Proposition I - Business Tax

What it does

Several companies have challenged the legality of San Francisco’s business tax. If the firms are successful in court, they would expose the city to a $800 million liability. Proposition I is intended to cure this legal exposure by amending the business tax so that all companies pay a payroll tax instead of a gross receipts tax. It would retroactively refund three years’ worth of the difference between the old and new systems to companies who would pay less under the amended system. Proposition I was placed on the ballot by the Mayor.

Why it is on the ballot

For over 30 years, the city has had a business tax consisting of either (a)gross receipts tax with a tax rate of $1.23 to $3.00 per thousand dollars of gross receipts, which varies by industry type or (b)payroll expense tax of 1.5%. The company pays the higher tax resulting from the two tax calculations. This system of paying either a payroll or a gross receipts tax is known as an “Alternative-Measure” system.

Pros

• Because of the lawsuit, the city literally had no choice but to do something like Proposition I. It is a proactive effort to correct possible discriminatory defects in the current business tax system, thereby, eliminating the plaintiff’s grounds for the lawsuit and $800 million in administrative claims. It protects city revenues for public services.
• For some small business there is a reduction in registration fees and for all taxpayers the proposition simplifies some administrative details.
• The new system protects small business by retaining the small business exemption, insuring that the 62,000 businesses remain exempt and do not pay taxes.
• Prop. I is convenient; it will consolidate deadlines for annual registration and tax filing.

Cons

• Even with passage of the proposition, the plaintiff’s are likely to continue with their lawsuits. It is unclear whether the courts will find the city’s remedy sufficient.
• The floating payroll expense tax may hinder job retention during economic recessions because it raises the tax rate during hard times.
• The floating tax rate doesn’t make sense. In general, payroll taxes correlate directly with the demands on city sources such as transit, so a consistent tax rate would be more logical.
• Prop. I shifts the tax burden from large out-of-town companies who sell products in San Francisco to local business who employ people here.

SPUR's analysis

If a company’s tax liability is less than $2,500, it is exempt from either tax under a small business exemption. There are also tax credits for job creation in enterprise zones and credits for other job retention and creation efforts.

Approximately 70,000 businesses are registered with the city. All of these firms pay a registration fee that is separate from the business tax. Due to the small business exemption, only about 8,000 businesses actually pay a business tax. Approximately four out of every five businesses pay under the payroll expense calculation rather than under the gross receipts calculation. The city annually collects $259 million in business taxes, consisting of registration fees ($10 million), gross receipts taxes ($37,000 million) and payroll taxes ($212 million).

Last year, General Motors, Kodak and several local companies sued the city claiming that the city’s business tax is unconstitutional. They argue that the Alternative-Measure business tax discriminates against interstate commerce because a local company may be exempt from a tax that a non-local company paid. Under this argument, the city can maintain only a single-measure business tax. A complex chain of motions, a ruling against the city, and a new ruling in a Los Angeles Unocal business tax case has caused the city to propose Prop. I. The city believes it will address the lawsuit issues and potential tax refund liability, estimated at $800 million (which by way of comparison is roughly equal to the city’s annual expenditures for police, fire and public health combined).

The U.S. Supreme Court has held that a city retains flexibility in responding to a judgment that a tax is inconsistent with the commerce clause of the U.S. Constitution. A city must make sure that local and non-local companies are treated equally. To date, the trial court has not found that the city’s business tax method discriminates against any taxpayer; therefore the City Attorney’s office believes a refund as sought by the plaintiffs is not appropriate. Even so, the city believes it is prudent to revise the tax in light of the plaintiff’s claims through making the tax system a onemeasure tax.

Its passage could eliminate a devastating financial liability that could jeopardize city services. The lawsuit has put the city in a very difficult position. While there is no guarantee that the legal strategy being pursued by the City Attorney will be successful, Prop. I appears to be a reasonable attempt to provide a “remedy” that the courts will accept, and one which continues to tax business at (more or less) the same rate.

SPUR recommends a "Yes" vote on Proposition I.