Budget crunch may cost firms key tax breaks.

During economic downturns, government often extends a helping hand to business, enacting tax breaks to spur growth and turn the economy around.

But with California facing a whopping $23.6 billion budget deficit next fiscal year, Gov. Gray Davis' revised budget proposes the exact opposite: taking away tax breaks from business to bring in an additional $2 billion in revenues.

Topping the list of Davis proposals of concern to business is a $1.2 billion tax break for struggling companies. Davis has proposed suspending this tax credit for two years, which business groups fear could cripple many firms that have been posting operating losses.

Also targeted are businesses that buy and operate fleets of cars. Like all Californians, these businesses will have to pay higher vehicle license fees if the Davis plan to roll back recent fee reductions goes through. Businesses pay about one-third of vehicle license fees, or $400 million a year.

Other Davis proposals that could impact the state's businesses include a 50-cent hike in the cigarette tax and a proposed reduction in tax credits for bad debts of banks and other lending institutions.

"When you consider that businesses are already operating in a very bad economic environment, these measures can only make a bad situation worse for thousands of businesses," said Martyn Hopper, state director for the National Federation of Independent Business, which represents 38,000 small businesses in California.

Hopper said the suspension of the tax break for businesses posting losses--called the net operating loss carry forward--has the potential to inflict the most damage, especially on startups and businesses in cyclical industries.

Currently, if a business posts losses in a given year, the net operating loss carry forward allows that business to forego paying any taxes that year and to reduce its tax bill by 60 percent of the loss over 10 years. So if a business has $100,000 in losses this year, it doesn't have to pay any taxes this year and can reduce its taxable income by $6,000 for each of the next 10 years.

Two-year suspension

In his May 15 budget revision, Davis proposed suspending this tax deduction on business losses for the next two years and allowing those losses to be deducted from incomes for two years longer than current law allows.

"This suspension of the net operating loss carry forward is really going to hit technology firms, agricultural firms, and start-ups very hard this year," said Fred Main, senior vice president with the California Chamber of Commerce.

Main said the Chamber recognizes the severity of the budget crunch and is in discussions with both the Davis administration and the Legislature on a compromise proposal.

Under the compromise, in exchange for businesses accepting the proposed suspension, businesses facing losses would be able to deduct a higher percentage of those losses from incomes in future years.

Assembly budget committee chair Jenny Oropeza, D-Long Beach, said it was too early in the budget process to comment on the compromise or other specific measures the Legislature might approve. But she said the feeling among her fellow legislators was that the suspension of the net operating loss carry forward seems to be a "reasonable" measure given the magnitude of the crisis.

In his May 15 budget revision, Davis proposed closing the $23.6 billion budget gap with $7.6 billion in cuts, $4.5 billion in borrowing against future tobacco settlement revenues, $4 billion in loans, fund transfers and debt refinancing, $2 billion in tax increases, and at least $2 billion in rollbacks of previously granted deductions.

Under the state constitution, the Legislature must pass a budget by June 15 and the governor must sign it by June 30. However, these deadlines are frequently missed and it's widely expected that the budget will be late this year.

Effect on fleets

The partial reversal in rolling back vehicle license fees could hit some businesses especially hard, including trucking firms, distribution companies and car rental agencies.

Typically, the vehicle fee was equivalent to 2 percent of the value of the vehicle, which depreciates over time. Over the last four years, vehicle license fees have been cut 67.5 percent, which has provided a huge boon to these firms.

Now, under the Davis revision, the fee cut would be lowered to 25 percent--about 1.5 percent of the value of the car, not the current 0.7 percent.

For the average car owner, the vehicle license fee would increase from the current $64 to $148. But for businesses with dozens or hundreds of vehicles, the increases could amount to hundreds of thousands of dollars a year.

"There's no question this is going to hurt businesses with fleets," Main said. But he also noted that since all Californians would be hit by this increase, the Chamber may not mount fierce opposition to it.

The state's banking industry also takes a hit. Currently, banks can deduct from their reported income the amount they set aside in reserve to cover bad loans. The Davis administration is proposing changing this for banks with more than $500 million in assets. These institutions would only be able to take deductions for the actual amount of bad loans in a given year. And, in a move that the Davis administration says will bring the state into conformity with federal law, these banks would also have to pay taxes on past reserves.

Together, these steps would bring in an additional $255 million to state coffers for the coming fiscal year, according to the Davis administration's May budget revision.

"This is a tax increase on banks," said James Clark, vice president of government relations for the California Bankers Association. "It's going to hit the big California-based banks the most."

Ultimately, he said, the higher amounts paid in taxes will be passed on to bank customers.

That will also likely be the major impact of the proposed 50-cent increase in the cigarette tax. However, this tax hike may cause some merchants to lose business from cigarette sales.

"With each tax increase on cigarettes, the problem of cigarette smuggling gets worse," Main said. "Also, as more and more Indian reservations open up to casinos and business, you will see smokers going there to buy cigarettes in bulk, since products sold on reservations are exempt from state taxes."