Should California Enact an Employee ‘Headcount’ Tax On Employers?

On May 27, Assemblyman Kansen Chu (D-San Jose) gutted-and-amended his bill, AB 398, to provide for the “COVID-19 Local Government and School Recovery Relief Act.” The bill would impose a $275 per employee tax (aka a “headcount tax”) on businesses with more than 500 employees that operate in this state. This tax would be in effect for five years.

The bill would add Part 1.5 (commencing with Section 16555) to Division 7 of the Business and Professions Code and add and repeal Part 25.5 (commencing with Section 47100) of Division 2 of the Revenue and Taxation Code. As a tax increase under Article XIIIA, Section 3 of the California Constitution, the bill would require a 2/3 majority vote of both houses of the Legislature, and signature by the Governor, in order to take effect.

In terms of timing, this measure passed the Assembly in an entirely different form and the new tax increase bill now in print has not been heard by a single committee in either house. Because AB 398 is currently sitting in a Senate policy committee, it is not likely to be heard and voted upon until after the June 26 deadline for the Senate to deal with measures in their house of origin.

The bill provides that, on and after January 1, 2021, but before January 1, 2026, there would be a tax on a large business, defined as an entity that has more than 500 employees that perform any part of their duties within the state, at the rate of $275 per employee. The California Department of Tax and Fee Administration (CDTFA) would administer the tax and the revenues collected would be put into a COVID-19 Local Government and School Recovery and Relief Fund, which the bill would establish. The bill would continuously appropriate the monies in this Relief Fund for distribution to counties, cities, and K-12 school districts.

Section 1 of the bill includes the following 11 findings and declarations:

• The COVID-19 pandemic has had a widespread impact across the globe.
• The COVID-19 pandemic has led to loss of life. The pandemic will continue to have a negative impact on people who have the virus and those around them.
• Governor Newsom issued an Executive Order declaring a state of emergency on March 4, 2020.
• On March 19, 2020, the Governor issued a statewide stay-at-home order.
• In addition to the health impacts of the pandemic, the measures the state and local governments took to protect public health including shelter-in-place and school closures have already had economic impacts on state, local, and personal finances.
• According to the Department of Finance, the economic disruption from the pandemic is expected to result in a recession and have significant negative effects on state revenues.
• This impact is expected to be immediate and ongoing, affecting the 2019–20 fiscal and continuing into the 2020–21 fiscal year and beyond.
• According to analysis by the League of California Cities, California cities are projecting a nearly $7 billion general revenue shortfall over the next two fiscal years.
• This shortfall will grow by billions if stay-at-home orders extend into the summer and beyond.
• According to the League of California Cities, 90 percent of cities projected that these shortfalls will impact core city services, including police, fire service, emergency management and planning and housing, and a majority of the cities surveyed anticipate lay-offs or furloughs, which will further impact core city services for residents, as well as local government employees.
• California cities need funding to continue to provide services to their residents and adapt to the impacts of the COVID-19 pandemic.

Section 2 of the bill creates the COVID-19 Local Government and School Recovery and Relief Act in the Business & Professions Code. It also establishes the Act’s Fund in the State Treasury to collect the moneys generated by the new tax, and would continuously appropriate the funds as set forth below. The Controller could use up to 5% of the funds to cover its costs in administering the program. At the local level, administration fees for local taxes are usually capped at 1%.

The Controller is required to allocate the moneys in the Fund among the counties in proportion to the share of the total number of employees counted that are reported to perform the majority of their duties in each county. Thereafter, the county must distribute the funds in the following manner:

• 20% to the county.
• 30% to the cities in the county in proportion to the share of the total number of employees counted that are reported to perform the majority of their duties in each of those cities.
• 50% to regions in the county based on city boundaries in proportion to the employee count, and then each city must distribute the funds in equal shares among the K-12 school districts that operate in the city’s jurisdiction.

Section 3 of the bill adds a new “COVID-19 Local Government and School Recovery and Relief Tax.” The new provisions of the Revenue & Taxation Code would define an employee to mean “any person who performs work, labor, or services for a large business, is on the large business’s payroll, and performs any part of their duties within the state.” It would also define a large business to mean “an entity, including, but not limited to, a limited liability company, corporation, or limited liability partnership, that has more than 500 employees that perform any part of their duties within the state.”

The bill would impose the tax on a “large business” at the rate of $275 per employee for tax years 2021 – 25, which would be for five years. CDTFA would be charged with collecting and administering the tax and be authorized to adopt regulations to implement this new taxing scheme. Each large business subject to tax would have to file a quarterly return, along with the tax due, with CDTFA containing any information that CDTFA determines to be necessary. The affected large business would also file a quarterly report that details the number of employees that perform the majority of their duties in each city and county in California.

AB 398 would amount to a jobs tax, imposing a financial penalty on employers in this state if they have more than 500 employees working in California. If the state intends to encourage economic development and job creation, this measure would appear contrary to that approach. Any employer would try and remain under the 500-employee cap. And, for those businesses with more than 500 employees, there would be an economic disincentive to hire additional persons and increase their tax liability.

California currently has a roughly 15% unemployment rate, up from 4% in just two months. A measure such as AB 398 would discourage businesses from hiring people. Ultimately, for those businesses that incur this tax, they will most likely pass along the tax increase in the form of higher prices for goods and services.