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Tipping the Tax Scale

August 28, 1986

California is about to join other states in modifying, if not abolishing, a bookkeeping procedure for taxing multinational companies that operate in the state.

Under the unitary method, corporations are taxed according to the percentage of their worldwide sales, property and payrolls that are in California. If that adds up to half of a corporation's business activity, a tax is imposed on half of the corporation's worldwide profits. The unitary method was adopted originally to prevent motion picture companies from shifting profits earned here to states where taxes were lower; it was later applied to multinationals.

The economic argument against the unitary method--that it discouraged investment in California--never added up. In the past decade California led the nation in attracting foreign investment, particularly from the Far East. State taxes are at best secondary factors in investment decisions. The primary factors are California's favorable business environment, huge markets, infrastructure and skilled and educated work force.

What tipped the scale in Sacramento, along with a massive industry lobbying campaign, was a political argument. Important trading partners--notably Japan and Great Britain--were unhappy with the tax, and their unhappiness complicated Washington's trade negotiations.

The cost to California of keeping Washington happy is calculated at about $83 million a year--far better than the estimated $600 million a year that would have been lost to total abolition.

Gov. George Deukmejian has not said yet that he will sign the revisions that passed the Senate, 27 to 7, and the Assembly, 65 to 11, but he has asked for changes every year since he took office, and the legislation is the best that he can hope for.

With this bill the governor also would get an obligation. The bill would grant the state Franchise Tax Board new authority to audit corporations. The governor would have to make sure that the board gets the resources needed to be certain that companies do not make paper transfers of profits out of the state and that the drain on California does not exceed the advertised $83 million.

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