San Francisco’s Proposition L will Encourage Outsourcing and Tax Avoidance – Thelegaltorts

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San Francisco’s Proposition L will Encourage Outsourcing and Tax Avoidance – JONATHAN TURLEY

By Darren Smith, Weekend Contributor

Voters within the City of San Francisco passed Proposition L, a measure designed to tax corporations having CEO compensation in excess of 100 times the median compensation of line employees. City analysts estimate the measure would raise between sixty and one hundred million dollars per year confiscated from large for-profit companies employing over one thousand persons nationwide and having administrative offices in San Francisco.

According to the San Francisco Voter Information Pamphlet:

• For a business that pays the Gross Receipts Tax, if its Top Executive Pay is more than 100 times Employee Pay, the business would pay an additional tax from 0.1% to 0.6% of its San Francisco gross receipts.

• For a business that pays the Administrative Office Tax, if its Top Executive Pay is more than 100 times Employee Pay, the business would pay an additional tax from 0.4% to 2.4% of its San Francisco payroll expense.

The Proposition invoked from a hearing of July 28, 2020 where the Board of Supervisors voted 11 to 0 to place Proposition L on the ballot.  The government wrote:

The more inequity between the top executive and their workers, the higher the surcharge. Corporations can avoid the tax by simply paying their executives less or by raising their employees’ wages.

We believe that big corporations that can afford to pay their executives million-dollar salaries every year can afford to pay their fair share in taxes to help us recover. Over the last 30 years, executive salaries in the United States have skyrocketed by 940 percent. But regular workers’ salaries have grown by just 11 percent. Prop L incentivizes companies to invest in their workers, not just their executives ~+~

That’s quite an incentive? Yes, I would agree: Laying off workers is the incentive that might actually come to mind at some companies.

There exist certainly countless different strategies as to what constitutes an effective tax rate to fund government spending and more so on which form of change politicians want to foster in the economy through tax regulation. Some have wide consensus such as encouraging the endowment of charities with cash in exchange for tax credits and deductions, while others seem more of punishment to be used to enforce an idealized social value, which I have stated for years is not a proper role of politicians or government. The latter to me seems clearly the goal of this Proposition.

I will say first that I do not agree with the efficiency or value in paying any employee, whether it be an entry-level worker, a mid-level manager, or an executive, excessively high levels of compensation. I see it as an example of diminishing returns in that it encourages frivolous behavior in their personal spending and many people in the end demand more money despite an overly-generous prior raise. Not that it is any of my business what one of my employees does with his or her wages, but in having to project and anticipate costs if you pay them too much the greedier they sometimes become. Plus, why pay one person a million dollar salary when I can get six well qualified individuals for the same price? I have no qualms about paying people a decent wage but there are limits. Most importantly, this is MY strategy and not that of others, so who am I to force it down their throats?  But with politicians, it is unfortunately often the case. The essential difference is that you the reader do not have to listen to me or subscribe to my ideals. But when government is involved you are mandated into compliance.

Here follows the Proposition’s text (which is italicized). My comments are in block letters and in blue.

ARTICLE 33: OVERPAID EXECUTIVE GROSS RECEIPTS TAX

SEC. 3301. SHORT TITLE.

This Article 33 shall be known as the “Overpaid Executive Gross Receipts Tax Ordinance,” and the tax it imposes shall be known as the “Overpaid Executive Gross Receipts Tax.”

SEC. 3302. DEFINITIONS.

Unless otherwise defined in this Article 33, the terms used in this Article shall have the meanings given to them in Articles 6, 12-A, and 12-A-1 of the Business and Tax Regulations Code, as amended from time to time. For purposes of this Article, the following definitions apply.

“Compensation” means wages, salaries, commissions, bonuses, property issued or transferred in exchange for the performance of services (including but not limited to stock options), compensation for services to owners of pass-through entities, and any other form of remuneration paid to employees for services.

