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Saturday, September 3, 2011

Cities and the Income Tax

The 481 cities in California are not allowed to impose an income tax (per Revenue & Taxation Code Section 17041.5); neither may other local jurisdictions in California. However, they are allowed to assess a business license tax based on gross receipts. Not all states have such a restriction though.

Per a recent report from the Tax Foundation (Fiscal Fact No. 280), in 17 states, over 4,900 cities and counties impose a local income tax, affecting 23 million people. The taxing jurisdictions include school districts too. The report notes that San Francisco has an income tax imposed on employers (the payroll tax),* but as noted by California law (see above), this is not a local income tax as they are not allowed at the local level in California.**

Rationale for local income taxes:
  • It will encourage local jurisdictions to favor high-paying jobs in its borders rather than minimum wage jobs at retail shopping outlets that generate sales tax (this is why many California cities seek big-box retailers - to get more sales tax revenue).
  • It is another way to get non-residents (here, those who work in the taxing city but live in a different city) to contribute to the cost of services they use. Of course, these non-resident workers are likely paying sales tax while in the city each day. This is a question I've blogged on before - how much, if any, income tax should a jurisdiction take from a non-resident who is not entitled to many government services (see 6/19/11 post). For example, a person who lives in San Jose but works in San Francisco, is unlikely to be able to register their child in a SF public school.
I think California could benefit in a few ways if local jurisdictions had an income tax tied to the state income tax. These benefits include:
  • An incentive that matches the state's incentive to have high-paying jobs in the state.
  • A broader economic development perspective in that local governments would be interested in having more than just big box retailers. For example, they would want to have a law firm. (Note - as to whether the city should impose the income tax on the law firm's taxable income versus also that of all of the lawyers working in the city-located law office, is another issue - see 6/19/11 post).
SB 653 would allow counties to impose an income tax (see 4/24/11 post).

* A 3/9/11 op ed in the San Francisco Examiner by former State Senator and SF Board of Supervisors member Quentin Kopp provides some background on R&T Section 17041.5 (he opposes the SF payroll tax). He says it was enacted in 1963 to prevent local jurisdictions from imposing income taxes. Apparently, at that time, San Francisco wanted to impose an income tax on those who lived or worked in the city to be sure they were contributing to the cost of city services they were using. The SF payroll tax applies to SF businesses with annual payroll over $250,000.

** The SF payroll tax was upheld as not being an improper local income tax in A.B.C. Distributing Co. v. City and County of San Francisco, 15 Cal. 3d 566 (CA S Ct, 1975). Per the court: "The short answer to plaintiffs' contention is that the payroll expense tax is not a tax on or measured by their income. Instead, the tax is imposed upon plaintiffs by reason of their employment of labor within the city and county, measured by the expense incurred by plaintiffs in conducting this aspect of their business. The fact that the tax is measured by wages paid to the employees would not convert the tax to an income tax. As this court explained in Gillum v. Johnson (1936) 7 Cal. 2d 744, 763, involving a federal social security payroll tax, such a tax may be an income tax to the employee, but "As affecting employers it is an excise tax, or a tax on the right to do certain things ....""

Do you think California cities should be allowed to impose an income tax? If yes, should it be a percentage of the taxpayer's state income tax or some other calculation? Who should pay it?

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