For the last decade, businesses in San Francisco have been adamant that the city’s payroll tax is holding back job growth. First, companies must pay the tax when they reach $250,000 in payroll, which discourages new hiring. Second, they must pay it when employees exercise their stock options — a strong incentive for any company considering an IPO to leave the city. SPUR, along with much of the business community, has argued that we should restructure the city’s tax system to remove these disincentives to hiring. Following payroll tax exemptions in 2011 for stock compensation and for businesses locating in the Mid-Market neighborhood, the call for payroll tax reform has sounded again. The city is finally responding, but will this effort lead to real reform?
City Controller Ben Rosenfield and Chief Economist Ted Egan have for the last three months been hard at work designing a replacement for San Francisco’s payroll tax. That tax is currently 1.5 percent of total payroll for every company with at least $250,000 in payroll. This means most businesses pay nothing, because they're too small to qualify. The city has also had difficulty collecting from entities that don’t clearly have “payroll,” including some partnerships, sole proprietors and financial vehicles. As a result, only 7,500 of the city’s 80,000 registered businesses pay the tax. One of the goals of the reform effort is to reduce rates on growing companies by asking all companies to pay something.
San Francisco is the only city in California to levy a tax on payroll; most other cities have some form of gross receipts tax. For all of the complaints about the city’s payroll tax, though, at least it’s simple.
Rosenfield and Egan have developed alternatives and conducted dozens of industry workshops to explore their implications. All proposals at this stage are designed to be revenue neutral (meaning they would create the same amount of revenue as the current payroll tax), but they would broaden the base of payers. In other words, the city isn’t looking for more money, but it is trying to increase the percentage of businesses that contribute.
To make the San Francisco ballot in November, proposed measures must be submitted to the Board of Supervisors by the first week in June. As of this writing, the controller’s office is on schedule to send a final proposal to the mayor and board president by the first week in May. There are currently two distinct proposals: a new gross receipts tax and a revised payroll tax. Below we summarize the main features of each. (You can also download the latest presentation from the controller’s office.)
Option 1: Gross Receipts Tax
Gross receipts taxes are based on a company’s total earnings, as opposed to a percentage of a company’s payroll. Most major cities in California have a gross receipts tax, and no other cities have a payroll tax.
· Uses industry-based rate schedules. Separates the business tax base into six groups, based on industry sectors. This structure mirrors that used in many other California cities but simplifies the structure with fewer schedules.
· Sets progressive rates. Transitions tax rates to a structure in which rates increase as earnings increase. Companies pay a higher rate as they earn more. Conversely, companies pay a lower rate if they earn less.
· Sets marginal rates. Creates tiers of rates that apply only to the range of gross receipts, rather than the entire amount of gross receipts, similar to personal income taxes. For example, a company in schedule 1 would pay 0.1 percent tax on gross receipts from $1 million to $2.5 million and 0.2 percent on all gross receipts from $2.5 million to $25 million.
· Broadens the tax base. Increases the number of businesses paying the payroll tax to 33,500 from only 7,500 in 2010.
Option 2: Revised Payroll Tax
The revised payroll tax proposal retains the current business tax structure but lowers rates in all categories and significantly increases the cost of business licenses.
· Increases business license fees. Retains payroll tax but increases business license fees at all levels. In the current system these fees range from $25 to $500 based on payroll. New rates would range from $150 to $10,000.
· Lowers overall payroll tax rates. As a result of higher license fees and a greater number of payers, payroll tax rates would actually be reduced at all levels. Rates would progressively increase with payroll but top out at 1.2 percent for those with the biggest payrolls.
· Uses progressive rates.Transitions the current 1.5 percent tax rate to a structure in which companies pay a higher rate as they earn more. Conversely, companies pay a lower rate if they earn less.
· Creates special real estate license fees. New rates would be assigned by type of facility. Residential buildings of more than four units would pay per unit, commercial real estate would pay per square foot of space, and commercial parking with more than 100 spaces would pay a flat rate per facility.
· Creates incentives for new businesses. Includes a one-year payroll tax holiday for all new businesses.
· Encourages growing businesses. Multi-year stock option smoothing and a $100,000 annual deduction for all businesses could help businesses grow and thrive.
· Broadens the tax base. Increases the number of businesses paying the payroll tax to 33,000 payers from 7,500.
All of this begs a very important question: What is the best way to transition a tax system that generates $400 million per year? Very carefully. The city is considering a multi-year transition that phases in the new structure in a way that ensures that the city doesn’t lose revenue — or collect too much. Details are not yet finalized, but it could look something like this:
Year | Business Tax Phasing Plan Old Payroll Tax Rate |
New Tax Rate |
1 | 90% | 10% |
2 | 80% | 20% |
3 | 70% | 30% |
4 | 60% | 40% |
5 | 50% | 50% |
Of course, there is always a third option: do nothing. It is still unclear whether a consensus will be achieved in support of a new structure.
Further complicating the process are separate proposals from the Board of Supervisors, including a small business payroll tax exemption introduced by supervisors David Campos and Mark Farrell, and a persistent push to generate new revenues from Supervisor John Avalos and others.
Depending on which path the eventual tax reform proposal takes on its way to the ballot, there are a number of possible outcomes. The mayor could simply choose to put a payroll tax reform package on the ballot by his own signature, in which case the board would have no influence over the content. But what happens if a proposal is carried by the board? Will there be adjustments to specific rate categories? Integration of one or more proposals from the Board of Supervisors? Perhaps even a proposal that generates additional revenue? Of course the more layers of complexity, the lower the chance that the proposal will make it to the ballot.
SPUR has mixed feelings about these proposals. We do not want to drive away firms headquartered in San Francisco, which is a real risk of the gross receipts option. On the other hand, we believe the payroll tax is probably worse. Our hope is that the city can fine-tune the gross receipts option so that it succeeds in building the tax base while keeping San Francisco a viable location for many different kinds of firms.