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planning effort in San Francisco, by the time the plan is complete, the assumptions upon which the plans are based are no longer valid.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 sinceÂ 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.