Kim Rueben is a Senior Fellow with the Tax Policy Center. Rueben examines issues of state and local public finance focusing on state budget issues, intergovernmental relations, municipal bond markets, capital markets and the economics of education. She is also an adjunct fellow at the Public Policy Institute of California.
Detroit filed for Chapter 9 bankruptcy protection yesterday, giving it the dubious distinction of being the largest municipal bankruptcy ever. By doing so, the city has put its future—and that of its citizens, employees, retirees, bondholders, and other creditors– in the hands of a federal judge. How did the Motor City get to this sad place, and what will it mean for other cities?
How did this happen?
Detroit has been in decline since the 1960s, when auto plants began to close and the city started hemorrhaging jobs. Its population declined from 2 million in 1950 to less than 700,000 today. But the city was slow to reduce its public payroll, and its retiree obligations have exploded. The city has been spending about $100 million more than it’s taken in over the last five years. It currently has an estimated $18.5 billion in long-term liabilities—nearly half of which are for retiree benefits ($3 billion for pensions and about $6 billion for health care and other benefits).
Was this bankruptcy inevitable?
Probably. Last spring, the state appointed veteran bankruptcy lawyer Kevyn Orr to serve as the city’s emergency manager. But Orr was unable to convince creditors to work out the city’s obligations, and individual lawsuits have been piling up.
The crisis has been building for years. Not only is Detroit’s population shrinking, but those who stayed are older and poorer and thus need high levels of municipal services. The city struggled to provide those services while meeting prior obligations.
But by delaying the day of reckoning, it very likely made matters worse. Detroit borrowed to pay for both current operating costs and pension obligations. Government officials also increased retiree benefits when negotiating labor contracts for public employees, trading off future payments for current needs. They ignored an important rule of budgeting: When in a hole, first stop digging.
Will Detroit salvage its finances and move forward?
Bankruptcy is the right move for Detroit. It is the only forum where public sector unions, retirees, and debt holders can work out their competing demands. In the end, it is likely they all will have to face reductions in payments.
Despite the headlines, bankruptcy does not necessarily mean the city’s bonds will default. Indeed, Chapter 9 can be a mechanism for borrowers to avoid default. However, Detroit faces a series of stark choices. If bondholders take a haircut, the city’s cost of future debt will rise, limiting its ability to invest in a new Detroit. But if the bulk of the settlement falls on public employees and retirees, what will that do to the city’s ability to hire the police officers, firefighters, and teachers it needs to attract new residents?
In the end, it’s likely the state will have to step in to help make pension payments, guarantee future borrowing, or both. However, if its creditors are satisfied, Detroit can learn some lessons from New York and Washington, D.C.—two cities that went to the financial brink and ultimately thrived. Both recovered thanks to tough new financial controls, transparency, and hard choices.
Is this beginning of a new wave of municipal bankruptcies?
Probably not. Other Rust Belt cities face the same demographic and pension issues that hit Detroit. But because of state requirements, some, like New York, have kept up pension contributions while others, like Cincinnati and San Diego, have introduced reforms to try to stem growing obligations.
It’s also important to note that most jurisdictions that have declared bankruptcy or threatened to do so were responding to the fallout of specific ill-advised projects, not to the kind of existential threat that Detroit is confronting. For instance, Harrisburg, PA’s highly publicized troubles are largely the result of a money-losing municipal incinerator project. Fortunately, there are not a lot of Detroits out there.
After years of grim revenue news, state tax collections are surging. As they do, governors and state legislators are making decisions about how to manage the unfamiliar windfall. Some governors, including California’s Jerry Brown, are husbanding resources, trying to hold down spending and paying down one-time debts. Others, such as New York’s Andrew Cuomo, are falling victim to the siren song of targeted tax cuts.
Cuomo is not cutting tax rates across the board, like some Republican governors. Instead, he’s doubling down on a strategy of growing the state’s economy through targeted tax breaks even though there is little evidence that previous economic development subsidies paid off.
