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HomeMy WebLinkAbout0525.091j 1 , 1 I I i December 5~ 1991 HONORABLE CITY CCUNCIL Palo Alto, California Attention: Finance Committee BUSINESS LICENSE TAX Members of the Co~ncil! Report in Brief This is an informational report and no Council action is necessary~ This report is intended to provide information on how a business license tax could be implemented to provide additional revenue for the City of Palo Alto. Bllckqrounc! In June 1984, Council Member }-.nne Witherspoon asked Council to authorize staff to investigate a business license tax. Although no report was sent to Council, an internal staff ~emo recommended a bUsiness license tax not be pursued because, as envisioned by Council at that time, it was no~ a significa~t revenue generator, had a relatively high administrative cost l and there were other yays to develop an inventory of businesses. On December 18, 1986 (CMR:594:6), staff trans~itted a report which estimated revenues at $350 1 DOO to $1.5 ~illion, depending on the type of tax imposed (flat r~te versus gross receipts), and also estimated the City ~ould need to add two inspectors and an account clerk at a cost of $117,000 annually to administer the tax. CMR:525:91 In early 1989 j e Business License Tax: stud),' committee ,,",as fonned 'Which included representatives from t,he Chamber of COl1l:il1erce and the Director of Information Resources~ 'I'he group met sEv-eral thcE:s, discussing such issues as the administr~tive costs of imposing t~e ta)(, business classificdtions and gro'J;linqs and taxation of rental property. Purpose of the T~x The main purpose of imposing a business license -r.ax is to raise revenue. Therefore, it is it:1portant to set the rat'=! hlgh enough to r-eccver costs and raise 'the appropriate rever,ue. S01!;e cities have started ""ith a 10\1/ tax and raised it later. Since there is so much political concer!"! on this issue. :most cities advise against setting a 10 ... rate and raising it later. They ;C:'..lggest it is better to rally the support one time rather than fighting the iss'l.le t .... ice. While the primary purpose for a business license tax is to raise revenue, there are other advantages. The establishlnent of a b~siness license tax allows the City to dev~lop an accurate aata base with an inventory of all bu~inesse3. This =an be ~ery helpful in planning the development of the City and forecasting sales tax or other tax revenues. In most cities, the business license tax is usefUl in obtaining information for both the City and other organizations such as the Cha~ber of Co ... unerce~ Autborit:y for a Business Licensem __ Tax Cities in California r.ave sigl"lificant flex..ibility in levying a business license tax. As indicated 1n Section 37101 of the California Government Code I "The legislative body may license, for revenue and regulation, and fix the license tax upon, every kind of lawful business transaction in the City .• ~."~ A.11 important distinction is made bet',,;een a revenue-raising versus a regulatory ordinance. RegUlatory business licensing provisions can apply only to those businesses or occupations that represent a potential health or s~fety ha~a~d to the community. Furthermore, license fees must relate dir-ectly to the cost of regulat ing the business activity. In contrast l revenue-raising ordir.ances apply tc all businesses operatin(3' '~rithin the city unless specifically exempted within the ordinance or by provisions of the state or Federal Constitution. Rates are levied for the privilege of doing business in the city. and ar-e determined based upon a city's financial need. The only restriction is that the tax may only apply to that portion of b\'Lsiness activit)' that is attributable to the city. Most Bay Area cities currently impose a business license tax. The following gives a comparison of some local cities: CMR:525:91 2 ~'.;~~ . ...; .;1 "#'-:," "'. Method of 1990-91 No. of City f.Q.PJ~.l a t __ t..:::.n Tax* 'p.£:venue Licenses San Jose 750,000 Employee $9,4Ca,OOO·u: 43,000 Sunnyvale 119,COO Employee 240,000 7,200 Hayward lOS,OCO Gress Rects. 1.100~OOO 9,000 Santa ClaIa 94,000 Flat Fee 400 .. 000 15,000 San Mateo 84 .. 000 Gross Rects. 1 .. 400:000 6,400 Redwood city 69 t 000 Ernplo~'ee 700,000 6,000 Mt. Vi.ew 65,000 Flat Fee 250,000 5,500 Los Gatos 29,ODO Gross Rects. 400,000 3,000 Menlo Parle 28,000 Gross Rects. 