on behalf of the largest, most profitable companies rooted in the possibility that a business might be unfairly taxed under certain theoretical scenarios. The settlement eliminated the gross receipts tax, leaving the payroll tax as the City’s sole business levy. Not only did the City float almost $90 million in bonds to pay a settlement to these firms, the settlement resulted in an effective tax cut of tens of millions of dollars per year for the biggest businesses.
Taxation is the primary tool local government can use to influence the economy. Public sector taxation and spending policies can change the habits of businesses by associating penalties or benefits to certain conduct. The current business tax rate is 1.5 percent of payroll expenses. Businesses that would pay $2,500 or less in payroll taxes, that is firms with payrolls less than $166,667, are exempt, as are nonprofits, skilled nursing facilities and biotechnology firms.
With San Francisco’s tax on payrolls, every time a business hires someone, or raises a salary, it increases its payroll tax burden. That policy discourages the creation of jobs in general, the retention of skilled employees, and of better paying jobs in particular because a firm’s tax burden rises as head count and salaries rise. San Francisco needs tax reform designed to encourage employment that shifts the burden from a narrow base of labor and payrolls towards a broader base of aggregate business activity
Currently, small businesses are exempt from paying the payroll tax. A business license fee is required, but is very inexpensive for small firms. The sales tax is passed directly on to customers. Voters have mandated living wages, health benefits as well as sick time for employees working in San Francisco, and these do impact business’ bottom line, especially low margin firms. These pro-worker policies also put more money in the local economy, generating more customers for local business and prevent the spreading of illness which also saves public and private dollars.
The gross receipts tax is a best practice to capture the totality of business function, because it applies to the full-range of activities that a business conducts. That range of activity generally correlates with the impact of the business on infrastructure which is provided by the public sector and facilitates business operations. The size of a firm’s payroll does not reflect the full cost to the public sector to maintain infrastructure used by business. A businesses’ receipts come closer to an accurate accounting of such impacts. A broader base of taxation can also provide more stable revenue because it is not dependent upon a single aspect of the conduct of business, employment.
San Francisco has been tabulating gross receipts data for several years now in anticipation of a shift. With unemployment past pandemic levels, it is time now to replace the payroll tax with a gross receipts tax to begin to turn the tide.
The City should also reverse course and encourage employment by offering a vigorous subsidy for job creation and retention in the form of a tax credit against the gross receipts tax for all full-time salaried employees with benefits who work an entire calendar year for a firm. The City should explore an even more attractive tax credit for businesses that hire and retain San Francisco residents.
One caveat about a gross receipts tax is the potential to disproportionately harm firms with low margins. It is not equitable to treat firms with high gross receipts, low profits and many employees the same way as a white collar firms which tend to have higher margins. Firms that operate similar to gas stations, as an example, which buy their product for pennies per gallon less than the price at the pump, should not be hit with a tax equivalent to their profit. The gross receipts tax rate should directly relate to a firm’s margin, but that tax rate should be applied against the aggregate receipts, not just profits. Ideally, we’d want to get the most out of those who make the most and return the least, high margin enterprises that employ few people while encouraging lower margin businesses such as restaurants which hire more people by taxing those firms less.
Ideally, we’d transition from the payroll tax to a gross receipts tax immediately, but without hard gross receipts data that might unfairly burden certain business classes. Thus, a short transition over a period of a few years would be preferable, with the burden shifting in steps from payroll to gross receipts by equal measures every year until the gross receipts tax generated the same amount of revenues as the current payroll tax and the payroll tax was finally eliminated.
After that, the gross receipts tax would rise in one final step to restore those revenues lost in the settlement of 2001 and achieve net revenue neutrality and would restore tax revenues to the level prior to the settlement. Given the gravity of the immediate crisis in municipal finance that is happening across the nation, if consensus could be developed that would allow the final step to be taken first, and the first increment of the gross receipts tax were levied before beginning to cut the existing payroll tax for one year, then the gross receipts tax would be an important means to help San Francisco resolve its pending $522 million fiscal deficit next year.
The devil, of course, is in the details and the economy is nothing if not as complex as tax policy is arcane. Care must be taken to do no harm. The City would need to determine the appropriate tax rates. Appeals processes would need to be devised. The Board of Supervisors should be authorized to ratchet the tax rates downward in the case of any egregious unanticipated consequences. Fortunately, the City need not start from scratch and can dust off the repealed gross receipts tax as a point of departure.