START-UP New York (SUNY Tax-free Areas to Revitalize and Transform UPstate New York), under consideration by the legislature today, would give businesses and their new employees ten years of tax breaks if firms open in specific areas designated on or near public college campuses. Employers would be exempt from corporate and property taxes (for the new business) and receive refunds for sales taxes. New workers at these firms would be exempt from personal income taxes on wages earned at the firm for five years and exempt from income taxes on income below $200,000 for another five.
Cuomo insists the subsidies would attract businesses from other states or lead to new businesses sprouting up. But researchers have found that targeted tax cuts rarely do that. While taxes matter, businesses make location decisions for many reasons, including infrastructure and labor force qualifications. Cuomo argues that while New York colleges and universities receive the second highest amount of research dollars (after California) they get much less private investment. And there is much less interest on the part of venture capitalists (as compared to California and Massachusetts). Of course, some might argue that the investment in these other states is more about the type of research underway at the schools rather than incentives from state government.
Another problem is that location-based tax breaks tend to move existing jobs around rather than creating new ones. If I’m thinking of starting a business in New York and can get a tax cut for setting it up in one building rather than another one in the next town over, I may do so. But it’s not clear I’ve created many more jobs in the process.
An existing economic development jobs program – called Excelsior Jobs – has produced disappointing results so far. But instead of going back to the drawing board the new plan would double down, by halving the required net new jobs (from 10 to 5) while increasing the size of the incentive (from 2 percent of a qualified investment to 5 percent).
Cuomo responded to earlier concerns about tax-free zones by refining the bill. He’s excluded location-driven businesses, including retail, real estate, and professional services. Benefits would go only to firms that move into specific properties. And he’d deny benefits to firms that merely move existing jobs to the tax free zones without creating new ones, though preventing such gaming is not easy. For instance, will these denials hold when the first business threatens to move to Connecticut if it doesn’t get the tax breaks? And what do the employee income tax exemptions mean for new vs. existing employees, will existing firms need two pay scales based on income tax requirements?
Not only would the plan cost the state revenues but it could also drain the coffers of local governments that rely heavily on property taxes. College towns already lose revenues because land owned by non-profits and the state are exempt from property taxes. If businesses set up in Cuomo’s new tax-free zones, local governments will take yet another hit.
And that’s what happens to places that are lucky enough to get the new businesses. What of the New York cities and counties that lose firms to college towns? They also stand to lose revenues in what is likely to become a zero-sum game.
Which brings us back to California, where the un-Cuomo Brown presides. He’s proposing to curtail enterprise zones through narrowing eligibility for hiring and sales tax credits, recognizing that such programs often just move money around without increasing economic activity. California is trying to offer some targeted tax incentives for businesses but a more promising model for New York might be their California Competes program of increasing degree attainment and performance of students, rather than trying to pick winners and losers.
In December 2011, I credited Cuomo with a tax plan that his legislature passed in two days and that ensured the state had enough money, while Brown needed to wait almost a year to see if voters would approve his new taxes (which they eventually did).
But Brown gets my vote now for better policymaking. While there is additional money in the California budget for the first time that I can remember, he’s taking the long view. Maybe it’s just because he’s been around long enough to remember surges in short term revenues often disappear.
Earlier this week, my Tax Policy Center colleague Elaine Maag blogged about proposals by the Center for Law and Social Policy (CLASP) to improve federal assistance for low-income college students, including better targeting of higher education tax credits. But there may be even more effective ways to help these students. One idea: Cut back on tax credits and use the savings to improve Pell grants and loan programs.
As part of the same broad initiative that generated the CLASP plan, I was one member of a group of experts assembled by HCM Strategists to reimagine financial aid. Our aim was the same as CLASP’s, but our proposals took a different tack: Refocus and simplify the whole federal financial aid system including federal grant, loan and tax programs so they work more effectively and cost-effectively.
