HomeMy WebLinkAboutStaff Report 156-09TO: HONORABLE CITY COUNCIL
ATTENTION: FINANCE COMMITTEE
FROM: CITY MANAGER
DEPARTMENT: ADMINISTRATIVE
SERVICES
DATE: MARCH 10, 2009 CMR: 156: 09
SUBJECT: BUSINESS LICENSE TAX ORDINANCE
REPORT IN BRIEF
The City of Palo Alto is a desirable and attractive environment for residents and the business
community. To sustain the economic health and vitality of Palo Alto, as well as City services and
programs, staff is proposing implementation of a business license tax program.
To assist with the development of the business license tax program, the City contracted with
MuniServices, the City's current sales and use tax audit consultant. MuniServices prepared a
Business License Tax Classification and Tax Rate Structure Report which provides three tax
models for Council's consideration. The three different tax models are based on number of
employees, a flat tax and gross receipts. Staff is recommending gross receipts as the
methodology for the tax measure. The City asked for a fourth model based on square footage,
however, due to the unavailability of adequate square footage data and the nature of the square
footage tax rates, MuniServices did not prepare a tax model for this category. Staff tested
MuniServices, assumptions, methodology, and forecasts for reasonableness, and modified the
proposed tax structure to meet the specific needs and conditions of the Palo Alto Community.
Based on MuniServices and staff's analysis, staff recommends a business tax structure based on
gross receipts with a $35 minimum tax and with a $20,000 ceiling. As a result, the median tax
payments for businesses in different sectors would range from $35 to $594. The estimated
annual revenue to the City's General Fund is approximately $4.4 million rather than the $6
million referenced in MuniServices's report. The City's projection reflects an adjustment in the
number of businesses, adjusted tax rates and a $20,000 tax payment ceiling.
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This report also provides information on tax rates for other local cities and provides guidance on
the legislative and procedural requirements for Council to authorize a vote of the electorate in the
November 3, 2009 general municipal election.
RECOMMENDATION
Staff recommends the Finance Committee:
• Provide feedback and direction on the proposed Business License Tax Program
• Approve gross receipts as the methodology for assessing taxes
• Approve staff's proposed tax rate structure
• Approve staff's proposed business classification system
• Approve a bi-annual increase in the business license tax minimum amount equal to the
Bureau of Labor Consumer Price Index (CPI) for all urban consumers for the San Francisco -
Oakland -San Jose, California Metropolitan Area
• Approve an annual increase in the business license tax ceiling amount equal to the Bureau of
Labor Consumer Price Index (CPI) for all urban consumers for the San Francisco -Oakland -
San Jose, California Metropolitan Area
• Recommend that the City Council authorize the placement of a ballot measure on the
November 3, 2009 general municipal election to enact a Business License Tax Ordinance
Approve staff's recommendation of implementing the tax effective July 1, 2010
• Late fees will be addressed in the Ordinance
BACKGROUND
Palo Alto is one of a few cities in California, and the only city in Santa Clara County, without a
business license tax, a tax most businesses expect to pay as a cost of doing business. The matter
of business license tax implementation has come before Council on several occasions over the
last decade. In early 2001-02, as Council explored ways to fund the City's infrastructure backlog,
a discussion of business license tax emerged as a potential funding source; however, business
license tax discussions were never finalized.
On January 23, 2006, staff recommended that Council provide direction on whether to move
forward with implementation of a Business Registry Fee or a Business License Tax; and on
whether to pursue an increase in the Transient Occupancy Tax (CMR: 119:06). After a lengthy
discussion, Council elected to proceed with a Business Registry at a nominal cost to businesses
rather than a business license tax program. On March 20, 2007, staff presented a Business
Registry Implementation Plan to the Finance Committee with a request that the Finance
Committee make an implementation recommendation to the full Council. After a lengthy
debate on the business registry proposal, the Finance Committee directed staff to return in
September 2007, with options for a comprehensive business license tax program. Consistent with
Council's direction, staff began the development of a business license tax program. This work
was placed on hold, however, while an infrastructure funding plan was developed to address the
General Fund's infrastructure backlog.
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With completion of the infrastructure backlog analysis, the City Council directed staff to explore
a business license tax to supplement the General Fund. The objective of the tax structure is to
maintain a sustainable city budget that can continue to provide the level of services provided to
the community.
DISCUSSION
Business License Tax Overview
Under California law cities have the ability to impose business license taxes subject only to
requirements in the state and federal constitutions and their own charters.
