State & Local Taxes
On November 2, 2010, the midterm elections featured several ballot initiatives dealing with state tax matters. In most instances, voters rejected initiatives to the extent that they would raise taxes, implicitly requesting that their governments look for alternative means to solve their states’ budget deficits.
California voters rejected a measure that would have repealed many of the favorable corporate income tax provisions scheduled to take effect January 1, 2011 (Proposition 24, rejected by California voters on November 2, 2010). Voters approved two measures relating to the legislative majorities that are needed to pass budget legislation and tax increases: One reduces the legislative majority needed to pass a budget from a two-thirds majority to a simple majority; the other maintains the two-thirds majority requirement for any legislative tax increase and expands the two-thirds majority requirement for any fee increase and certain tax measures that do not result in a net increase in revenue (Propositions 25 and 26, respectively, approved by California voters on November 2, 2010).
Missouri voters approved a measure that repeals cities’ authority to enact an earnings tax and requires those cities that currently have an earnings tax to hold a referendum in 2011 whereby voters will decide whether to retain or abolish the earnings tax in their respective cities (Proposition A, approved by Missouri voters on November 2, 2010). In Nevada, voters rejected a measure that would have authorized the legislature to amend the state’s sales and use tax laws without obtaining the approval of voters (State Question no. 3, rejected by Nevada voters on November 2, 2010). Washington voters rejected a proposal to impose a personal income tax but approved a measure that requires a two-thirds supermajority of the legislature to approve tax increases (Initiative Measure 1098, rejected by Washington voters on November 2, 2010; Initiative Measure 1053, approved by Washington voters on November 2, 2010).
Proposition 24: Repeal Corporate Tax Loopholes Act: Proposition 24 reached the California ballot as a voter initiative backed by several public service unions in an attempt to repeal several provisions characterized as special corporate tax breaks set to go into effect on January 1, 2011. The changes are projected to reduce the tax liability of large corporations by nearly $2 billion a year. Voters rejected the ballot initiative by approximately a 3–2 margin. With the failure of Proposition 24, California tax provisions enacted throughout the past two years, including the passage of Senate Bill 858, a trailer bill to the California budget, will remain unaffected.
Accordingly, beginning on January 1, 2011, most taxpayers may elect single sales factor apportionment (under which market-based sourcing is required) in lieu of traditional three-factor apportionment with a double-weighted sales factor (under which cost of performance sourcing is required). In addition, members in the same combined reporting group will be able to share credits. A two-year net operating loss carryback will be allowed for tax years beginning on or after January 1, 2013, and the length of the net operating loss carryforward will be 20 years.
Propositions 25 and 26: Changes to legislative voting requirements approved: With the downturn in the economy, California has had an increasingly difficult time passing a balanced budget on time. The difficultly has stemmed from California’s widening budget deficits, political wrangling, and the requirement that a two-thirds legislative majority was necessary to pass the budget. The original intent of requiring the two-thirds majority was to prevent one political party from controlling the budget without receiving input from the other party. However, the high threshold needed to pass a budget has at times stalled budget negotiations, delaying a budget agreement until well after the June 15 deadline. Since there was no penalty for delay, the legislature was not held directly accountable.
In response to California’s historic difficulties in passing a timely budget, voters considered Proposition 25, which reduces the legislative majority needed to pass a budget from a two-thirds majority to a simple majority and also provides that if legislators fail to pass a budget bill by June 15, all members of the legislature must forfeit their pay for every day until the budget is passed. Voters also considered Proposition 26, which was intended to maintain the two-thirds voting requirement for any legislative tax increase and expand the two-thirds majority requirement for any fee increase and certain tax measures that do not result in a net increase in revenue.
The appearance of the two propositions on the ballot resulted in objections that the use of a simple majority to approve a budget could allow tax increases to be passed within the budgetary process. Litigation ensued, and the California Court of Appeal held that passage of Propositions 25 and 26 would allow the budget to be passed with a simple majority vote but that any increases in taxes or fees would require a two-thirds majority vote (Yes on 25, Citizens for an On-Time Budget v. Superior Court of Sacramento County, Nos. C065707 and C065708 (Cal. App. 3d Dist. 8/9/10) (unpublished opinion)). Ultimately, the California electorate approved both Propositions 25 and 26, although even after enactment of both propositions there is concern that the California legislature may attempt to pass tax legislation tied to the budget with only a majority vote. If this approach is taken, lawsuits undoubtedly will be filed.
