Governor Gavin Newsom unveiled his May budget revision May 10, presenting a 2024-25 plan with provisions that cumulatively represent an $18 billion tax increase on California businesses over four fiscal years.
Newsom’s budget (detailed in proposed budget trail bill language released May 15) proposes to reverse a recent Office of Tax Appeals ruling – resulting in a tax increase – and revive the net operating loss and tax credit limitations used in the past to address budget deficits.
In a report released this morning, the Legislative Analyst’s Office advised lawmakers that the governor’s plan would “lead to a less equitable tax system” and increase taxes on California businesses approximately $2 billion in 2024-25, increasing to more than $5 billion annually in future years.
Over the three years during which NOL deductions and tax credits would be limited, these and other tax increases would total approximately $18 billion.
Corporate Tax Increase on Foreign Dividends
The OTA’s unanimous decision in the Appeal of Microsoft, regarding the treatment of foreign dividends included in a taxpayer’s apportionment formula, decided a long-running dispute between taxpayers and the Franchise Tax Board, concluding that the FTB has applied the law incorrectly. The governor’s budget summary characterizes the proposed apportionment change as a “clarification of existing law that when a corporation receives income that is excluded from taxable business income, it must exclude this income from its apportionment factor.”
As written, Newsom’s proposal would apply retroactively as well as prospectively, to taxable years “beginning before, on, or after the effective date of this bill.”
Labeled on the Department of Finance website as an “apportionment factor fix,” the proposal also includes a statement of legislative intent that it “does not constitute a change in, but is declaratory of, existing law.” Additionally, the bill would authorize the FTB to bypass the Administrative Procedure Act when developing regulations, rules, notices, “or any other guidance” pursuant to the legislation.
A Senate budget subcommittee heard testimony on the proposal May 16 but did not vote. The panel’s analysis includes this fiscal impact estimate: “The FTB estimates that, without action, around $1.3 billion in refunds are at risk based on similar tax filings from prior years, and there are additional annual prospective refunds of around $200 million due to lower apportionment factors for multi-state and multi-national firms.” (CalTax: The statement that “refunds are at risk” is misleading. As the OTA correctly ruled, the refunds are required by law. The only “risk” is to companies that were forced to overpay their corporate taxes and then fight for refunds, and now face the additional hurdle of an after-the-fact legislative change designed to allow the state to keep the money.)
Suspension of the NOL Deduction and Limitation on the Utilization of Tax Credits
Newsom proposed prohibiting businesses with annual revenue in excess of $1 million from deducting their net operating losses and limiting usage of business tax credits to $5 million for the 2025, 2026, and 2027 tax years.
The proposal includes a provision to revert back to the current NOL and tax credit laws if cumulative cash receipts from the state’s “big three” taxes – the personal income tax, corporate income tax, and sales and use tax – exceed the 2024-25 budget act’s forecast by 3 percent or more from May 2024 to April 2025.
The result of these proposals: tax increases estimated by the state to be $900 million in 2024-25, increasing dramatically to $5.5 billion in 2025-26.
The Legislative Analyst’s Office warned lawmakers that suspending the NOL deduction would undermine the deduction’s positive effects on the state’s economy.
“Typically, when a business experiences a NOL, it is allowed to carry forward these NOLs and deduct them from their income in future years,” the analyst wrote. “This allows businesses to smooth profits and losses such that businesses with similar profits over time pay similar taxes. Without this smoothing, businesses in riskier or more innovative industries – such as the technology, motion picture, and transportation sectors – could end up paying more taxes than businesses with similar but more stable profits. As such, suspending NOL deductions would lead to a less equitable tax system. While the suspension of NOL deductions has been a go-to budget solution for decades, the frequency at which this approach has been used is now starting to raise questions. Should the Governor’s proposal take effect, the state will have disallowed NOL deductions in nearly half of [the] years between 2008 and 2027. At this rate, it seems reasonable to ask whether suspensions have begun to meaningfully undermine the purpose of allowing NOL deductions in the first place.”
Elimination of the Bad Debt Sales Tax Deduction
The governor additionally proposed to eliminate the bad debt sales tax deduction for a lender or retailer’s affiliate – a tax increase estimated by the Department of Finance to be approximately $25.3 million in 2024-25, increasing to $50.6 million per year beginning in 2028-29.
Corporate Tax Rate Increase and Other Tax Increases Under Consideration?
During his May 10 press conference, Newsom repeatedly stated that he does not support “general tax increases.” At one point, he expressed frustration that reporters continued to ask him about taxes after his numerous statements of opposition.
Asked specifically why he isn’t proposing an increase in California’s corporate tax rate, Newsom said: “When considering the 8.84 percent corporate tax – which is the highest, arguably, depending on how you analyze it, in the country – no, I’m not prepared to increase taxes. We have among the highest tax rates in the United States of America for high wage earners, we have among the highest tax rates, as I noted, for corporate taxes. … I feel strongly that we have to live within our means.”
To address revenue volatility, Newsom unveiled a proposal to establish a new budget account to capture “excess revenue” from capital gains and limit appropriations until that revenue materializes.
Other Budget Provisions
The governor’s revised budget calls for $288.1 billion in total spending, down from the $291.5 billion that Newsom proposed in January, and significantly down from the $310.8 billion approved last year for the 2023-24 budget despite many indications that it was not sustainable relative to the state’s revenue.
Newsom pegged the deficit at $27.6 billion for 2024-25 (after adjusting for $17 billion in “early action” items signed into law in April) and $28.4 billion in 2025-26.
The budget calls for using approximately $21.5 billion from state reserves and cutting approximately $32.8 billion in spending over two years – including $19 billion that was appropriated for new spending in recent years but hasn’t been spent yet, and now will be withdrawn.
Newsom also wants to eliminate 10,000 state positions that currently are not filled – part of what his office described as making California government “more efficient, leaner, and modern – saving costs by streamlining procurement, cutting bureaucratic red tape, and reducing redundancies.”
The Legislature has until June 15 to approve a budget bill or forfeit their pay until a budget is passed.