Economically, small businesses should ideally pay something. But if it is not politically feasible to tax small businesses at the lowest rate, because of the burden of other voter mandated benefits, then the existing exemptions should be maintained. The mechanism for a tax credit for job creation and retention would need to be thought through to be in balance with revenue models, and loopholes should be anticipated and plugged.
San Francisco must act on its own since Sacramento and Washington have neither the inclination nor the capacity to fix our finances. We must take care to assiduously protect our own economic interests to make sure that we do what we can to stem the tide of job losses with policies that are industry agnostic yet reflect the realities of various business models. Most importantly, we need to put San Franciscans back to work first. The best step we can take right now towards job creation and retention is to stop taxing labor by transitioning to a fair and equitable gross receipts tax.
Marc Salomon is an unemployed computer programmer/analyst.
The Hunger Site
December 11, 2009 at 11:06 pm
Arthur,
Actually there is no proven link between the presence of housing and activated ground floor commercial although the practice holds the status of planning gospel. Even at the height of the boom, there was significant vacancies along many commercial corridors in the Eastern Neighborhoods. The problem with planning economics is that it is a faith based initiative that is too interested in serving the interests of developers to tolerate any empiricism.
I believe that in 2004, the Mayor and Board passed legislation or agreed that they would that would have lowered the tax for certain classes in an effort to pass a very low gross receipts tax. My goal in writing this piece is to spur discussion on how to learn from 2004 to win something that holds broad consensus in 2010. I appreciate that you’ve contributed.
We don’t get anywhere in this legal system unless we try to figure out how to run the gauntlet without losing all of our blood, no guts, no glory?
I don’t mind being proven wrong if I am able to learn from that and not repeat the mistakes. This approach to a shift from the payroll to the gross receipts tax has many empirical benefits and few downsides and tries to learn from past failure.
-marc
December 11, 2009 at 9:25 am
marc,
Thanks for your additional thoughts.
You say:
“… Prop 13 puts a horizon on the ability of residential property in particular to generate tax revenue … housing does not pay for itself in up-front infrastructure costs nor downstream with property taxes for city operations.â€
Even so, the development of empty lots into neighborhoods encourages the emergence of new businesses. They pay taxes, and consumers who buy from them pay sales taxes.
You say:
“The Board of Supervisors and Mayor can always tweak taxes down after they’ve been approved by the voters …â€
I’ve rarely, if ever, seen the politicians tweak taxes down.
You say:
“the tax rate would be based on profit, which needs to be sussed out legally.â€
Good luck with that!
You say:
“Milton Friedman would have us fellate corporations as the sources of all that is good in society.â€
Unlike Richmondman, I’m not an admirer of Milton Friedman. The existence of corporate monopolies, exercising a huge influence on both government and industry, is one of the great evils of modernity.
You say:
“We’ve got to get past the ideological descendants of Marx and Locke fighting it out for their third century running.â€
We agree on this point, although both Marx and Locke were great intellectual innovators in their times. Their followers, however, created sects in their names.
The key to understanding things is to be open to new facts and adjust theories accordingly. The wrong approach is to clutch onto dogmas and avert eyes away from facts.
December 9, 2009 at 4:10 pm
Here are two examples of rate formulae:
rate = ( margin / n ) + k
n = 5, k = 0
Margin Tax Rate
1% .2%
5% 1%
8% 1.6%
10% 2%
15% 3%
20% 4%
30% 5%
n=4, k=-.15
Margin Tax Rate
1% .1%
5% 1.05%
8% 1.6%
10% 1.85%
15% 3.55%
20% 4.8%
30% 7.3%
Formulae could be constructed with a variety of policy goals in mind. These are two simple examples to demonstrate the concept.
-marc
December 9, 2009 at 4:06 pm
Arthur, actually Prop 13 puts a horizon on the ability of residential property in particular to generate tax revenue as assessments are restricted for the duration of ownership. This is, paradoxically, more of a problem for rental which rarely if ever turns over than for condos, as rental tends to allow for both affordability and for greater labor mobility while purchase tends to be more expensive and more restrictive. The Planning Department stipulates to the fact that housing does not pay for itself in up-front infrastructure costs nor downstream with property taxes for city operations.
