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A commission charged with reforming California's tax structure will recommend repealing the state sales and corporate taxes, flattening the income tax rate and taxing businesses in a way that has never been tried on a wide scale in the U.S.
The Commission on the 21st Century Economy is expected to submit a sweeping report to the governor and Legislature today after spending a year looking for ways to stabilize California's volatile tax system.
A draft copy of the report obtained by The Associated Press said the commission will recommend California change its personal income tax structure to reduce the burden on the wealthy.
It also recommends replacing the state sales and corporate taxes with a new business levy that taxes net receipts, in an attempt to tax the value of all goods and services produced by businesses in the state.
"California has long been a place where people seek a brighter future. The changes the commission recommends will be a step toward renewing that promise," the report says. "They will create a tax structure that more reliably supports the services that allow society to function."
The commission's process has been marked by skepticism and concerns from all sides. Union leaders worry the policies might drive down wages, and businesses fear being unfairly taxed. Critics argue the plan has not been well studied.
The commission found that California's tax system is out of date, which has put the state at a competitive disadvantage. Since the tax system was established in the 1930s, when farms and factories drove the economy, the state's tax policies have not kept up with the technology and service industries that now dominate, at times making its regulations inconsistent.
"Certain businesses selling services are not subject to sales and use tax while other businesses selling goods are subject to the tax," the commission wrote.
The system also has made the state's finances more volatile. California used to get most of its revenue from the sales tax but now personal income tax makes up the majority of money coming in.
That shift has made California vulnerable to the booms and busts of Wall Street and led to a series of budget crises when revenues fell, since the state now relies heavily on the top 10 percent of income earners, who paid more than 53 percent of the personal income tax last year, according to the report.
Instead of a progressive income tax structure where millionaires are taxed up to 10.55 percent of their income, the commission recommends a simpler system with just two rates: 2.75 percent for individuals making up to $28,000 a year and couples making $56,000, and 6.5 percent for those who make more.
Schwarzenegger has called for a special legislative session to take up the commission's recommendations, but Democrats in the Legislature could decide to start over.
"I know there have been concerns raised by the business community and concerns raised by advocates for middle-class families and low-income workers," Assembly Speaker Karen Bass, a Democrat, said in a statement. "Californians deserve a fair and full assessment of the ways these recommendations would affect them."
If the Legislature adopted the commission's recommendation, joint filers would have a standard deduction of $45,000, while the figure for single filers would be $22,500, much higher than the current rates. The practical effect of that means joint filers who make up to $101,000 would still be taxed at the 2.75 percent rate.
Those above that would be taxed at 6.5 percent.
At the heart of the commission's proposal is a plan to phase out the state sales and corporate taxes over a five-year period starting in 2012. It recommends replacing that revenue -- about $36.4 billion or 40 percent of all state revenue -- with a new business tax that some commissioners compare to taxes applied in Europe.
While a sales tax is levied on the total value of a product to the consumer, most European nations use some form of value-added tax, a consumption tax that is levied on the value added to a product at every stage of the manufacturing cycle.
The so-called "business net receipts tax" differs because it would apply to all companies doing business in California, including sectors that are not taxed today, such as legal, engineering and accounting services.
To calculate the tax, a business would subtract the cost of its purchases from all its incoming payments. A tax rate not to exceed 4 percent would be applied to the net amount.
The recommendation came with a warning that more study needs to be done.
The panel suggested lawmakers study whether wages and salaries should be deductible, if financial institutions should be taxed separately, what to do about business tax credits that spur research and development and whether it would affect capital investment and job creation.
They fear the plan would shift the tax burden off the wealthy and onto lower and middle-income Californians while hurting businesses.
"I am reminded of a police department that latches on early to a prime suspect in a murder case, looking for a quick and easy arrest," Pomp wrote in a dissenting report. "By the time DNA testing shows the wrong person was arrested, all other leads have gone cold."
To monitor the changes, the commission recommended a review panel evaluate the transition each year. For example, if the business tax was not producing as much revenue as expected, the panel could stop the sales tax from being lowered to make up the difference.
The commission also revived the rainy day fund, a formula-driven plan to set money aside each year for emergencies. Voters rejected a similar plan by the governor and Legislature last spring in a package of complicated budget-balancing ballot measures.