800,000 3,000 Los Altos 27,500 Employee 300,000 3,000 ~See next section . •• Ooes not include $4 ~illion from landfill business license. In the .state of Califoz-nia.. it is common to impose a business license tax based on 1) a flat fee per business, 2} grO$S receipts, 3) number of ernployees. or 4} some combination thereof. Even 'With a tax based en gross receipts or number of employees, residential landlords may be taxed at a flat fee up to a certain number of units, and cO!'l1I!'Lercial landlords may be taxed en a fee up to a cert~in nwnber of square feet. Flat Fee: A flat fee per business \t,rould .not vary with any factor which measures the size or prof i tability of the business. It "'ould be r~ssible to establish a different flat fee for different types of businesses. Fo!' example .. a ~hole.sale co~pany could pay $30 and an auto sales and service company could pay $50. The use of flat fees as a taxing measure is most often defended on the grounds that it is the least complex of the available alterna­ tives. Because no computa.tion is involved, there is little compliance cost for a busi!1ess. Businesses are not rpguired to disclose information regarding their financial condition, nor are they normally subject to a large tax inasmuch as most flat fees are set at a nomirlal rate to take the. smaller I less profitable. businesses into account. Similarly, t'he tax is relatively easy and ine~pensive for the City to ad~inist~r. ~he use of flat fees c~n make revenue estimating easier, and it Cal) be a particularly effective way of taxin~ certain bUsinesses where enforcement might otherwise be a problem. CMR:S25:91 3 o. ._---- :-~ , " On the other hand. unless rates are adjusted annually, the use of flat tees does not provide the City w,,"ith a revenue source that responds to cha~ging economic conditions. Incre~ses in ousiness tax revenue would be dependent on t.he addition of ne", businesses to the cortm1unity. FUt'therl."1ore, the use of flat fees can result in ;el hiqhly re9ressive rate structure becau$€ the same fee is applied to a variety of businesses without regard to the profita!::lility of those businesses. As cClmpared to other measures which more. accurately reflect busi~ess done ... ~thin the city~ flat fees can be particularly unfair when applied to those doing limited business with the city. Gross Receipts: From the standpoint of raiSing re,\'enue, gross receipts is cleal"ly adv~!1tageous. Not only ooes this :method of taxation offer a broad tax base, thereby permitting large amounts of revenue to be produced at relatively low· tax rates, but it also p~,:widEs for revenue grow·th inasmuch as it is responsive to overall economic: change. When a business license tax is based on gross receipts, it is common to establish an annual license fee determined by ranges in gross receipts. For exa:rnple, a business with gross receipts :between $0 and $25,000 could pay $50, and a business with gross receipts of $25,DOO to $50,000 could pay $75. This schedule can be simple or complex. The schedule can be different for different types of businesses. The tax structure can be regressive, however, it tax rates decli~e as gross receipts increase~ If the gross receipts me.thod is used, the tax rate usually is determined OTt the basis of variations in profit among different classes of businesses. While it is possible to establish differing ra'tios among broad classes of businesses for taxing purposes without creating a tax structure that is administratively burden­ some and co-roplex, it is not as prac'C-ical to 'tI,ake the same refined dist:'nction between various types of b'.l.siness I,,'ithir: a particular classification. As compared to a fl~t fee, compliance can be more complicated for those firms transacting business in several cities and admini,stratiorJ and enforcement by the City can also be somewhat more complex. According to information provided by Municip~l Resource Consul­ tants, 40 percent of the City of Palo Alto's sales tax revenue is produced by 20 companies. Thus, any busin~ss license tax ba~ed on gross receipts would have the most impact on these companies~ CJoffi:525:91 • Nu~ber of Employee~: Frog the standpoint of levying business license taxes for reve::1Ue­ raising purposes~ the use of average number of employees is less effective in revenue genEration for the City th~n gross receipts, but superior to a flat rate tax beca·J.$c the revenue 'Jould increase ",hen businesses add empl<jyees. As compared to a flat fee, the use of average number of employees tends to distinguish bet ...... een businesses by providing ~ rough Deasure of business volume. Employers have little difficulty computing the avarage number o.f eillployees becaUSe they are presentl~{ required to keep records for Social Security and t,ax 'Iolithholding p\jrposes~ Similarly, few administrative problems are encountered by the City. Vlhile the use of averaqe number of ecployees as a tax measure is substantially better, in most cases, than a flat fee~ it can present problems. While it does provide some measure of business vo:!ume, it can penalize those businesses that are labor intensive ~hile virtually ignoring those having high profit margLns but few employees. 