A revenue raising ordinance can apply to all businesses operating within the City unless
specifically exempted by the ordinance, or by provisions in the state or federal constitution.
Rates for a revenue raising ordinance are determined based on the City's financial need.
However, a City may only apply the tax to that portion of business activity which is attributable
to the City. In addition, like other taxes, a business license tax, requires a vote of the electorate.
Constitutional amendments such as Propositions 13, 62 and 218 have limited the taxing authority
of cities and make distinctions between types of revenue raising measures and the voter
approvals required to enact them. Each measure (e.g. tax, fee, assessment) determines when
elections are held, how revenue can be used, and what percent of the vote is required for passage.
The proposed business license tax is considered a general tax measure. Revenue from the tax will
be used for General Fund purposes such as ensuring public safety and health, providing general
infrastructure improvements, and park and recreation services. As a general tax, a simple
majority vote of the electorate will be required. This vote must occur at a regularly scheduled
general election at which members of the Council will be elected, unless by unanimous vote, the
Council finds that there is an emergency that justifies placing the proposed tax before the voters
at a special election.
PROGRAM DEVELOPMENT
To understand business license tax programs and ordinances, staff spoke with and visited
business license tax professionals in several local cities including: Santa Clara, Benicia,
Sunnyvale, Mountain View, Fremont, Menlo Park, Oakland, Cupertino, Hayward and Monterey.
In addition, staff reviewed on-line posting of other California municipal business license tax
programs and ordinances. Staff also held roundtable discussions with business license tax
professionals from some of these cities to discuss business license tax software systems,
administration, enforcement and State of California reporting requirements. During the
evaluation process various methodologies and options on how the tax can be levied were
explored and particular attention was paid to anticipating the needs of the business community.
The advantages and disadvantages of various rate structures and a tax ceiling were discussed in
detail.
A recurring theme throughout the interviews with other cities was the need for an ordinance
that provides for ease of administration. The insights gained have benefited staff planning efforts
in several areas. One of the lessons staff learned is that a well drafted ordinance has four distinct
CMR:156:09 Page 3 of 12
features: a simple, uncomplicated tax structure; ease of administration and compliance; a
uniform method of calculating the tax; and the ability to generate sufficient revenues in changing
economic conditions. Staff's business license tax proposal has sought to incorporate these
features.
To assist with development of a business license tax program, the City issued a Request for
Proposal for a qualified firm to provide professional guidance on a Business License Tax
Classification and Tax Rate Structure Program. MuniServices, the City's current sales and use
tax audit consultant, was awarded the contract. MuniServices produced a comprehensive
business license tax report which contained tax models and revenue estimates. Staff concurs with
the base model of MuniServices' proposal; however, to evaluate the consultant's conclusions,
staff analyzed various raw data elements from the report to conduct sampling test and
reasonableness studies to determine the validity of the reports' assumptions. After conducting
internal tests and analysis staff concurs with most of MuniServices' conclusions and
recommendations. Based on staff's installation of a maximum tax payment of $20,000 and
business inventory sampling, the most likely revenue amount will be approximately $4.4 million.
METHODOLOGY
Business Inventory Analysis
The names and addresses of businesses in Palo Alto were compiled with the assistance of
MuniServices, who developed the inventory list from a variety of public and private databases,
including property tax information, sales tax permits and doing business as (DBA) business
listings. The business inventory generated for the City utilized more than 35,000 business data
records which resulted in more than 21,000 business listings. The initial inventory of more than
21,000 entries was corrected to eliminate businesses that no longer existed, statutorily exempt
businesses, duplicates, and non-profit organizations, which resulted in a final inventory
population of approximately 9,800 businesses. Staff excluded the category of single family
rentals (1,500 businesses) from the inventory list to make the City's proposed ordinance
comparable with other cities. Research and comparison confirms this is standard practice as
most cities only license residential rental properties with three or more units. The exclusion of
the single family rentals resulted in a "final" inventory of 8,300 businesses. Development of the
business inventory presented a huge challenge to staff because the City did not have a
comprehensive and complete listing of all businesses in Palo Alto. The business inventory will
require continual updating and maintenance to remain current. As the business license tax
program is implemented, further refinements to the inventory list will be made. MuniServices
states that due to compliance issues, it could take three years or more for the City to compile an
accurate list of businesses.
