Progressives get excited about raising taxes on corporations and the rich. They are not typically stirred by changing the way businesses are taxed unless it increases the overall revenue pie. But plans by San Francisco Mayor Ed Lee and Board President David Chiu to place an initiative on the November ballot shifting the city’s business tax from payrolls to gross receipts deserves progressive support. San Francisco only abandoned its gross receipts tax due to a very suspect Court of Appeal ruling over a decade ago that has since cost cities across California billions of dollars. And given that San Francisco ballot measures raising business taxes without addressing payroll taxes failed in 2002 and 2004 (the latter in a very large turnout election), the shift in tax strategy is the most politically feasible approach to more progressive business taxation.

After the recently district-elected Board of Supervisors approved a $70 million lawsuit settlement in early 2001 that also gave up the city’s gross receipts tax, progressives vowed to find new ways to make the big corporations behind the lawsuit (which included the Hearst Corp., owners of the San Francisco Chronicle) pay their fair share. But efforts to recapture this annual loss of $25 million failed, as progressive ballot measures could not overcome big money anti-tax campaigns that swayed even more liberal San Francisco voters.

As a result, the city’s businesses are taxed on job creation, a regressive policy that has only been sustained by the lack of an alternative. Now, due to the rise of San Francisco’s tech sector – which is employee intensive – the possibility exists for taxing businesses the right way, which is not gross receipts, not payrolls.

Proposed November Ballot Measure

The Controller’s Office recently released an economic analysis of this proposed shift in how San Francisco taxes businesses. Don’t be deterred by its title: it is so easy to understand that its authors, Controller Ben Rosenfield and his chief economist, Ted Egan, might be ostracized by their peers for showing that economic writing does not have to be dense and obscure.

Their proposal identifies a number of key issues that still must be addressed, including the increased costs to the city of administering a gross receipts tax. And they make it clear that because San Francisco has not leveled a gross receipts tax for over a decade, the actual amount of revenue produced cannot be projected with certainty.

But what is certain is that some deal will be reached that gets a reform initiative on the November 2012 ballot. Such tax measures only require majority vote if on a general election ballot, which means that failure to reach the ballot this November would delay a new initiative until November 2014.

Supervisor David Chiu began talking about shifting from payroll taxes to gross receipts from the very start of his tenure in 2009. With Chiu and the Mayor both backing a November initiative, it is sure to happen.

The Politics of Business Tax Reform

There are three political obstacles that have prevented this business tax reform.

First, only 10% of registered businesses in San Francisco pay payroll taxes under the current system, which means that shifting to a gross receipts tax means that 90% of businesses will pay more. Nearly a third of the 90% not paying payroll taxes have payrolls under $250,000, and most would likely pay only a proposed $150.00 annual registration fee under a gross receipts tax.

But powerful real estate and financial industry corporations would pay much more under the gross receipts tax, and their political clout has stopped prior efforts to end the payroll tax. This fight among the city businesses explains why the Chamber of Commerce has opposed the shift.

The difference today is that we have a Mayor and Board of Supervisors President committed to implementing this shift, and we have a high-tech sector that has been politically organized to fight for it. There is a great profile of Ron Conway in the current San Francisco Business Times (“Citizen Conway,” by Patrick Hoge, which cannot be linked as it is only available to subscribers) that explains how 90% of the city’s tech jobs involved employers now affiliated with San Francisco Citizens for Technology and Innovation (sf.citi).

Conway is the chairman and chief organizer of the group, which is pushing hard for the business tax shift. Hoge quotes Aaron Peskin saying that Conway “turns off most established business and civic leaders” and “lacks political finesse” – but these may be the attributes needed to get the shift from payroll to gross receipts tax done.

The other political obstacle is from progressives who see no reason to reform business taxes without increasing revenue. After all, downtown businesses have never made up the money they saved through their business tax lawsuit, so a revenue neutral tax reform measure unfairly allows them to keep this windfall.

Unfortunately, the San Francisco electorate rejected new business taxes in 2002 and 2004, and would likely do so again in 2012 absent revenue neutrality. The reason is two fold.

First, corporate interests spend lavishly to defeat tax hikes and have a greater self-interest in defeating the measure than do proponents. Second, the proposed initiative shifting from payroll to gross receipts tax would already mean that most businesses will pay more, so their argument to voters is that their taxes are being increased even in the overall impact is revenue neutral.

Some may look at the recent passage of a higher real estate transfer tax on transactions over $5 million in November 2010 (Prop N, sponsored by Supervisor John Avalos) as evidence that voters will back a business tax shift that increases net revenue. But that tax involved one small segment of the city’s business community. A business tax initiative involves thousands of businesses in all fields, many of which will actively oppose any ballot measure that is not revenue neutral.

Getting voters to raise business taxes in San Francisco is a lot harder than many progressives realize. Shifting from taxing jobs to gross receipts is itself a progressive victory, and creates a platform from which future revenue increasing measures can be spawned.