We started by acknowledging that Congress has greatly expanded federal support for higher education—doubling the amount spent on both Pell grants and tax credits—but there is little evidence that all those extra dollars have similarly expanded the number of college graduates. Almost half of all undergraduates receive a Pell grant but Pell recipients are half as likely to get a Bachelor’s degree within six years as those getting no assistance. And while federal aid has made college more accessible to minority students, it has done little to improve their graduation rates. We concluded there must be a better way and suggested four reforms:
Simplify the aid process. We would replace today’s myriad of programs with one grant program and one loan program and make it possible for students to apply with a simpler application. Grants would be targeted to those who most need aid, and students would be encouraged to take more classes each semester—a step that raises graduation rates. Loans would be consolidated into a single program with common annual and aggregate limits for undergraduates and repayment based on income levels. For all students, the financial aid form would be automatically pre-filled with IRS data, with a small set of students needing to enter more information . By consolidating the application process to rely more on tax return information, the Department of Education could also require better reporting of education costs to the IRS, information that is currently reported on a haphazard basis.
Replace the current tax credits with one tax credit for both college and lifetime learning. Currently we offer numerous tax benefits for higher education including three different credits or deductions for college costs. These credits do little to increase enrollment, largely because students often must pay tuition long before they receive the tax credit (usually in April when they file their return). Students also sometimes choose the wrong credit. Under our proposal loans and grants would provide most support for undergraduate education, but there would also be a tax credit for a broader set of post-secondary options. That credit would recognize that we are moving beyond traditional models of higher education that involve nineteen year olds attending college full time. It would help workers pay for classes that teach new skills, allow students some help in attending school part time, and could be used to pay for an evaluation of on-line learning as programs evolve.
Promote shared responsibility. Students would be encouraged to graduate sooner in part by limiting the amount of time during which they can obtain grants and loans. College applicants would receive both clear financial aid packages and a scorecared that shows how the school performs. This would help students make informed decisions on what schools to attend.
At the same time, institutions would need to do a better job reporting information about both their entire student body and how students do in school. Instead of the current cohort default rates used to determine institutional eligibility for federal financial aid, we propose using a more comprehensive assessment of performance with a new Institutional Effectiveness Index. Comprised of threes measures the index would include the number of Pell recipients attending the school,on-time graduation rates (adjusted for student characteristics if possible) and loan repayment rates. If schools fall in the bottom 10% for two of three measures, they would lose access to federal higher education funding.
Improve the quality of data and create pilot programs. Some of the savings from these proposals would then be used to support pilot projects and collect better information. Pilots could seek more cost-effective ways to prepare students for college before they enroll, ways to award aid based on competencies gained and not hours spent in class, and examine alternate ways of distributing aid.
Of course, streamlining aid and federal assistance requires funding streams that best achieve national goals. In practice reform could run aground against the Congressional committee system with different committees controlling the grant and tax programs. Federal funds can be an important tool to help low-income students get to college and, most important, graduate. But we need to use those dollars in a smarter way.
Higher education is a good investment, even though some new grads currently struggling to get jobs don’t think so. But does it make sense for the federal government to subsidize college with both tax incentives and direct grants? And if it doesn’t, which program should it dump?
There is a strong case that the government should keep and enhance the Pell Grant program, which is the main form of direct assistance for low-income kids. At the same time, it may be time to eliminate or at least consolidate some of the confusing collection of education tax credits.
That, at least was the consensus among witnesses at a recent hearing at the Senate Finance Committee. Experts ranging from Sue Dynarski of the University of Michigan, Scott Hodge of the Tax Foundation and James White of the Government Accountability Office all argued that the credits needed to be reformed.
There are currently 14 tax benefits available for college students and their parents. These include three broad classes – tax benefits for tuition and related expenses , tax benefits for student loans, and tax benefits for education savings plans. Basically benefits for before, during and after college attendance. JCT estimates the cost to the federal government of these tax benefits to be $95.3 billion between 2010 and 2014.
The size of these programs and direct federal grants have rapidly expanded in the last few years. Spending on Pell Grants has doubled – from $18.3 billion in 2008 to $36.5 billion in 2010, reflecting more generous programs and expanded enrollment during the recent recession. Likewise, spending on education tax credits doubled from $9 billion in 2008 to $18 billion in 2009.