Inventory Assessment
In order to begin assessing the impacts of possible tax structures on the business community in
Palo Alto, staff examined in detail the 2,500 businesses in the inventory for which gross sales
data was available. This data was reviewed in great detail. Errors and omissions were corrected
by contacting the business directly or by reviewing business information on-line. After
CMR:156:09 Page 4 of 12
completing the review process the final list contained 2,250 businesses which were categorized
into seven (7) sectors: professional, miscellaneous, retail, services,
wholesale/manufacturing/construction, commercial properties and multi -unit rentals. The total
gross sales from these 2,250 businesses were $3.88 billion, and thus represent a significant
portion of the City's business community. Summary information on this dataset is presented
below in Table 1. Staff would have preferred to directly contact all the businesses in the
inventory, however; due to time constraints and expense this was not feasible.
Table 1
ummary of Business Sample Gross Sales Results
Category
No. of
Business
in Sample
Business
Percentage
In Sample
Gross Sales
Average Gross
Sales
Professional.......................................................................................... ......................_103............... 4.58%.... 221,019,057 $ 2,145,816
Retail .884 ..... ... ...... 39 29% 2,069,368,`31`x........................_2,340,91.5...
Services........................................................................................................ .................1..,049...............,........46 ;62%..............1,140,799,732...........................1 096. 091„
WholesaleIManufacturing.Constr. 115 5.11% 415.920.666 3 616 701
Miscellaneous 99 4.40% 31 340 166 316 567
Total 2,250 100.00% $ 3,887,448,535 $ 9,516,091
Standard
Deviation of
Gross Sales
P$ 3,471,074
8,528,028
r 18,790,858
19,688,145
w..........814 425
* Gross Sales Data for Commercial Property and Mult-Unit Rentals were not available
A number of conclusions can be drawn about the business sample. First, the retail and services
sectors represent a significant number of businesses with gross sales. Second, manufacturing and
service industries show a wide dispersion, as shown in the standard deviation. This is the result
of the manufacturing sector being comprised of a small number of very large businesses, and the
services sector, having a large number of both very small and very large businesses. Finally,
because of the high dispersion within the sample, staff is using the median value in its analysis,
as opposed to the mean.
Classification System
A well -drafted business license tax classification system addresses equity by permitting the
application of different taxing measures or tax rates to a given class of businesses. For example,
a classification could be based on the profitability or nature of a particular type or class of
business. Particular attention was given to the development of a classification system that
ensures similar businesses are classified together and taxed similarly which allows for a balance
between administrative ease and equity. The City's proposed classification system is broad
enough to ensure that all types of business activities are subject to the provisions of the ordinance
while being taxed equitably. Staff's proposed classification system is as follows:
• Retail -includes any business activities where the goods, wares, merchandise are sold as
retail (e.g., department stores, drug stores, auto dealers)
• Wholesale -typically is business to business activity where the goods, merchandise and
wares are intended for resale (e.g., technology firms)
• Service -covers all service related businesses (e.g., landscape architecture, etc.)
CMR:156:09 Page 5 of 12
• Professional -typically includes any business where a professional license is issued or
businesses that are regulated by the state (e.g. dentist, attorney )
• Manufacturer -businesses that manufacture, produce or package goods
• Construction — (e.g., home builders )
• Transportation — (e.g., limousine service)
• Miscellaneous -a "catch all" classification for unique or non -classified businesses
Horne based businesses are assigned to the above classifications based on the business activity.
Tax Rates
To determine appropriate gross sales tax rates,- business license tax ordinances of local cities
were analyzed. Cities within close proximity to Palo Alto (Menlo Park, San Mateo and East Palo
Alto) and those with a similar economic base and business license tax structure were examined.
In addition, staff and the consultants evaluated the ordinances of Mountain View, Sunnyvale, and
Santa Clara. Mountain View and Sunnyvale generate nominal revenues of approximately
$200,000, while Santa Clara generates approximately $800,000 annually. As MuniServices
states in its report, "The taxes and fees collected in Santa Clara are for regulatory purposes and
not for revenue generating." These cities do not use gross receipts as the basis for their tax
measures; instead they use number of employees, flat fee, and number of units, or a combination
of these tax measures, which are all regressive taxes. For these reasons, the business license tax
programs of these cities are not comparable to Palo Alto's proposed revenue raising tax program.
To retain and encourage new high revenue businesses, Palo Alto's proposed business license tax
program will have a ceiling. This ensures that under the proposed rate structure the largest gross -
receipts companies will pay no more than $20,000 annually - a tax burden that should be
affordable to the largest businesses.
