California Bill Aims to Close Tax Loophole for Multinational Corporations

SACRAMENTO — A decades-old corporate tax policy that costs California billions in lost revenue annually is facing potential repeal as the state grapples with budget deficits and reduced federal funding. Assembly Bill 1790 seeks to eliminate the “water’s edge” tax break, a provision allowing multinational corporations to exclude income from their foreign subsidiaries from state taxation.

Assemblymember Damon Connolly (D-San Rafael), a primary sponsor of the bill, stated, “The tax bills of the wealthiest, most powerful corporations in the world are at all-time lows,” according to a press release. “Meanwhile, we’re struggling to fund programs that feed children — I think everyone understands that now is the time for long-term budget solutions.”

GOP Opposition and Budgetary Concerns

Republican Senator Roger Niello, vice chair of the Senate Budget and Fiscal Review Committee, expressed opposition, arguing the bill would lead to double taxation and further harm California’s business climate. As outlined in the bill text, Niello compared the proposal to enacting tariffs, stating, “California already has the reputation of being not particularly business friendly. This would really just compound that.”

Governor Gavin Newsom’s office has not yet commented on the proposal, but has generally been hesitant to support fresh tax increases. Legislation requiring tax increases needs a two-thirds majority vote in the California legislature.

How the Water’s Edge Election Works

Currently, multinational corporations in the United States can choose between two tax filing methods. Worldwide reporting considers all global profits and losses, whereas the water’s edge election allows U.S.-based parent companies to exclude income from foreign subsidiaries. Digital Democracy explains this allows corporations with profitable foreign operations to potentially pay less tax in the U.S.

State Budget Crisis Fuels Debate

California is facing an estimated $18 billion budget deficit, exacerbated by federal cuts impacting healthcare funding. A federal tax and spending bill signed in the previous year shifted funding away from social safety nets.

Experts suggest the timing of the bill is linked to the state’s financial challenges. Kayla Kitson, a senior analyst at the California Budget and Policy Center, noted, “The stakes are really high this year,” and that discussions are underway to address the state’s budgetary issues.

Growing National Trend

The movement to repeal the water’s edge tax break is gaining momentum nationwide, with states like Maryland, Minnesota, and New Hampshire similarly considering similar measures. Carl Davis, research director for the Institute on Taxation and Economic Policy, attributes this to increased awareness of profit shifting – a practice where corporations move profits to tax havens to reduce their tax burden. According to the bill text, this practice allows some corporations to avoid U.S. Taxes.

Potential Revenue and Administrative Considerations

The Legislative Analyst’s Office estimates repealing the water’s edge exemption could generate “single digit billions” in additional revenue for the state annually, though the exact amount is uncertain due to the difficulty in tracking profit shifting. Rowan Isaaks, an economist with the office, cautioned about potential budget volatility due to the sensitivity of foreign income to global economic conditions. Yet, the office found no strong evidence companies would leave California if the tax break was repealed.

Jennifer Barton, director of the legislative services bureau for the California Franchise Tax Board, indicated that implementing worldwide reporting would not pose significant administrative challenges for the state.

Public Opinion and Alternative Proposals

A Pew Research Center survey from last year found that 63% of American adults believe large corporations should pay more in taxes.

Another tax-related proposal, the Billionaire Tax Act, a proposed state ballot initiative to levy a 5% tax on California’s billionaires, is also under consideration, though it faces criticism from Governor Newsom. Davis believes the debate over corporate taxation will continue regardless of the outcome of AB 1790.