Increasing enrollment and encouraging students to complete college, especially for students from low-income families, is one of the best ways to address growing income inequality. According to Dynarski, college attendance rates vary dramatically by income group, with only 9% of children born in the lowest income quartile earning a BA compared to 54% of children born in the top quartile. This gap has increased in the last 20 years.
Does the current panoply of programs, including grants and tax incentives, further the goal of increasing college attendance? While there is some evidence that Pell Grants help, there is little evidence that tax credits do.
The current programs and options are too complicated and families regularly select the wrong tax credit or program or fail to apply at all. The other problem is timing: A student may not see see the benefit of the tax break for up to 18 months after she must pay her tuition. While Dynarski thinks the solution is to simplify the credits and change the timing of delivery, I agree with Hodge that we would be better served by eliminating the tax credits. We could use some of the savings to protect the recent expansion of Pell grants. While we’re at it, we should simplify the Pell application process too.
Unfortunately, we are flying blind in our efforts to reform these subsidies. There are limited data to help evaluate the effects of these programs, including recent expansions. We know little about what the grants and credits mean for students over time. A key question is whether either or both programs result in higher tuition.
One big step forward: The IRS and Department of Education could coordinate their data so we could better understand how these programs work. More importantly, coordination could result in simpler forms for students and their families.
Helping low-income kids get to—and finish–college should be a top priority. But Congress needs to find the most cost-effective way to do that. And the belt-and suspenders approach of grants and tax subsidies may fail the efficiency test.
In testimony before the Senate Committee on Finance this morning, I discussed what federal tax reform would mean for state and local governments and how Congress could help by coordinating tax law across states. Here are my opening remarks. You can find my full testimony here.
With increasing concerns about the federal deficit, fairness, and the complexity and inefficiency of our tax system, the need for fundamental federal tax reform is critical. Often overlooked, however, is the fact that any such reforms will also affect the tax and fiscal policies of state and local governments. Although the country’s economic condition is improving, state and local governments are still struggling to balance their budgets. They also play an important role in our economy, running about half of all domestic public programs and with state and local spending making up about 15% of gdp.
Decisions about changing federal policy should take into account the potential effects on state and local government budgets in both the short and the long run.
I will make 4 points today.
Federal tax policy and reform can help or hurt states. Federal policy affects how attractive specific taxes are for state and local governments and, therefore, how those governments organize their tax and revenue systems. State revenue sources—especially income taxes—often piggyback on federal rules. More specifically, statutory changes in federal law can result in significant increases or decreases in state revenue. For example, state income tax revenue increased after the 1986 tax reform expanded the federal income tax base, and allowed states to also reduce their rates. In contrast, the elimination of the state and local tax deduction could increase the cost to state and local governments of providing services.
Unstable federal tax policy trickles down to the states and uncertainty is especially problematic for state and local governments. State and local governments are required to pass balanced budgets every year. This requires being able to accurately forecast revenues. Problems with state tax systems are exacerbated by uncertainty in federal tax rules. Temporary extensions of credits, deductions, and tax rates complicate state forecasting. Policy changes and uncertainty can directly affect state tax bases through changing definitions of income or indirectly due to changes in taxpayer behavior. Especially problematic has been uncertainty about future federal estate taxes and tax rates on dividends and capital gains, sources of volatile income for states
If fundamental tax reform is undertaken, transition relief might be important for state and local governments. Tax changes can help or hurt states, but understanding the short-run effects will be important and may require slower adoption of policies or some fiscal relief. Understanding the state of the economy and the fiscal health of state and local governments will be important.
Due to our federalist system, Congress has a role in helping to coordinate or protect the existing state and local tax base. State and local governments’ ability to raise revenue can be hobbled by limitations that Congress could remove. Most notably, Congress could enact legislation that could help coordinate action across states and would help enable state and local governments to collect taxes on internet and mail-order sales.