Palo Alto's proposed rates are as follows:
CLASSIFICATION
TAX RATE
Retail
$0.50 per $1,000 of gross
receipts
Service
$0.75 per $1,000of gross
receipts
Professionals
$1.00 per $1,000 of gross
receipts
Manufacturing, Wholesale & Construction
$0.50 per $1,000 of gross
receipts
Commercial Property Rentals
$1.50 per $1,000 of gross
receipts
Miscellaneous
$1.00 per $1,000 of gross
receipts
Multi -Unit Rentals
$0.75 per $1,000 of gross
receipts
Horne based businesses will be charged
business license tax based on the
classification claimed.
$0.50 per $1,000 of gross
receipts
* A retail business with gross receipts of $75,000 would pay a tax of $.50 per $1,000 in gross receipts
(75,000-1,000 x.50= $37.50)
CMR:156:09 Page 6 of 12
As illustrated in the graph below Palo Alto's business license tax payments will be comparable
to or lower than surrounding cities that use gross receipts as a tax measure.
Comparative City Business Tax
by Business Type Median Gross Receipts
$1,000
Business License Tax
$500
$0
$712
341
27
8500
\'
$742
8250
850 $126
SibW
arc s. cua 9 A` � �4
0
tiq
Qo
Business Category (Median Gross Receipts)
a San Mateo
• Menlo Park
o East Pato Alto
+3 Palo Alto
$260
ocPri
AP
8125
$51 560
Tax Measures
Cities have a broad range of options available when selecting taxing measures. For example, a
theater may be taxed on the number of seats for sale or a bowling alley may be taxed on number
of lanes. However, as stated in the MuniServices report, the most common tax measure is gross
receipts, with flat tax and number of employees being alternatives. Tax measures that are
attached to a unit of measure such as number of employees are considered regressive and should
be avoided. A regressive tax does not reflect a businesses' profitability. For example, a tax based
on a flat rate or number of employees does not grow in proportion to business expansion as well.
as the gross receipts model. The most commonly used tax measures are illustrated in the chart
below:
CMR:I56:09 Page 7 of 12
MEASURE
PRO
CON
Flat Tax -a tax of the same
•
Administrative ease
•
Does not reflect
amount imposed on all
•
No calculations
economic conditions
engaged in the same
•
Revenue estimating
•
Limited growth
business, regardless of the
•
Regressive tax
amount of business done or
profit margin
•
Limited tax base
Number of employees -a tax
•
Administrative ease
•
Penalizes labor
on the number of persons
•
Easy to compute
intensive businesses
employed in a business
•
Limited tax
apportionment
•
Not a direct measure
of ability to pay
concerns
•
Limited growth
potential
•
Limited tax base
Gross Receipts -a tax on the
•
Indicator of
•
Administratively
total amount of the sale
economic change
more complex than
price of all sales and/or the
•
Broad tax base
other tax measures
total amount charged or
•
Eliminates double
•
Some tax
received for performing any
taxation concerns
apportionment
business activity or service
•
Can be calculated on
considerations
a percentage or flat
fee sliding scale
•
Calculation can be
labor intensive
•
Enforcement more
complex
Revenue Estimates
Staff developed modeling of various tax schedule impacts on estimated revenue to the
City. Since MuniServices' inventory listing contained information gaps such as gross receipts for
approximately two-thirds of the businesses, staff was unable to analyze the entire business
inventory as discussed in the methodology section. To develop the models, staff first
"normalized" the sample data so that the data fully reflected the distribution of businesses in
each sector in the total population of the businesses inventory. For example, while professional
businesses represented 4.6% of the sample population of 2,250 businesses for which gross
receipts were identified, the sector represented 30.7% of businesses in the full population of
8,300 businesses.
The results from this analysis included a factor to take into account sampling error. Partial
results of these analyses are presented in Table 2. The results indicate that the' recommended tax,
a $35 minimum tax with a $20,000 maximum will result in median payments ranging between
$35 and $594. The total revenue for the City, under this scenario is estimated at $4.4 million.
CMR:156:09
Page 8 of 12
Table 2
Summary of, Estimated Tax' and Revenue
Category
Proposed
Business Tax
Rate
Est. Average
Tax Payment
with $35
minimum
$20K Ceiling
Est. Median
Tax Payment
with $35
minimum
$20K Ceiling
Estimated
Business
License Tax
Revenue
Professional
Retail
Services..............................................................................
