CALIFORNIA GOV. GEORGE DEUKMEJIAN told a story a couple of years ago about two hikers who encountered a hungry bear out in the wilderness. As the bear started toward them, one of the hikers reached into his pack and pulled out a pair of running shoes. "Why do that?" the other hiker asked. "You can't outrun a bear." Lacing the shoes, the first hiker looked at him and said, "I don't have to - I just have to outrun you."
The California governor went on to say that the state was once again competing for business, in contrast to a period of several years during which the machinery of state government often seemed indifferent, or even hostile, to job-creating commerce. After his speech, Gov. Deukmejian met with reporters on the back steps of the hotel where he had spoken to discuss plans to change the unitary tax law. That law that had been driving foreign investment away
from California to states with less expensive taxes.The unitary tax system bases a firm's state income tax on all income earned worldwide. The result was high taxes for big multinational firms that wanted to operate small- or even medium-sized plants in California.
The governor said he planned to switch to a water's edge formula, one that based a company's state tax only on income earned in the United States. He estimated his plan would grant $200 million in tax relief to multinational companies. The water's edge tax bill approved by the California Legislature and signed into law this month is not quite thatsplashy, but it's still expected to reduce taxes for the multinationals by about $80 million.
Not everyone is overjoyed about that. California taxpayers almost certainly will grumble if they have to cut $80 million in state services to make up the loss.
But Gov. Deukmejian is relying on the strategy of outrunning the other hiker rather than the bear. Already, there have been reports that Japanese companies that had moved operations to Oregon and Washington are re-evaluating the prospects for doing business in California.
If changing the unitary tax prompts a few key Japanese firms to locate plants in California instead of Washington or Oregon, the additional income generated could result in additional tax revenue that would replace a good part of the $80 million. Those plants also would create hundreds of new jobs, further strengthening California's economy.
The new tax formula is a calculated gamble, but we believe it is one that ultimately will pay off for California. We also believe the states of Washington and Oregon are going to have to become more competitive if they hope to expand their role as sites for multinational investment. Otherwise, those states may find the bear that appears on California's state flag looking more and more hungry.