Closing tax loopholes in California budget is a good start

There's no precise definition of the term "tax loophole." It is, like beauty, in the eye of the beholder or, as the late Supreme Court Justice Potter Stewart once opined about pornography, "I know it when I see it."

A broad definition would be that a loophole -- or "tax expenditure," as the taxation professionals call it -- is an exemption from an otherwise widely imposed tax that benefits a particular class of taxpayers. That said, one person's loophole is another person's legitimate tax-incentive policy, and we are beginning to see a debate along those lines.

The California state budget is billions of dollars in the red. Closing tax loopholes is being touted by Democrats, Legislative Analyst Elizabeth Hill and Gov. Arnold Schwarzenegger as a way to narrow the deficit. Republican legislators say it's just a tax increase by another name.

"What we need to do is fix problems, and let's just put everything on the table and not debate over the definitions," Schwarzenegger said last week.

All tax policy is arbitrary. Which activity or commodity is taxed, and at what rate, is a purely subjective decision generally made to benefit some voter bloc or interest group. One tiny tax law illustrates that arbitrariness: Hot food from vendors is subject to sales tax while cold food isn't -- a difference that sparked a big battle in the state Board of Equalization over whether theater popcorn, sold while hot, should be taxed when it turns cold by the time the theatergoer returns to his or her seat.

Some loopholes -- the biggest ones, generally -- have fairly broad benefits and political popularity, such as the income-tax deduction on home-mortgage interest ($5.7 billion a year) or the sales-tax exemption for food ($3.8 billion). But once you get past the biggies -- something that has a revenue effect of a billion-plus dollars a year -- you find a confusing array of loopholes.

Much has been made about allowing purchasers of yachts, motor homes and airplanes to avoid sales taxes by taking possession of the machines outside the state and keeping them out for at least 90 days. But narrowing that loophole by imposing a 12-month waiting period, which Republican lawmakers have blocked, would raise just $21 million a year -- a potent symbol, perhaps, but not even a drop in the bottomless well of the deficit.

We've heard very little about another sales-tax loophole that costs the treasury more than twice as much and is, if anything, even more difficult to justify than the yacht loophole -- tax-free treatment of custom computer-software programs typically purchased by business. While ordinary consumers must pay sales taxes on their off-the-shelf software purchases, the custom programs to manage payroll or inventory are exempt simply because longtime Democratic legislator John Vasconcellos carried exemption legislation a couple of decades ago at the behest of Silicon Valley software firms.

Likewise, when consumers lease a car or other item for personal use, they generally pay sales taxes. But the leases of master recording tapes by musicians or others who control recording rights are tax-free, thanks to a special law passed decades ago at the behest of the recording industry that costs the state $65 million a year.

And so it goes. Beneficiaries of loopholes defend their supposedly beneficial effect. In toto, however, they cost the state an estimated $50 billion a year in lost revenue, three times as large as the deficit and half as large as the budget itself.

It's simply ludicrous to contend, as many Republicans do, that all are justified, or are at least more important than spending cuts that otherwise would be needed, just as Democrats shouldn't defend all spending.

A rational approach would begin with eliminating not only nonessential spending but nonsensical tax loopholes as well.

(Contact Dan Walters at dwalters(at)sacbee.com. For more stories visit scrippsnews.com.)

(Distributed by Scripps Howard News Service, www.scrippsnews.com.)