“Executive Pay Ratio” means the ratio of the annual Compensation paid to the person or combined group’s Highest-Paid Managerial Employee for a tax year to the median Compensation paid to the person or combined group’s full-time and part-time employees based in the City for that tax year, determined on a full-time equivalency and annualized basis. For purposes of this definition:

(a) An employee is “based in the City for [a] tax year” if the employee’s total working hours in the City for the person or combined group during the tax year exceeds the employee’s total working hours in any other local jurisdiction for the person or combined group during the tax year.

(b) Compensation paid to a part-time employee for the tax year shall be converted to a “full-time equivalency” by multiplying the part-time employee’s Compensation for the tax year by 40, and dividing the result by the average number of hours the part-time employee worked per week during the tax year for the person or combined group.

(c) Compensation paid to an employee who was employed by the person or combined group for only a portion of the tax year shall be “annualized” by multiplying the employee’s Compensation (or, as stated, for a part-time employee, full-time equivalent Compensation) for the tax year by 52, and dividing the result by the number of weeks that the employee was employed by that person or combined group during the tax year.

“Highest-Paid Managerial Employee” means the individual employee or officer of a person or combined group with managerial responsibility in a business function who received the most Compensation for a tax year.

SEC. 3303. IMPOSITION OF TAX.

(a) Except as otherwise provided in this Article 33, commencing with tax years beginning on or after January 1, 2022, for the privilege of engaging in business in the City, the City imposes an annual Overpaid Executive Gross Receipts Tax on each person engaging in business within the City where the Executive Pay Ratio for the tax year of that person or the combined group of which it is a part exceeds 100:1.

(b) The Overpaid Executive Gross Receipts Tax shall be calculated as follows:

(1) 0.1% of the person or combined group’s taxable gross receipts for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 100:1, but less than or equal to 200:1;

(2) 0.2% of the person or combined group’s taxable gross receipts for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 200:1, but less than or equal to 300:1;

(3) 0.3% of the person or combined group’s taxable gross receipts for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 300:1, but less than or equal to 400:1;

(4) 0.4% of the person or combined group’s taxable gross receipts for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 400:1, but less than or equal to 500:1;

(5) 0.5% of the person or combined group’s taxable gross receipts for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 500:1, but less than or equal to 600:1; or

(6) 0.6% of the person or combined group’s taxable gross receipts for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 600:1.

(c) For purposes of this Section 3303, “taxable gross receipts” means a person or combined group’s gross receipts, not excluded under Section 3304, attributable to the City. The person or combined group’s gross receipts that are attributable to the City shall be determined in the same manner as in Article 12-A-1, as amended from time to time.

(d) Notwithstanding any other subsection of this Section 3303, every person engaging in business within the City as an administrative office, as defined in Section 953.8 of Article 12-A-1, shall pay an annual overpaid executive administrative office tax if the Executive Pay Ratio for the tax year of that person or the combined group of which it is a part exceeds 100:1. This overpaid executive administrative office tax shall be measured by the person’s total payroll expense, as defined in Section 953.8(f) of Article 12-A-1, that is attributable to the City. If a person is a member of a combined group, then its tax shall be measured by the total payroll expense of the combined group attributable to the City. Such person or combined group shall pay only the overpaid executive administrative office tax, and not the tax imposed under other subsections of this Section 3303, but a person or combined group may be liable for the administrative office tax imposed by Section 953.8 of Article 12-A-1 and the homelessness administrative office tax imposed by Section 2804(d) of Article 28 in addition to the overpaid executive administrative office tax imposed by this subsection (d). Unless specified otherwise, this overpaid executive administrative office tax shall be considered part of the Overpaid Executive Gross Receipts Tax for all purposes. The overpaid executive administrative office tax shall be calculated as follows:

(1) 0.4% of the person or combined group’s total payroll expense attributable to the City for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 100:1, but less than or equal to 200:1;

(2) 0.8% of the person or combined group’s total payroll expense attributable to the City for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 200:1, but less than or equal to 300:1;

(3) 1.2% of the person or combined group’s total payroll expense attributable to the City for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 300:1, but less than or equal to 400:1;

(4) 1.6% of the person or combined group’s total payroll expense attributable to the City for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 400:1, but less than or equal to 500:1;

(5) 2% of the person or combined group’s total payroll expense attributable to the City for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 500:1, but less than or equal to 600:1; or

(6) 2.4% of the person or combined group’s total payroll expense attributable to the City for a tax year if the person or combined group has an Executive Pay Ratio for that tax year of greater than 600:1.