Other panelists explored the costs of current federal tax preferences—the state and local tax deduction and tax-exempt municipal debt—that affect state and local governments as well as how federal legislation could help state and local governments coordinate tax policy in the face of changing technology. The hearing was lively and a good mix of both considering long-term reform and more practical measures that Congress is more likely to act on.
Opening statements from Senators Baucus and Hatch and the other witnesses are here.
With apologies to Charles Dickens, I’d like to tell a Tale of Two States. Earlier this month, on December 5, California Governor Jerry Brown and New York Governor Andrew Cuomo both announced that, even though state revenues in general were rebounding, they were both facing budget shortfalls. This isn’t totally surprising since earlier in the recession both states passed temporary tax increases that had expired or were about to, and both depend heavily on progressive income taxes. Both governors announced a desire to respond to forecast budget deficits with tax changes, including increasing income taxes on high income households. But that is where their tales part ways.
Last year, throughout the budget season, Brown couldn’t get the legislature to extend California’s expiring tax increases He failed both because state revenues were stronger than anticipated last Spring and, more importantly because it took a supermajority of the legislature to pass tax increases. The budget the legislature did pass assumed these strong revenues would continue, even though the source of those extra dollars wasn’t totally understood. Indeed, the budget included an additional $4 billion in unspecified revenues that if not realized would trigger automatic spending cuts.
Well, after a bumpy summer and even bumpier fall, the Legislative Analyst’s Office projected actual revenues will fall $3.7 billion below forecast and help produce a 2012-2013 budget shortfall of $13 billion. That would trigger the large automatic cuts in higher education, social services, and K-12 education. In response Brown announced that he’ll bypass the legislature and ask voters to approve a retroactive tax increase in November 2012.
While some spending reductions will still kick in, late-year revenue increases mean these cuts are smaller than originally expected. However, bigger budget cuts will depend on what voters decide next November, including whether to retroactively raise income taxes and increase the sales tax. However, the presence of numerous other tax proposals might make passage harder. In any event, this year’s budget debate will be interesting, with legislators forced to consider what happens if the ballot measure doesn’t pass.
In contrast, Cuomo proposed comprehensive reform of New York’s tax code. Although he has cut spending and won concessions from labor unions, the state still spends more per capita than nearly all other states and it faces a $350 million shortfall for this year and a projected $3.5 billion deficit next year.
With a temporary surcharge on incomes above $200,000 expiring at the end of this month, Cuomo hoped to make the state income tax more progressive by permanently increasing top marginal tax rates from their pre-surcharge levels (though importantly they’d still fall from what they are today). At the same time, he wanted to lower rates for middle-income taxpayers, streamline other provisions of the code, and restore funding for some government programs. Thus, revenues would go up, Republicans could claim that tax rates will be lower than they are now, and Democrats could take credit for a more progressive tax system and some new spending. Cuomo negotiated his tax reform with just two people – the Republican Senate majority leader (Dean Skelos) and the Democratic Assembly Speaker (Sheldon Silver). The often dysfunctional state legislature approved the whole package within a week.
Cuomo definitely benefited from the timing of the expiration of the temporary tax increases. The recovery looks more uncertain now than it did last year, and by revising rates before the surcharge expired he framed the package as a tax cut. In theory Jerry Brown could also negotiate a deal with a subset of legislators, leadership from both parties in both houses – a gang of five, instead of three. However, in practice often in California, agreement isn’t reached or legislators defect and a deal isn’t kept. Requiring another trip to the ballot box.
Fiscal institutions and rules matter. But as Cuomo proved, good timing and some legislative hardball are just as important when it comes to budget reform.
As a brief respite from our discussions of all the various flat tax plans being proposed (or recycled) – below is a post I did for Metrotrends yesterday on budget antics at the subnational level.
Last month I blogged about how the federal and state governments could learn from cities, which seemed to be making the tough choices and balancing their budgets without politicizing every move. This month, alas, I’m honor bound to report that some cities (and states) aren’t above the political fray.
