what's the highest gross receipts tax we could impose. because we haven't charged a gross receipts tax in san francisco for a number of years and we don't exactly know what the gross receipts base is in the city, there's a lot of uncertainty in terms of what that tax would generate. in order to be revenue neutral, we would not like to phase out the payroll tax until we phase in a gross receipts tax and see what we make. so the basic idea of the phase-in is, in the first year, you charge the gross receipts tax at a small rate and gradually increase that over four or five years and the following year you reduce the payroll tax depending on how much gross receipts tax that you generate to make sure that you're compensating businesses with a reduced payroll tax rate with exactly what they are paying in gross receipts. so in that way, we can guarantee that the proposal will be

revenue neutral and if we didn't have that phase-in, we couldn't make that guarantee. it would be our best guess and the uncertainty would almost be too much to bother doing. so that's two important points, that the proposal is revenue neutral and that there would be a phase-in period to ensure the city is not getting more or less money it would have gotten under the payroll tax. as you'll see on the next few slides, as you know, we have a flat 1.5% payroll taxerate now. we would not envision a flax gross receipts tax that every business would pay. it makes no sense to charge a a retailer and a law firm the same gross receipts rate because the economics of those two industries are so different so we have set up four schedules, each one of which applies to different industries so a business would look up what schedule applies to their type of business and then pay the

rates. you'll see in each of these sclds schedules that there are four tiers and the taxes are progressive within each tier. the rates are also marginal. i'll walk through this when we get to the schedules. you only pay the highest rates once on your gross receipts that are above a certain tier so what it winds up being is that your payments increase gradually as gross receipts gradually. an important factor and gross receipts are a complicated tax. an important factor in a grows grows -- gross receipts tax is apportion. businesses can derive gross receipts from sales inside san francisco and outside san francisco and rules have to be set regarding the amount businesses can be taxed for receipts outside of san francisco. we have to set rules that businesses will follow and we're following the practice of other cities and states in

establishing these rules. in you're a service industry, you'll use what's walled payroll based apportiononment which says look at your global gross receipts and look at the percentage of all of your payroll expense that takes place in san francisco and maybe that's 5% of all of your payroll expense happens in san francisco. apply that 5% against your gross receipts, your global gross receipts, and that's the amount of pay the tax rate against in san francisco. so if you're a small business and you're in the service industry and all of your payroll takes place in san francisco, then it's very simple. 100% of your gross receipts is taxable by the city but it's apportionable by your payroll so for example if you do -- if you're based in san francisco but you do a lot of deliveries around the bay area and maybe only half of your payroll expense is incurred in san francisco, you'd only pay the tax on half of your gross receipts so that's the rule that

would apply to service businesses. there's another set of businesses that derive gross receipts from renting property. this would be like a real estate company or a hotel. and the rule for these companies is even simpler. if the property is in san francisco, it's taxable gross receipts. if the property is not in san francisco, it's not. so that's a very simple rule. those companies exclude everything that's not within san francisco and finally there are a is the of companies that are trickier from an apportion ment point of view because they sell tangible or intangible property. if you're in the manufacturing industry or if you're in the information industry or the wholesale trade industry, your business involves moving physical or intangible property. it's common in industries like this to use an apportionment formula that considers where you are selling to. so that if you're deriving more revenues from outside of san francisco, your taxable

gross receipts in san francisco is less. the apportionment formula we're envisioning for these companies is a combination of payroll and sales so basically half of your apportionment would come from where your payroll is based and half of your apportionment would come from where your sales are based. i'll show you an example of this. it's better to go through the math on one than to explain it. i think the other two are more self-explanatory. let me walk through each of the four schedules and tell you which industries they apply to and how the schedules would work. schedule one is the lowest set of rates and it would apply to businesses that are in the wholesale trade industry, retail trade industry and right now the insurance industry and other services. in each case, we are assigning industries by their industry classification code businesses use to pay federal taxes. the other services includes

nax81, that's basically neighborhood services like beauty salons and repair and maintenance services and one other big one i'm forgetting but it's largely miscellaneous personal services so for businesses in those industries, if they earn less than $100,000 in gross receipts, they pay no tax at all. we're envisioning a $100,000 deductible to apply to every business. every business would write off their first $100,000 in gross receipts and if you had less than $100,000 in gross receipts, that eliminates your tax liability completely. you would have to pay a minimum $150 business registration fee, however. if you start getting gross receipts into the second tier in the 100,000 to 2.5 million tier, you would pay the registration fee and a percentage above