SEC. 3304. EXEMPTIONS AND EXCLUSIONS.

(a) An organization that is exempt from income taxation by Chapter 4 (commencing with Section 23701) of Part 11 of Division 2 of the California Revenue and Taxation Code or Subchapter F (commencing with Section 501) of Chapter 1 of Subtitle A of the Internal Revenue Code of 1986, as amended, as qualified by Sections 502, 503, 504, and 508 of the Internal Revenue Code of 1986, as amended, shall be exempt from taxation under this Article 33, only so long as those exemptions continue to exist under state or federal law.

I have to wonder what the goal was of the city for the non-profit type organization above. Was it due to the reality of federal supremacy regarding the taxation of non-profits or city politicians’ political deference to charities? If their conviction against “excessive” CEO compensation is to be genuine then how is it not unsavory that mega-churches, hospitals, and big charities can pay their executives however richly their boards of directors choose?  Perhaps it is explained in the paragraph below.

(b) For only so long as and to the extent that the City is prohibited from imposing the Overpaid Executive Gross Receipts Tax, any person upon whom the City is prohibited under the Constitution or laws of the State of California or the Constitution or laws of the United States from imposing the Overpaid Executive Gross Receipts Tax shall be exempt from the Overpaid Executive Gross Receipts Tax.

(c) For purposes of this Article 33, gross receipts shall not include receipts that are excluded from gross receipts for purposes of the gross receipts tax imposed by Article 12-A-1.

(d) A person or combined group exempt from the gross receipts tax as a small business enterprise under Section 954.1 of Article 12-A-1 shall also be exempt from taxation under this Article 33. But the exemption in this subsection (d) of Section 3304 shall not apply to persons subject to the overpaid executive administrative office tax in subsection (d) of Section 3303.

SEC. 3305. COMBINED RETURNS.

(a) Persons subject to the Overpaid Executive Gross Receipts Tax shall file returns at the same time and in the same manner as returns filed for the gross receipts tax imposed by Article 12-A-1, including the rules for combined returns under Section 956.3, as amended from time to time.

(b) If a person is subject to the Overpaid Executive Gross Receipts Tax, but is not required to file a gross receipts tax return under Article 12-A-1, such person or combined group’s Overpaid Executive Gross Receipts Tax return shall be filed at the same time and in the same manner as if such person or combined group were required to file a gross receipts tax return under Article 12-A-1.

(c) For purposes of this Article 33, a lessor of residential real estate is treated as a separate person with respect to each individual building in which it leases residential real estate units, notwithstanding Section 6.2-15 of Article 6, as amended from time to time, or subsection (a) of this Section 3305. This subsection (c) applies only to leasing residential real estate units within a building, and not to any business activity related to other space, either within the same building or other buildings, which is not residential real estate. The Tax Collector is authorized to determine what constitutes a separate building and the number of units in a building.

SEC. 3306. TAX COLLECTOR AUTHORIZED TO DETERMINE GROSS RECEIPTS.

The Tax Collector may, in the Tax Collector’s reasonable discretion, independently establish a person or combined group’s gross receipts within the City and establish or reallocate gross receipts among related entities so as to fairly reflect the gross receipts within the City of all persons and combined groups.

SEC. 3307. CONSTRUCTION AND SCOPE OF THE OVERPAID EXECUTIVE GROSS RECEIPTS TAX ORDINANCE.

(a) This Article 33 is intended to authorize application of the Overpaid Executive Gross Receipts Tax in the broadest manner consistent with its provisions and with the California Constitution, the United States Constitution, and any other applicable provision of federal or state law.

(b) The Overpaid Executive Gross Receipts Tax imposed by this Article 33 is in addition to all other City taxes, including the gross receipts tax imposed by Article 12-A-1, as amended from time to time. Accordingly, by way of example and not limitation, persons subject to both the Overpaid Executive Gross Receipts Tax and the gross receipts tax shall pay both taxes. Persons exempt from either the gross receipts tax or the Overpaid Executive Gross Receipts Tax, but not both, shall pay the tax from which they are not exempt.