Exhibit 1 – Harrisburg. The capital of Pennsylvania has been having money troubles for the last few years, and has been on the short list of places most likely to go broke. Earlier this month the shoe dropped, and the city declared bankruptcy. Or at least the city council did – the mayor is against it and so is the state. This has led to a series of announcements from different parties on whether or not Harrisburg is in bankruptcy, who gets to declare bankruptcy, and whether the city council can choose bankruptcy court over accepting a state takeover plan. The council members thought the state takeover would leave the city in worse shape, paying off bondholders while destroying the city’s ability to meet service needs. It also included veiled threats about state officials needing to learn how to put out literal instead of figurative fires, if the sale of assets to pay debtholders led to a lack of firefighters.
The problems in Harrisburg largely stem from an investment project gone wrong – an incinerator upgrade that was supposed to generate revenues through generating power that never materialized. With the current antipathy for Wall Street the council members think they are better off in bankruptcy court which could lead to bondholders taking a loss and possibly lower the cost to taxpayers.
Exhibit 2 – Scranton. While much less extreme an example than Harrisburg, Scranton’s city council and mayor came up with competing proposals to solve its budget deficit that involve either selling the parking meters (to the parking authority) or borrowing against meter revenue to get a one-time payment to balance this year’s budget. Either plan would generate the $6.5 million to plug this year’s deficit. The only problem with this strategy is that next year’s budget deficit is probably going to be even bigger and then what? This strategy either sells off an asset or commits a decade’s worth of revenue to pay for this year’s problem.
So does this mean we are on the brink of a spate of local bankruptcies? No, although the National League of Cities reports cities ending fiscal year 2010 with the largest year-to-year reductions in general fund revenues. However, most cities balanced their budgets by making even larger cuts in spending. And in what might reflect city officials recognizing a “new normal” in city budgeting, a smaller share of them report that they are less able to meet financial needs, even though revenues are down for the fourth year in a row (in real terms)—just 57 percent of cities this year, down from almost 90 percent two years ago. Revenues are going to be tight but in most places, officials are making hard decisions and cutting real programs as well.
Yes, politicians in Harrisburg may be throwing metaphorical cream pies at each other, but most other cities are cutting the mustard.
This year marks the 100th Anniversary of California’s initiative process . In 1911, California famously adopted the direct initiative process and ballot box decision-making has become almost as synonymous with the Golden State as beaches, hi-tech innovation, and Hollywood. While 75% of voters in California still see direct initiatives as a good thing, a similar percentage thinks it could use some tweaking. In honor of the anniversary, Zócalo Public Square garnered commentary on the initiative process. Here’s what I wrote:
What’s the Single Best Thing We Can Do to Improve the Initiative Process?
Make it harder
California’s initiative process gets a lot of attention and blame in discussions of the state’s budget and governing problems. This is in part because it is used either directly or as a bargaining tool to legislate many issues. In 2010, voters considered two initiatives in June and nine more in November. These included rules on the legalization of marijuana, suspending or changing environmental regulations, rules on redistricting, and many fiscal issues. Although ballot initiatives give Californians a loud voice in their government, raising the hurdles for passage would serve everyone better.
So what’s wrong with giving citizens such power? For starters, voters have often approved initiatives that conflict with one other. For example, San Franciscans, when asked whether to rebuild or remove a damaged highway after the 1989 Loma Prieta earthquake, voted yes to both rebuilding it and removing it. (The freeway was removed because that option had more yes votes.) Courts have thrown out initiatives because their language is confusing or vague. California could solve those problems, either by requiring constitutional review before any vote or by making the process less direct by having initiative authors work with legislators to come up with workable proposals. Massachusetts gives that role to the legislature, and many fewer initiatives end up on its ballots.
But I want a procedural reform. Initiatives often pass with a simple majority but mandate that future actions require a super-majority action of voters or legislators. For example, California’s famed Proposition 13 requires a super-majority to enact any new special taxes. Proposition 218 did the same thing for some fees. Shouldn’t any law with super-majority requirements be required to have a super-majority vote to pass?