The proposal is for businesses with big gross receipts and lowest margins to pay the lowest tax rates. The Board of Supervisors and Mayor can always tweak taxes down after they’ve been approved by the voters, and if there are any cases of injustice where the gross receipts are so big and even the lowest tax rate is too much, there are remedies and business tends to get listened to at City Hall on matters such as this.
Again, the tax base is the gross receipts which is legal, and the tax rate would be based on profit, which needs to be sussed out legally.
Milton Friedman would have us fellate corporations as the sources of all that is good in society. I’d prefer a tax system that did not kick corporations in the gut whenever they made payroll to Friedman’s Randian libertariatopia.
There so is much more to freedom outside the libertarian precincts than the right to accumulate massive amounts of property. Most people will not, so will never attain “freedom,” although they remain “free” to not become free no matter how hard most try.
We’ve got to get past the ideological descendants of Marx and Locke fighting it out for their third century running.
-marc
December 4, 2009 at 9:58 am
Residents are consumers and workers. However, when Government interferes with freedom of people to voluntarily enter into commerce, they ultimately take freedom away from their constituents. For example, if Government either requires or prevents workers from joining unions, they are promoting monopolies. It benefits some people at the expense of others. My wife is a school teacher. She disagrees with many poliicies of the union, and would prefer not to be a member, but she is required to join and pay them almost $100 per month for the “privelege”. Another example – there are 27,000 workers employed to support 700,000 residents. Do our elected representatives work for the benefit of the 24,000 (many of whom reside in other communities), or the 700,000 who live here? They are fighting to prevent the layoffs of 500 workers, when many residents believe there should be many more layoffs than that. Tax laws are written primarily by and for the benefit of the wealthy (and tax lawyers), and simplification of all taxes and tax laws would be in the best interest of all.
December 3, 2009 at 4:02 pm
Brief responses for marc & Richmondman:
* * * * *
marc,
We seem to agree on a number of basic principles. The difficulty lies in the details.
You say:
“Eastern Neighborhoods is one of the largest development plans yet put forth. It would have an impact that is much less than fiscal policy.”
Maybe. Then again, when neighborhoods are developed and stay prosperous, they continue to generate wealth for the city for many decades. That’s true regardless of the particular taxes in place.
You say:
“In the instance of a firm that lost money, they would pay gross receipts tax at the lowest tax rate, which might end up being zero or close to it.”
Fair enough. But what about businesses that have only modest profits but with big gross receipts?
If you introduced a formula to take these gradations into account, you would end up with an income tax disguised as a gross receipts tax. I doubt that the courts would let it stand, if income taxes are forbidden to CA municipalities.
You say:
“To the extent that the City can do what it is able to encourage employment, we can help maintain or increase consumer demand in the form of providing small businesses with more customers.”
Agreed! The question here, though, is whether the details of your proposal will accomplish that goal, and whether the courts will let the details stand.
You say:
“In the case where labor is taxed, they would tend to avoid hiring and avoid increasing payroll. If those tax disincentives to employment were removed, then we would see some job growth.”
We agree that a tax that is based on the size of the payroll is counterproductive to job creation and economic growth. The question is the best way to correct the problem.
* * * * *
Richmondman –
You say:
“All government actions should promote business and employment growth to the benefit of its residents. Period.”
Not so fast! Government also has an obligation to protect consumers, workers, and the natural environment.
We tried laissez-faire capitalism in the 19th century. The results were catastrophic.
All businesses should be regulated with an eye toward the common good.
December 3, 2009 at 1:05 pm
All government actions should promote business and employment growth to the benefit of its residents. Period. Glad to see you are coming aroud to Milton Friedman’s philosophy. Remove all of the bureaucratic BS needed to open and operate a business in SF.
December 3, 2009 at 8:27 am
Arthur, you said that more development would have a large impact on the economy. Eastern Neighborhoods is one of the largest development plans yet put forth. It would have an impact that is much less than fiscal policy.
The existing payroll tax has a floor under which small firms are exempt. I would assume that there would be a similar escape valve for small businesses. In the instance of a firm that lost money, they would pay gross receipts tax at the lowest tax rate, which might end up being zero or close to it. Just because a firm is losing money does not mean that it operates with impacts on public infrastructure. There is a balance there that needs to be maintained.