1..1so~ if the tax ra~e declines as the number of employees increases, the business license tax structure can become highly regressive. When a business license tax is based on number of employees, it is commcn to establish an annual license fee determined by ranges of r.umber-s of employees. For example r businesses 'With 1 to 5 employees could pay $50, and businesses 'With 6 to 15 employees could pay $200. Agair., the schedules can be simple or complex and can be different fc,r different types of businesses~ Business Classifications: The business classification sy~tem, or specific groupings of business activities identified on a city~ 5 ordinance, can range from as few as one business category to over 100. The most common categories of business activity incb.J.de: retailing, wholesaling, manufacturing, contractors, rental of property, services, profes­ sions~ and miscellaneous. Thus a gross receipts business lic~nse tax for a city may require a $35 fee for a retail company vith gross receipts of S25,OOO, but only a $25 fee for a manufacturing company ~ith the sa~e gross receip~s. In late 198.9 Ralph Anderson & AS5c>ciates completed a statewide survey to determine ho .... ' businesses are tax:ed across California. rt found that gross receipt3 is the preferred bdsis of taxation for most types of business activities: 51 percent of businesses licer.sed were taxed on gross receipts i 25 percent -were taxed on number of employeesj and 14 percent were. taxed on flat tax. seventy-four perce~t of the cities responding }'"1ad minimum tax: payment requireI:"1ents in place and 3 a perce:nt had a :maxirr~um tax in place. CMR:525:91 5 stiffing Requirements Staff est~mates that it .. 'ould ta~.e up t.o three additional people to administer any ~ew tax. The new staff would issue licen5~s, mail renewal r.otices, renew licenses, maintain a cata base, monitor the tax: t!lrouqh the use of tax retu!'"ns, newspapers, re",/erse telephone dir~ctories, county records~ etc. I make field and telephone contacts with noncompliar.ts, issu~ citations and handle slt\all claims ac.tions, prepare state-required reports, and supply information to other city staff and the Cha~ber of Comm~rce. While some cities use !eIJer staff, they are not able to perform all these functions. There are 14 peoople in Sa.n Jose administering the busi~ess license tax. Santa clara has 5 people and Hayward has 4 staff. Mountain View, Los Gatos~ Surl1'J.yvale~ Los Altos, Menlo Par}c~ Redwood City and San Mateo each have one staff lIIe~ber assigned to business license: tax~ The citiEs 'Which have only one staff member assigned to business license tax can only process payments and complJr with stato:-required reports and have 1 i ttle or no staff time devoted to mordtorin; compliance. Although a reduced level of administrati9n is possible, staff feels up to three people are needed for the fUnctions listed above. The additional staff .. ould be added to c:he Treasury Division of the Finance Department and cost bet ... een $100,000 and $150,000 annually. At this time, the additional staff ""'ould be located with the utility bill processing center at 425 Bryant Street. Voter Approval Proposition 62 has been challenged several times, ~nd all ehal~e~ges ha~e upheld tne unconstitutionality of the voter prov~s10ns. Under the State Constitution, Charter cities can enact a business license ta~ ordinance without the voter's approval. Whether or not thE Council decides to seek voter approval, staff would recommend the formation cf a joint City and Chamber of COll1llle:rce cotnJr,ittee and public r.earings. A schedule could be as follO\Js: CMR:52S:91 6 .. r,. . , Form committee Draft Implementation Plan (Typt< of Tax) Discuss Imple~entation Plan With Finance Cornmitte~ Return to council ~itn Irnpleroentation Plan committee Planning Meeting Finance Committee Study (Dollar level and classification structure) PUblic Hearings Council Approval Election (Council option) IIraplementaticn 1/92 -2/92 3/92 -4/92 '5/92 6/92 7/92 8/92 -10/92 11/92 -3/93 12/92 -4/93 11/2/93 12/93 -3/94 The Franchise Tax Board of California has se:r~t cities instruction:;. for submitting city business tax information as required by Revenue and Taxation Code section 19286~8. These reporting requirements will impact the time nGlcessary to administer a business licenso! tax. Staff ~ill need to dete~mine ho~ to classify businesses to make the filing easier. For example; if th~ State of California is developing certain