San Francisco Payroll Tax: Mayor Lee Proposes Sweeping Change To City's Tax System

SAN FRANCISCO -- San Francisco Mayor Ed Lee has made no secret about the growth of San Francisco's booming technology sector being his administration's foremost priority.

While most of Lee's moves so far have been relatively uncontroversial (at least within the city's greater business community), his latest proposal--a reformation of San Francisco's payroll tax--has created a fracture, with tech firms on one side and a bevvy of other industries on the other.

At issue is Lee's proposal to scrap San Francisco's 1.5 percent tax on the payroll of all large companies operating in the city in favor of a tax on total gross revenues. The payroll tax generates approximately six percent of San Francisco yearly budget. Last year, the city's haul from the tax amounted to around $400 million.

Opponents of the payroll tax have argued it discourages hiring and drives up the unemployment rate by increasing the cost of bringing on each additional employee. San Francisco is currently the only city in California to impose such a tax. A handful of other cities in the state levy a gross receipts tax; however, the majority of cities around the country rely solely on revenue generated from sales taxes.

The mayor has long backed reforming San Francisco's taxation system. A proposal to alter the tax, at least in a very vague form, appeared in the 17-point economic road-map released by his campaign last year.

This switch would be a boon for tech firms, the majority of whose expenditures are on personnel. But because Lee's aim with the tax swap is to keep everything revenue neutral, the slack would likely be picked up by companies that simultaneously maintain relatively small staffs while generating high profits--think law firms, real estate and financial service companies.

"San Francisco is the financial capital of the West Coast," San Francisco Chamber of Commerce president Steve Falk told The Huffington Post. "So we have a lot of large financial services firms that are nervous about what the new system would look like."

"We don't want a large finance firm moving across the Bay because we didn't get the rates right," he added.

Falk instead argues for expanding the city's corporate tax base. Currently there are only about 8,000 companies contributing to the payroll tax out of some 40,000 total. The rest come in under the $250,000 cap or take advantage of other exemptions, such as the one for firms with only one employee or companies located inside the mid-Market redevelopment zone. By broadening the base, Falk argues, rates could theoretically be reduced across the board; however, he admits executing that in practice could prove considerably more difficult.

It isn't just tech that's backing a move to a gross receipts tax. Other labor-intensive industries, such as the restaurant sector, have publicly come out in favor of Lee's proposed overhaul.

"We are in support of moving away from a payroll tax," Golden Gate Restaurant Association Executive Director Rob Black told HuffPost. "It hurts those industries that hire a lot of people because it taxes inputs instead of outputs."

One of the biggest backers of the switch is famed angel investor Ron Conway. Conway is a Silicon Valley legend, getting in early on wildly successful firms like Google, Facebook PayPal and Twitter. He was also one of Lee's largest advocates during last year's electoral campaign, shelling out $670,000 in independent expenditures and paying for the Mayor's election-night victory party.

"While we have not taken a position on any specific proposal at this time, we are in favor of a gross receipts-based tax solution…to reform San Francisco's business tax structure and incentivize job creation," Conway said in a statement to the San Francisco Chronicle.

According to the Chronicle, at a meeting of local business leaders last week Conway evangelized the benefits of switching to a gross receipts tax and boasted that, with the payroll tax gone, the tech sector could grow by 8,000 new jobs in the next year alone.

San Francisco used to have both a payroll tax and a gross receipts tax in place, with firms paying whichever was higher. About a decade ago, a coalition of 68 companies (including some of the city's most famous institutions like Chevron, Gap and Levi Strauss) sued, claiming the two-tiered system was unfair. Faced with the possibility of having to pay back astronomical sums in refunds if the case didn't go its way, the city settled with the coalition, and has since scrapped the gross receipts tax in favor of applying the payroll tax across the board.

This strong advocacy on behalf of a gross receipts tax has bristled other sectors of the business community, who worry about losing out as City Hall helps tech to a bigger slice of the pie. "The tech companies don’t seem to be team players," small-business advocate Scott Hauge told the San Francisco Examiner.

Even with the additional burden the payroll tax puts on local businesses, the San Francisco market is so attractive to technology firms that there's barely enough space to accommodate them all.

A recent report by Jones Lang Lasalle found that the number of technology employees in San Francisco in 2012 is once again approaching the levels of the city's Dot Com heyday. But as opposed to the heady days of the late 1990s, more of Silicon Valley's energy is focused inside San Francisco proper, with companies looking to be as close as possible to the city's talented workforce.

Earlier this year, Salesforce scrapped plans to build a massive campus in Mission Bay and instead inked a deal for 400,000 square feet in SoMa because the company's ambitious 14-acre campus wouldn't be constructed fast enough to accommodate the software giant's rapid growth.

While Lee has kept mum on the specifics of his plan, a report put out last month by the city's Controller Ben Rosenfield and Chief Economist Ted Egan offered a possibility as to what a gross receipts tax might look like.

The proposal broke down businesses into six different categories, with wholesale trade paying the least (0.08 percent at top marginal rate) and a group comprising private education, health services, and administrative and support services paying most (0.65 percent at the top marginal rate).

Black said that differentiating between different industries is the key to ensuring a switch to a gross receipts structure doesn't harm the city's overall economy. "We don't want to go out and suddenly double anyone's taxes overnight," he told HuffPost.

The report also included an alternative proposal that would leave the payroll tax in place but significantly lower rates across the board while increasing the cost of business licenses.

Lee hopes to get a tax reform measure on this November's ballot.