SEC. 3308. ADMINISTRATION OF THE OVERPAID EXECUTIVE GROSS RECEIPTS TAX ORDINANCE.

Except as otherwise provided under this Article 33, the Overpaid Executive Gross Receipts Tax Ordinance shall be administered pursuant to Article 6 of the Business and Tax Regulations Code, as amended from time to time, including all penalties and other charges imposed by that Article.

SEC. 3309. DEPOSIT OF PROCEEDS; EXPENDITURE OF PROCEEDS.

The Overpaid Executive Gross Receipts Tax is a general tax. Proceeds from the tax shall be deposited in the City’s general fund and may be expended for any City purposes.

Oh, the old general slush fund that receives the tax receipts; if only the voters simply read Section 3309 before reading city leaders’ big promises as to how the tax would actually be spent. From the Proponents’ Argument in Favor of the Proposition…

CITY LEADERS AGREE ON THE OVERPAID EXECUTIVE TAX

The Pandemic isn’t over. Cities around the country are preparing for another spike in the curve by stocking up on medical equipment and hiring nurses, doctors, first responders, and other essential healthcare workers. San Francisco needs to be ready.

Prop L is expected to raise over $140 million every year which would allow the City to hire hundreds of nurses, doctors, and first responders.

Unsurprisingly, there is no mention of police officers among those who would be hired. Perhaps to them that might be worse than a CEO making too much money. Nowhere in the Proposition does it delegate where the CEO tax revenue will be allocated specifically. It stretches the city’s credibility in claiming a definite and bona fide purpose of changing the business behavior of an entity toward that of economic security or growth and is more likely simply punishment for what politicians consider objectionable behavior with a dash of extra revenue to spend on pet projects.

SEC. 3310. AMENDMENT OF ORDINANCE.

The Board of Supervisors may amend or repeal this Article 33 by ordinance without a vote of the people except as limited by Article XIII C of the California Constitution.

SEC. 3311. EFFECT OF STATE AND FEDERAL AUTHORIZATION.

To the extent that the City’s authorization to impose or to collect any tax imposed under this Article 33 is expanded or limited as a result of changes in state or federal statutes, regulations, or other laws, or judicial interpretations of those laws, no amendment or modification of this Article shall be required to conform the taxes to those changes, and the taxes are hereby imposed in conformity with those changes, and the Tax Collector shall collect them to the full extent of the City’s authorization up to the full amount and rate of the taxes imposed under this Article.

SEC. 3312. SEVERABILITY.

(a) Except as provided in subsection (b), if any section, subsection, sentence, clause, phrase, or word of this Article 33, or any application thereof to any person or circumstance, is held to be invalid or unconstitutional by a decision of a court of competent jurisdiction, such decision shall not affect the validity of the remaining portions or applications of this Article. The People of the City and County of San Francisco hereby declare that, except as provided in subsection (b), they would have adopted this Article and each and every section, subsection, sentence, clause, phrase, and word not declared invalid or unconstitutional without regard to whether any other portion of this Article or application thereof would be subsequently declared invalid or unconstitutional.

(b) If the imposition of the Overpaid Executive Gross Receipts Tax in Section 3303 is held in its entirety to be facially invalid or unconstitutional in a final court determination, the remainder of this Article 33 shall be void and of no force and effect, and the City Attorney shall cause it to be removed from the Business and Tax Regulations Code.

SEC. 3313. SAVINGS CLAUSE.

No section, clause, part, or provision of this Article 33 shall be construed as requiring the payment of any tax that would be in violation of the Constitution or laws of the United States or of the Constitution or laws of the State of California.

Section 3. Appropriations Limit Increase. Pursuant to California Constitution Article XIII B and applicable laws, for four years from November 3, 2020, the appropriations limit for the City shall be increased by the aggregate sum collected by the levy of the tax imposed under this ordinance.

Section 4. Effective and Operative Dates.