In addition, there is uncertainty regarding the effect of Proposition 26 on the federal conformity legislation enacted earlier this year, under which the Internal Revenue Code conformity date was changed from January 1, 2005, to January 1, 2009 (S.B. 401, enacted April 12, 2010, and effective January 1, 2011). Since Proposition 26 is retroactively effective to January 1, 2010, the California legislature may need to reenact the conformity legislation with a two-thirds majority vote of the legislature, as such legislation contained tax increases requiring supermajority approval.
Nearly 7 out of 10 Missouri voters voted in favor of Proposition A, a measure that repeals the authority of cities to fund their budgets using an earnings tax. Currently, only two cities—St. Louis and Kansas City—have enacted this type of tax. The passage of Proposition A does not repeal these cities’ earnings taxes. Rather, it prohibits cities that have not enacted an earnings tax from enacting one and requires Kansas City and St. Louis to hold a referendum in the spring of 2011, where voters will determine whether to retain or abolish their earnings taxes.
If the voters in St. Louis and Kansas City decide to keep the earnings tax, Proposition A requires each city to hold a referendum on the issue every five years. If the St. Louis and Kansas City voters decide to abolish the earnings tax, Proposition A requires the tax to be phased out over a 10-year period. Interestingly, only 45% of the voters in Kansas City County and only 32% of voters in St. Louis voted in favor of Proposition A. This suggests that the vote to enact Proposition A was driven in large part by residents of cities that do not currently have an earnings tax who want to ensure that their cities do not enact an earnings tax in the future, and it could mean that the current taxes imposed by St. Louis and Kansas City are unlikely to be abolished by the voters in 2011. Because the earnings tax generates significant revenue for St. Louis and Kansas City, abolition of this tax could result in the elimination of many essential city services.
Under current Nevada law, the Sales and Use Tax Act of 1955 prohibits the Nevada legislature from amending the state’s sales and use tax laws without first obtaining the voters’ consent. The Nevada legislature sought such authorization on this year’s election ballot pursuant to State Question no. 3. The impetus behind this proposal was to allow Nevada to change its sales and use tax laws to begin requiring out-of-state sellers to charge sales tax on internet purchases made by Nevada consumers if Congress ultimately overrules the U.S. Supreme Court’s decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), which requires that a seller have physical presence in a state to have a sales and use tax collection and remittance obligation in that state.
Following the results of a similar vote in 2008 (State Question no. 4, rejected by Nevada voters on November 4, 2008), Question 3 was soundly defeated by a 2–1 margin. Accordingly, if Congress overturns Quill, the Nevada legislature must pose the question once again to the voters before it can impose a collection obligation on out-of-state sellers.
Initiative 1098: Enactment of personal income tax rejected: Washington is one of seven states that has historically not imposed a personal income tax. Washington voters overwhelmingly rejected Initiative 1098, a proposal to impose a personal income tax beginning in 2012 on adjusted gross income above $200,000 for individuals and above $400,000 for married couples filing jointly. This tax would have generated substantial amounts of revenue, as initial estimates for the first five years in which the tax was to be imposed were set at $11 billion (Fiscal Impact for Initiative 1098, Washington Office of Financial Management, August 2010). The initiative was defeated by a 2–1 margin.
Initiative 1053: Changes to legislative voting requirements approved: As a means to prevent simple legislative majorities from imposing tax increases, Washington voters approved Initiative 960 in 2007. Initiative 960 required any legislative tax increases to be passed by two-thirds of both houses or to be submitted to the public in a statewide election. However, Initiative 960 allowed for a simple majority of Washington legislators to repeal or amend Initiative 960 after two years. In early 2010, in light of budget concerns, the Washington legislature suspended Initiative 960, allowing legislative tax increases to be passed by a simple majority. In response, Initiative 1053 reached the Washington ballot and ultimately was approved by a 2–1 margin. This initiative, which is similar to California’s Proposition 26, permanently restores the requirement that all future legislative tax increases must be approved by a two-thirds supermajority in both houses of the Washington legislature.
Next Steps for States Affected by Ballot Initiative Results
As state budgets have collapsed in the face of ongoing economic malaise, state legislatures have wrestled with the unenviable choice of raising taxes or cutting services. Politicians largely have avoided supporting significant tax increases, and if the results from the state ballot initiatives are any indication, it appears that voters will not directly raise taxes on themselves. Further, voters are willing to support initiatives that prevent their legislatures from passing tax increases unless largely unattainable supermajorities are achieved. Accordingly, states affected by these types of initiatives will have to consider new forms of revenue generation that will not be considered tax increases subject to supermajority provisions, come to broad-based agreements to increase taxes that pass supermajority muster, or slash services as a way to close structural budget deficits.
Greg Fairbanks is a tax senior manager with Grant Thornton LLP in Washington, DC.
For additional information about these items, contact Mr. Fairbanks at (202) 521-1503 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.