Economists agree that a main problem of the current economic quandary is low demand. Demand is created by employment. Workers drawing reliable paychecks by stuff. To the extent that the City can do what it is able to encourage employment, we can help maintain or increase consumer demand in the form of providing small businesses with more customers.
Economists also agree that tax policy has an effect on the conduct of business. They tend to adapt their purchasing and spending to avoid tax. In the case where labor is taxed, they would tend to avoid hiring and avoid increasing payroll. If those tax disincentives to employment were removed, then we would see some job growth.
Shaky businesses are already under tax pressure. That pressure discourages employment. San Francisco should change the tax pressures that businesses face so that they get tax relief for hiring, not for firing.
-marc
December 2, 2009 at 11:07 pm
marc,
I’m getting a better idea of your plan as you provide more details. But some of the details seem beside the point. And some of the conclusions seem shaky.
Let’s see if we can clarify the situation.
You say:
“My recollection was that Eastern Neigborhoods would have created $3.5b maximum in new value out of thin air due to height increases. Most of that money leaves San Francisco, some of it stays.”
How does this claim relate to the topic of discussion?
You say:
“The goal of a gross receipts tax is to figure out the broadest base of the economy and identify the lowest tax rate which can cover that breadth and still provide revenue.”
That’s a good goal! However, as noted earlier in this thread, a tax on gross receipts is unfair to shaky businesses that show losses in profits despite having high gross receipts.
On the other hand, if the tax is tweaked to account for this unfairness to shaky businesses, then it becomes an income tax, which you say is illegal.
You say:
” a shift from payroll to gross receipts is a middle of the road position in San Francisco, and during a time of economic hardship and job losses, we cannot afford to wait for Sacramento to maybe act.”
How will increasing the tax pressure on shaky businesses promote recovery from the Great Recession?
You say:
“this proposal to shift the tax base from payroll to gross receipts does not raise taxes … My proposal is revenue neutral.”
Then how will it make any overall difference to the city’s economy?
In fact, the change will be to put greater stress on shaky businesses, as noted.
You say:
“The City needs to step in to ensure that local demand is fortified so that the deflationary cycle at least in San Francisco stops now. We can do this by changing fiscal policy to encourage payrolls …”
We keep coming back to this basic point: Increasing the tax pressure on shaky business will not encourage the survival of these shaky businesses. If they go out of business, all their employees will lose their jobs. Such a development does not encourage the creation of jobs.
On the other side of the same coin, if the gross-receipts tax is tweaked into a disguised income tax, it will be open to court challenges.
I dunno. I’m not convinced.
December 2, 2009 at 12:17 pm
Arthur,
All governments levy taxes. My assertion was that how taxes are crafted has the greatest impact that government can have on the economy, aside from levels of direct spending that we can’t even approach in San Francisco.
There might be a case for more, higher taxes, or for fewer, lower taxes, but that is not the subject of this piece.
The SF economy in constant 2000 dollars is $86b. Adjusted for inflation, that is $102b in 2007 dollars.
My recollection was that Eastern Neigborhoods would have created $3.5b maximum in new value out of thin air due to height increases. Most of that money leaves San Francisco, some of it stays. That’s like 60% of the annual SF budget spread out unevenly over several decades if the real estate finance economics under which those plans were developed applies as the economy finds its new level. That number is probably orders of magnitude less relevant to the local economy than a tax system that generates some ~$300m/yr or so.
The goal of a gross receipts tax is to figure out the broadest base of the economy and identify the lowest tax rate which can cover that breadth and still provide revenue.
Perhaps state law should be revisited to allow localities to tax profit. But a shift from payroll to gross receipts is a middle of the road position in San Francisco, and during a time of economic hardship and job losses, we cannot afford to wait for Sacramento to maybe act.
The mechanics of a firm submitting lines from their tax returns are pretty well established. The state already collects this. Moving parts are to be avoided, but this moving part is pretty constrained and well understood.
The nature of a firm’s expenses is really irrelevant to its margin or gross receipts. The one major exception to this is payroll, which we might want to exempt from consideration as the gross receipts number because employment is a desired response to a gross receipts tax system.