(a) The effective date of this ordinance shall be ten days after the date the official vote count is declared by the Board of Supervisors.

(b) This ordinance shall become operative on January 1, 2022. ~+~ END ~+~

The bottom line for the most part will be whether in the end it is simply cheaper to pay this tax and go on with the status quo for the time being or to make changes to reduce or eliminate the tax liability of eligible companies. Personally attacking the decision makers of an organization or group of individuals does not often have the desired result. Given California’s proclivity to enact law in the hope of the political message spreading to other states, eg. environmental policy, this might be one goal of the politicians there. For their sake they should hope so because creating an island of undesirability to engage in business makes every other location appear more rosey.

I anticipate for at least the next few months there will be inevitably a legal challenge from affected businesses in an effort to avoid this tax entirely. Though probably not actionable, it does seem almost attainder-like in that single individuals are targeted and not the entirety of the employee base. (The opposite example being with minimum wage laws that bind entire groups of employees to a minimum compensation else the company faces a sanction). But this will be obviously for the courts to decide.

Yet if companies choose to remain doing business in the city and are subject to the CEO tax you will see changes made to personnel and I suspect the lower wage earning employees will see the brunt of it.

For example, let us assume an arbitrary company that has 1,100 employees of which 100 are based in San Francisco. One CEO is over the compensation limit and she wishes to mitigate the taxation. At the administrative office twenty employees are maintenance and housekeeping, forty are well paid professionals, thirty are clerical workers, and nine are senior management. What to do? Lay off all the housekeepers and maintenance engineers and outsource them from a building contractor, then they can move the clerical division to Oakland or have the workers telecommute from outside the city three out of five days per week. Now that the company has slashed its San Francisco employee base, that is, only its lowest and medium compensated members, the median employee rate just went into the highly paid professional level and brought the CEO an even greater level of compensation potential before the CEO tax kicked in. City officials seem to believe it will be the bottom workers who will benefit, but given the mathematics that the tax calculation relies on Median instead of Average, there is a strong disincentive to hire more employees on the entry-level side of the line.

And what is to become of other forms of compensation that the city officials might have overlooked? I have to wonder how they would treat Deferred Compensation or issuing executives Convertible Bonds or even reclassifying the executives as independent contractors who “work” eleven months  per year and are actually self-employed. Maybe it is just easier to pack up and leave. Maybe it is more cost effective to pay the tax and pass it along to the San Francisco customer base who will have to pay more. Either way, it is not coming out of the pockets of the corporate decision makers themselves.

How far will the reach of the city’s CEO tax will stretch, either under the present or future tax law, it could usher in a more convoluted approach toward accounting and business practice. If a multinational desires to open a storefront in San Francisco will they then be required to franchise their name brand to a wholly-owned separate entity just to avoid the excess tax on the payroll or gross receipts?

As to the human side of this, outside just the numbers of tax liability, it is highly doubtful the CEOs are going to relinquish their “excessive pay” regardless if the company has to ante up the tax. To provide big raises to large numbers of basic employees is going to be prohibitively expensive, possibly exceeding the tax itself.

It is folly to believe that forcing a form of altruism on companies scales to the needs of a large corporation where it might for a small business. A five person company having a CEO that makes 101 times that of each of his four employees does seem harsh and a bit predatory (not to mention probably not workable), but if a company wants to perform to an international audience it necessitates several orders of magnitude of complexity and nuance to compete and be successful. That demands the need for exceptionally driven and capable individuals and those individuals cost big money. I have maintained for years that if you wish to attract a certain ability of a person, you must also be willing to accept whatever nuance or spill-over cost that type of individual carries with them. And I suspect that most executive caliber individuals are not content with living in a 2,000 square foot house and making the median salary in the community. If boards of directors want the talent to grow the company, they have to accept the greed and lofty expectations of those who might provide such expertise. It is the nature of that beast. But that is a decision for the board and the stock holders, not politicians on some city council.

By Darren Smith

The views expressed in this posting are the author’s alone and not those of the blog, the host, or other weekend bloggers. As an open forum, weekend bloggers post independently without pre-approval or review. Content and any displays or art are solely their decision and responsibility.

 

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