classifications, the City staff cou Id make reporting easier by developing a Palo A1 to tax that is consistent with the State classifiGaticn. Cost/Benefit currently, there are three proposals before the Co\.!ncil Finance Committee which I;/Qu1d involve new sources of r.evenues tor Gpneral Fund purposes; the business license tax; the real property conveyance tax; and the landscape and lighting assessment district. Adoption of any of t.hese measures 'Will impact the City's position vis a vis its proposition 4 (Gann) limit. If the Council approves implementation of the real property conveyance tax in the current fiscal year as staff recommends, the estimated "room" remaininq between General Fund appropriations sUbject to the Gann limit is approximately $1.5 to $3 million; placing an upper limit on tax CHR:525:91 7 : ! I I " ! o revenues unless the Cour.cil places a Gann override measure en the ballot. In addition, staff believes the busi~ess license tax may have a negative imp.act on business retention in Palo Alto if imposed at a level that bUsinesses consider onerous. Estimated costs to administer the tax ace between $100,000 and $350,000, so that revenues less than $500,000 do not appear to be cost effec­ tive. Staff :::onsequently reco","n1ends, if Council approves the concept of a busine.ss 1 icense tax. tha;t staff be directed to develop a tax progra!J that \rill net approximately $1 to $1.50 ~illion annually. Eff.~t on Business in Palo ~lto Imposition of a business license tax given the curre.nt economic climate CQuid adversel)o~ affect the City's overall financial structure, if additic~al taxation results in businesses relocating operations out of Palo Alto or discourages no;!'W businesses from coming to the City. Oiscuss ions with Stanford Research Park tenants indicated that the City is already one of the most expensive l~cations in the United States on a cost per square foot basis, and that any additional costs that negatively impact their -bottom line" :may make relocatio:1 unavoidable. It is interesting to note as 'Well that at the current time, bl.lsiness<f!s and non­ residents provide ahr.ost three quarters ~t 'the City's General Fund revenues -j~5t under 50 pe~cent from busineSSES and just under 25 percent from non-residents, in the form of sales, property, utility users, transient occupancy and other taxes, as well as service fees and p~rmit and miscellaneous revenues. with less than 30 percent of General Fl.lnd revenues coming from residents, it may be more appropriate to target ne~ revenue sources to residents, ~ho derive siq-nificantly more benefits from General Fund services. The council ~ill also recall that the business community supported the cre.o.tion of a utility users tax .'hen it "'as placed 01"'. the ballot in 1987, at least in part because of ~he recognition that the City of Palo Alto did not levy a busi!1ess license tax. Because implementing and adpinistering a business license tax can be a tremendous administr~tive effort, consideration should be given to other means of achieving the intended purpose of revenue generation. For example, in adopting the comprehensive User Fee/Cost Allocation Study j ""'hich determined the costs of user fee services, the City Council approved increases to fees as a result of that study which r.ais~d the overall cost recovery leval for fee­ supported services from 50 percent to 58 percent. resulting in estimated ne~ revenue of $860,000. An alternative to the business license tax, ~hich ~~uld require no additional staff or ~verhead cost, would be to have the City COuncil direct staff to pursue a higher cost recovery level for user fees, ..,.,hich would result in revenues in excess of the business license tax. CMR:525:91 a • ( '-- R.t:~.nd.tion .It council 4r'is!1es staff to pur:::ue implementation of a busir.ess license tax, staff l'ecommerlds council prcvide direction on which of the types of tax Council wishes to implement, and whether O~ not to plan on a ballot measure. Staff ~ould then return in mid-1992 ~ith a specific prcposal and i~plementation plan. Respectfully sub~ittedi 'yj~ B. ,:lc--d .~- GORDON B. FORD Tr~a~ ~JManager .U{L~ EM l..Y HARRISON Di~~O~~~~~;-______ __ 'pIIjIILLIAM ZANER City Manager Attachment cc: Palo Alto Chamber of Commerce Related st,af! Reports: Cl-'".R: 594: 6 CKR:525:91 9 " ATIACIMENT A 1""\ '.1 ~ O"""""L 'USIJ'fU',JU ~ t ........ ,...,...... .. ""*e .............. ' ...... ~I~r ..... ,~. , ......... .-:.,. . -.. ~.At'''''.SAlilS .. ~n...e.,~",~ t I'IICIfISSIOU. ClCCll'Io rDeS ..:I SlJtIIJC-.J II. ~rlLlCOMl·~ • t IIIOret..!. /IOrltl. ~ -'Q('...r:~ IOIoACiMC NOUSI1 ~u I\M;Jllr ~u ~~ ~CQJllr'!.I ... 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