$100,000. if you have gross receipts above 2.5 million to 25 million range, you would pay the first $150 registration fee, .1% of your gross receipts from 100,000 to 2.5 million and a higher rate on gross receipts to the 25 million range. you would also pay another $100 in business registration at that point. rates become progressive but marginal so everybody pays the low rate on the first tier and you only pay the higher rates to the extent you have gross receipts in that level. if you are in these industries and have over $25 million in gross receipts, for the amount above 25 million, you pay .25 gross receipts and an additional $250 in business registration fee so that's how the marginal rates work for all of the schedules.

and you'll see there's commonalities across all four of the schedules. this is schedule two with the same $100,000 deductible, the same tiers. the only difference is the first tier rate is .15 rate, the second tier rate rises to .25% and the third tier rate is .35% and all of those are applied against the gross receipts apportioned to san francisco. this schedule applies to the construction industry, manufacturing, transportation, warehousing, information and food services. schedule three, an identical structure, the initial rate is .35% and rises to .4% in the second tier and .5%, applies to financial services, real estate, professional services, hotels and the arts and entertainment industry. we are envisioning an exclusion for gross receipts associated

with the rental of rent controlled buildings because those owners have no ability to legally pass those receipts on to their tenants so that's not true for other branches of real estate so we are proposing that owners of rent controlled buildings could exclude 50% of the gross receipts they derive from rent controlled buildings. back in the day when san francisco had a gross receipts tax that applied to real estate, the residential rate was half the rate of commercial and that's partly why we're coming up with that 50% number. finally, schedule four only applies to two industries -- the education and health services sector and administrative and support services. they have the highest gross receipts rate. the first tier is .55%, the second tier is .6% and the third tier is .65%. those are the four schedules,

really every industry in san francisco, every business would fall into at least one of those schedules and calculate their tax from that. i'm going to walk quickly through an example of sales plus payroll apportionment because it's slightly complicated. as i mentioned, these apply to businesses that sell tangible or intangible property. a video game is an example that you would distribute over the internet is an example of intangible property so that's what this business would use. in this example, the company has $1 billion in gross receipts. they have $300 million in payroll of which $150 million are in san francisco so that's 50% of their total payroll. however, their billion dollars in sales, only 25% -- i'm sorry, only 25 million or 3% of their sales takes place in san francisco. so this is a very common feature of businesses that are based in san francisco but sell outside. a lot of their sales come from

outside the city but much of their payroll takes place. so their apportionment factor becomes 26.25%, 25% comes from the payroll, half of the fact that they have half of their payroll here and the gross receipts destination factor, that's weighted half, it's against the 3% that they get in san francisco which leads you to 1.25. so what this boils down to is they owe -- their taxable gross receipts from the city's point of view is 26.25% of their global gross receipts or $262.5 million and they calculate their tax using the marginal rates i just discussed. if you're selling a product or a piece of information, you would use this form of apportionment and what it tends to do is reflect both where your payroll expense is and where your sales

are. let me talk briefly about the economic impact of the alternate because one of the reasons for considering replacements for the payroll tax is the economic side of it. we project that even a revenue-neutral replacement of the payroll tax with a gross receipts tax would create many jobs in san francisco. we think that over a 20-year period, it would create on average about 2500 jobs simply by removing that disincentive to applies to the cost of labor. partly that's what that's from. it's also due to, as i mentioned before, the payroll tax is growing faster so in the future you'd be paying less tax with a gross receipts tax and we've shifted the tax burden across industries and we believe we've shifted the burden on to industries that have the potential to create more jobs in the city so some of the job gain comes from that. but on a net basis, in 20 years,

we would expect to have about 3500 more jobs in the city with this replacement than we would with our current payroll tax. looking industry by industry and it may be best to read this off of your -- if you can't read it it on the screen, off the paper. this is an industry-by-industry breakdown of what we think the payment would be under the current payroll tax versus the gross receipts alternative and the pie on the gross receipts alternative is changing slightly so don't hold me to that number exactly but in general, what's happening is, right now we are very, very reliant on professional services as a huge source of our business tax revenue. that one industry now pays almost about a third. we would seek to reduce that to less than a third, about 28%, and most other industries in the city would also see reduced tax payment. the one sector that would see an increase payment or the several