Wholesale/Manufacturing/Con str
Miscellaneous
Sub -total
Commercial Property_
...................:...._........ .............. ..............................................000 N/A N/A 33,272
Commercial Rro ert 1.501 1, .... ............................ . ............................... ........ .............. ... ..................... .......... .............2
..........nit Rentals $0.75 / $i 000 290,600
Mult U
$ 4,373,176
�.. 00._x.. $1,000
• $0.50 / $1,000
$0.75 / $1,000
:...........................$0.50../..$1,000
$1.25 / $1,000
347
..............................59 4
356
98
64
35
9,984,903
................._ . . .............
1,334,401
665,295
122,222
22,484
$ 4,129,304
Total
Timeline
If the business license tax ordinance is approved by the electorate in November 2009, staff
estimates it will take several months for the program to implement technical and administrative
capabilities. Therefore, staff recommends a July 1, 2010 implementation date. This delayed
implementation also takes into account the current economic conditions.
Election Requirements
The business license tax ordinance must be approved by Palo Alto voters, The Palo Alto City
Council's next opportunity to place a business license tax measure on the ballot is November 3,
2009. A general tax ballot measure must be submitted to the County of Santa Clara 88 days
(August 7, 2009) before the scheduled regional general election. If this deadline is not met, the
Council's next opportunity to place a measure before the voters will be November 2011. Staff
has outlined the critical procedures and tentative timelines that must be met for the Business
License Tax Ordinance ballot measure to qualify for the November 2009 general election.
CMR:156:09 Page 9 of 12
RESPONSIBILITY
REQUIRED PROCEDURE
TIMELINE
Finance Committee
•
•
Make a recommendation to the full
Council regarding adoption of the
Business License Tax program
Tentative Follow-up
March 10, 2009
April 7, 2009
City Council
•
•
Council input on Finance Committee
recommendation
Review key elements of Business
License Ordinance
May 18, 2009
City Council
•
•
•
Council recommendation to submit
Business License Tax Ordinance to
voters
Approve the resolution submitting
ballot measure to voters, designate
ballot argument authors and authorize
the City Attorney to prepare an
impartial analysis
Decide whether to accept rebuttals
July 20, 2009
City Clerk
•
Election Code Requirement — last day
to submit ballot measure to Santa Clara
County
August 7, 2009
City Clerk
•
Election Day
Nov. 3, 2009
Business Community Outreach
In an effort to determine business community response to the proposed Business License Tax
Ordinance, staff held a preliminary discussion with representatives from the Chamber's
Government Action Committee. Staff intends to continue involving the business community in
future discussions and plans related to implementation of the tax. Staff will conduct outreach
meetings to the general community and in particular the business community, regarding
implementation of the business license tax program.
Resource Impact
Cost estimates are approximate and are based on staff's cost models for implementation and
renewal. The estimated resource impact is summarized in the table below:
CMR:156:09
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Implementation
Ongoing
Fixed Costs:
Staffing:
$290,000
$290,000
Variable Costs:
Forms, envelopes,
software, hardware, etc.
$90,500
$40,500
Contingency:
$10,000
Total:
$390,500
$330,500
To cover the cost of the program and to generate the $4.4 million in revenue, staff is proposing a
minimum business license tax fee of $35 and a maximum fee of $20,000.
Costs are preliminary and will be refined as the program progresses. In addition, if approved by
voters, staff will issue and RFP to select a qualified firm to implement and manage the City's
business tax program. However, staff's recommendation is that the enforcement component of
the business tax program should be administered in house.
Further, staff proposes an annual CPI adjustment to the business license tax minimum and
ceiling amounts both rounded to the nearest dollar.
Policy Implications
The actions described in this report are consistent with Council's direction provided at its March
20, 2007 meeting. If approved by the electorate, the Business License Tax Ordinance will require
that all businesses, except statutorily exempt businesses including non -profits, pay a tax to
operate a business in the City of Palo Alto.
Environmental Review
The actions described in this report do not constitute a project under section 21065 of the
California Environmental Quality Act.
Attachment
Attachment A: Business Tax Classification & Tax Rate Structure Report
CMR:156:09 Page 11 of 12
PREPARED BY:
/1,06
Joyce White &
sie Stokes
Senior Financial Analysts
Taxun Narayan rl Van Orsdo
Senior Financial Analyst
DEPARTMENT HEAD APPROVAL:
CITY MANAGER APPROVAL:
Manager Energy Risk
LALO PEREZ
Director, Administrative Services
ES KEEN
ity Manager
CMR:156:09 Page 12 of 12