California should also raise the bar for constitutional changes (as opposed to statutory changes). Right now, the only additional requirement for changing the constitution is that a slightly higher number of signatures be collected: 8 percent of the number of votes cast for Governor in the last election rather than the 5 percent needed for statutory changes. With the advent of paid signature gatherers, the bar should be raised for constitutional changes. And passage should require more than a simple majority vote.
If the process were a tad more cumbersome and fewer initiatives made it to the ballot, discussions of the initiatives could be more thoughtful, elected officials would need to take more responsibility, and possibly California would be slightly more governable.
Legislative leaders in California, big box stores, and Amazon have reached an agreement to delay internet tax collection until September 2012. There is no word on whether Governor Jerry Brown will support the plan and no mention of whether the 7,000 distribution center jobs Amazon previously offered the state is part of the package. Amazon did agree to stop supporting a repeal referendum and will join other retailers in pushing Congress to enact an internet sales tax law applying to all 50 states and the District of Columbia.
In a landmark 1992 ruling governing collection of sales taxes by remote sellers (they were mail-order firms then), the U.S. Supreme practically begged Congress to resolve the mess by enacting national standards. But Congress never acted, and given how quickly legislation gets through Congress these days, that’s not likely to happen any time soon.
Nonetheless, Amazon promises to start collecting the tax in September 2012 if Congress fails to act. It will be interesting to see whether that really happens.
After threats and tough talk for most of the summer, Amazon seems to be changing tactics in its battle against collecting sales tax on purchases by Californians. For months, the firm has been bankrolling a ballot initiative to reverse a new state law requiring online retailers to collect the levy. Wednesday, Godfather-like, Amazon made Governor Jerry Brown an offer it thought he couldn’t refuse: Amazon would open new distribution centers in California in exchange for a two-year delay in the law. Yesterday, the governor said he thinks not. He hasn’t made a final decision but he’s signaling no. I’m sure that Amazon and its supporters will now blame Brown for costing the state 7,000 new jobs.
Here’s the back story: In June, Brown mandated collection of the tax. Sales tax collections by out-of-state sellers are governed by a legal principle called “nexus.” In effect, if a business has a physical presence in a state, it must collect taxes. Amazon promptly cut ties with 10,000 California business affiliates to erase any physical presence. It refused to collect the tax and funded the campaign to repeal the law through the ballot box. This isn’t a new fight. We blogged about it last March, when states started proposing laws to collect internet sales tax, and back in 2009, when New York first raised the issue of Amazon paying taxes due to the presence of affiliates within the state.
Amazon offered to bring 7,000 distribution center jobs to California to avoid a ballot-box fight in exchange for a two-year moratorium on the tax. Want to guess how long the jobs stay once the freeze ends? Are 7,000 jobs worth the $200 million-a-year in sales taxes the state figures it will collect (plus another $100 million for local governments)? And would they ask for another delay or blame Brown for sacrificing these jobs? Of course, offering to set up distribution sites has already worked for Amazon in South Carolina and Tennessee.
Meanwhile, the repeal effort rolls on. Amazon has donated over $5 million to collect signatures, and many of the paid signature gatherers were set up in front of its big box store competitors. The referendum, which would repeal the law, requires 505,000 signatures of registered voters to make it onto the ballot. Given California’s record on tax votes, chances are the repeal will go through.
Amazon is bound and determined to avoid collecting sales tax to keep a price advantage over its competitors, even though in doing so it is effectively encouraging its buyers to break the law. Other e-tailers seem to have no problem calculating and collecting the tax.
What does this mean for California’s budget? It obviously doesn’t help. State revenues already appear to be coming in below projected levels, which means more budget cuts later this fall. But that might be a blog for another day.
Meanwhile, Amazon’s move may signal the end of my love affair with my Kindle. As convenient as shopping at Amazon is, I’m going to buy things from sites that charge their customers sales tax. While I did pay use taxes in California (where you report it on your income tax return) I haven’t figured out how to do the same in DC (my current residence). Amazon’s refusal to collect taxes encourages customers to avoid the taxes they owe. I’ll stop feeding my Kindle because, in the end, I think a customer boycott may be the only way to get Amazon to behave.