Arthur, this proposal to shift the tax base from payroll to gross receipts does not raise taxes any more than allowing the Bush tax cuts to expire raises taxes. My proposal is revenue neutral and cures the de facto tax cut attendant to the legal settlement.
The Federal Government is taking a hands off approach to saving jobs. The City needs to step in to ensure that local demand is fortified so that the deflationary cycle at least in San Francisco stops now. We can do this by changing fiscal policy to encourage payrolls, and by taking care to prevent layoffs of City employees by cutting hours instead of jobs.
This idea has been around for some time, will probably win the support of the business community if crafted thoughtfully, and really deserves a turn at the ballot box.
-marc
December 2, 2009 at 10:51 am
marc,
Thanks for clarifications. I have a better understanding now of your proposal.
Still some concerns, though.
You say:
“Taxation is the primary, (operative word: primary) way that local government can influence the economy.”
This is a value judgment. By stressing taxation as the primary tool, you encourage politicians to think of new ways to levy taxes.
But you could equally well stress the creation of a business-friendly environment as the thing that influences the economy.
For example, streamline the approval process, relax zoning restrictions, cut government spending to allow more of the city’s wealth to be available for other uses, etc.
This approach is also a value judgment. It encourages politicians to have a positive, encouraging attitude toward commercial creativity, which is what generates wealth.
You say:
“State law prohibits taxation of profit by localities, so there have to be proxies that get at that number.”
The state prohibition should be revisited. CA cities suffer by not being able to tax profits, especially excessive profits.
You say:
“My suggestion is that the profit rate be used to determine the tax rate on gross receipts.”
The mechanics of the process are complicated. Which means lawsuits.
You say:
“If a firm were making debt payments, then those debt payments would be accounted for as expenses which would lower the margin and hence the tax rate.”
There are many other factors involved in profitability besides debt payments. For example, advertising costs, legal expenses, cost of raw material, labor rates, etc.
It gets sticky.
You say:
“I don’t try to address everything else in this piece, just the role that the business tax structure plays with respect to the employment climate.”
Encouraging the idea of increasing taxes will not play well during the Great Recession.
December 2, 2009 at 8:01 am
Arthur,
Taxation is the primary, (operative word: primary) way that local government can influence the economy. There are other means, but they are not as effective and they should be reserved for another discussion.
State law prohibits taxation of profit by localities, so there have to be proxies that get at that number. My suggestion is that the profit rate be used to determine the tax rate on gross receipts. That level of indirection would probably pass muster under state law.
If a firm were making debt payments, then those debt payments would be accounted for as expenses which would lower the margin and hence the tax rate. Further tweaking might be required, but more moving parts means less elegance. Elegant policies with few moving parts are easier to implement.
I agree with you that Jeff Adachi is taking the right approach to dealing with structural defects in San Francisco’s budget. I don’t try to address everything else in this piece, just the role that the business tax structure plays with respect to the employment climate.
-marc
December 1, 2009 at 9:54 pm
Marc,
Thanks for the thoughtful article. Some observations –
You say:
“Taxation is the primary tool local government can use to influence the economy.”
What about the hundreds of millions of dollars that the city pours into nonprofits every year, with no performance standards to judge their productivity? Doesn’t that practice affect the economy?
What about reducing the bloated annual budget of $6.6 billion for the city’s bureaucracy? Doesn’t that drain on citizens’ resources affect the economy?
What about creating a climate that is conducive to the creation of new businesses? Doesn’t the lack of such a climate affect the economy?
What about the city’s huge costs due to bloated pensions? – which Jeff Adachi has called attention to. He says these costs will soon eat up much of the city’s budget. Won’t that development affect the economy?
You say:
“The gross receipts tax is a best practice to capture the totality of business function, because it applies to the full-range of activities that a business conducts.”
The gross receipts tax ignores the fact that a business can incur debts and operating expenses that exceed its receipts. A business can have a large amount of gross receipts yet be on the verge of bankruptcy.
A fairer approach is a tax on profits, not gross receipts.
You say:
“The gross receipts tax rate should directly relate to a firm’s margin, but that tax rate should be applied against the aggregate receipts, not just profits.”
What does this sentence mean?
November 30, 2009 at 11:33 am
Nice article, not sure I often or ever agree with what Marc says but here I can not agree more. As I was reading down I started to ask myself questions about High Margin companies and the next paragraph Marc address those concerns.