CALIFORNIA BUDGET GIMMICKS: The latest idea to close the state's shortfall involves the wrong kind of tax code manipulation.

Editorial From the Los Angeles Times

August 16, 2008 — Seven weeks into the new fiscal year, the scrum in Sacramento over the California budget continues unabated. How the Legislature and Gov. Arnold Schwarzenegger will close the $15-billion-plus gap between anticipated tax revenues and the cost of ongoing programs remains in doubt, as numerous ideas -- some harebrained, some not -- continue to be tossed into and out of the mix.

One proposal backed by Democratic lawmakers would raise an estimated $1.1 billion from businesses by delaying the deduction of net operating losses (costs that exceed revenue) for three years. At the urging of some corporate lobbyists, Schwarzenegger recently offered a counterproposal: After the three-year moratorium lifts, businesses would be able to deduct their 2008 losses from the taxes they paid in 2006 and 2007, entitling them to hundreds of millions of dollars in rebates.

The biggest beneficiaries of the proposal would be companies that ran up large profits in 2006 and 2007, then saw their fortunes plunge in 2008. Let's see, who might that be? How about the lenders that grew rich off subprime and other risky mortgages before their what-me-worry approach to underwriting caused an explosion in foreclosures. Say, for example, Countrywide Financial Corp. (now owned by Bank of America).

Given how radioactive these firms have become, it's hard to find anyone defending the proposal publicly. Yet there is ample precedent for letting businesses write off losses retroactively. The federal government has long allowed companies to "carry back" a current year's losses and deduct them from the federal taxes they paid for the three previous years. By contrast, California permits companies only to "carry forward" losses, which they can deduct from taxable profits over the subsequent decade.

We're not big fans of the government using the tax code to sway behavior, mainly because such efforts tend to be ineffective and prone to abuse. We'd prefer a simple, fair tax code that merely raises the revenue needed to pay for government programs and services. Yet there's a solid rationale for letting companies carry losses into the future: It encourages larger (and, potentially, riskier) investments that take years to recoup. Pharmaceutical companies, bio- engineering ventures and microchip manufacturers are prime examples of companies making large bets on profits that won't soon be realized.

No such benefit would come from letting companies recoup losses retroactively, however. Instead, it would encourage a less-productive kind of risk-taking by giving companies more protection against the pain caused when a profit-inflating bubble suddenly bursts. Lawmakers should be figuring out how to put the state budget on a steadier path, not helping lenders recover from their subprime bender.