sectors that would see an increase payment would be finance, insurance and real estate, which would go from about 16% of the total to about 26% of the total. because this is a revenue-neutral proposal, that increase in taxes paid by those industries would be used to reduce the tax rate paid by other industries and as i said, that's one of the reasons why we believe this proposal is a job creator. another aspect that's important part of business tax reform is base broadening. as i said, about 7500 companies paid the tax in 2010. we think that under this gross receipts proposal, about 33,000 businesses in the city would pay tax in some form. i would point out, though, that of those, about 25,000 would pay only in tier one. so it is -- it would be an example of tax reform that would bring more businesses into the tax system but it would also

recognize that small businesses generally can't afford to pay the same rates as larger businesses and the vast majority of small businesses would be paying at a significantly lower rate than large businesses. that still leaves about 62,000 businesses not officially paying the tax. the only reason they wouldn't be paying the tax under this proposal is because they have less than $100,000 in gross receipts. it is not desired to go after those businesses that are very sort of marginal businesses in terms of their earnings and derive a lot of tax revenue from them. however, they would pay an increased business registration fee of $150. our current lowest business registration fee of $25, which only sole proprietors pay, would go away under this proposal and the minimum registration fee would be $150. so that's the gross receipts alternative, and i took some time to explain it because it's

significantly more complicated than our payroll tax. but i do think that it addresses many of the concerns but not all of the concerns with our current payroll tax. it's far more positive for the economy than the payroll tax. we believe it will be less volatile than the payroll tax and we believe that it better matches or broadens the base and deals with the inequity of only 10% of the businesses or less than 10% of the businesses paying any tax at all but doing so in a way that is mindful of business' ability to pay. however, as we initially presenting last month the gross receipts alternative, we were very candid that that was not the only way to address weaknesses in the payroll tax and that there were many of the weaknesses or challenges in the payroll tax you docked by reforming the payroll tax so we've been asked to develop what we're calling a payroll only alternative that would address some of those issues within the context of a payroll tax so this

alternative, the most important part of it is, it does not involve a gross receipts tax at all. it would require voter approval because we are raising the taxes paid by some businesses, but it would simply change things that we're currently doing in the payroll tax, in the introducing a new tax. specifically, it would increase the business license fee for all business payers. and it would do that significantly, anywhere between five times to 20 times what businesses are paying now. secondly, it would explicitly include the earnings of sole proprietors and partnerships that we now say don't have payroll, it would say the compensation that the owners of those businesses get is subject to the payroll tax and would bring them into the tax system. it would also broaden the tax by including non-profits but only in the business license fee. right now, non-profits don't pay

the tax and they don't pay the license fee. this proposal would make them pay the license fee but not the tax. it would replace the current small business exclusion in which, as i said, businesses below 250 don't pay the tax at all with a $100,000 payroll deductible so what that would mean is any business with less than $100,000 in payroll would pay nothing and businesses bigger than that could deduct their first 100,000. dealing with the issue that 250,001, that business is paying the same as a really big business is paying and that would make the tax slightly more progressive around that level. another piece of feedback we've gotten about the payroll tax is it's punitive to new businesses because they have to pay the payroll tax as soon as they have expense. they don't pay a gross receipts tax until they start making sales so that would address that without bringing in a gross

receipts tax, by allowing new businesses to have a payroll tax holiday for the first three years in operation and specifically they would be able to deduct up to $1 million in payroll tax expense for each of their first three years and after three years they would pay the payroll tax as normal. we've also heard a lot of feedback about the payroll tax's impact on stock base compensation and stock options. the city has introduced a couple of policy changes over the past year to deal with that but frankly, they don't affect most businesses that have stock based compensation. what this would do would allow any business with stock based compensation not to exclude that from their payroll tax but to pay that tax over many years. so what will sometimes happen with a publicly traded company that has a good year for their stock, that year, all of their employees will cash in their options. that turns into compensation. the business has to pay a fat

tax so during one year they could have an unexpectedly high payroll tax rate. rather than saying you don't have to pay us that, what this proposal would do is say you can pay it to us on a rolling average. tell us what your stock based compensation was for each of the last five years and just pay us the rolling average of that number. so we basically smooth it out over time rather than excluding it completely or rather than forcing the business to deal with those spikes caused by their stock price. here are the detailson the alternative business license fee, what businesses pay now and what they would pay under the proposal. right now, if you have zero payroll or between zero and 67 dollars of payroll a year, you pay a $25 business license fee. that would rise to $350 a year under this proposal. if you have some payroll but less than $666,000, you now pay $150 in business license fee.

that would rise to $750. the next tier that pays $250 now would pay $2,500 a year and the largest businesses with over $3.3 million in payroll would see their fees rise from $500 a year to $10,000 a year. one of the major things and i'm sorry if i didn't stress that on the previous page, that this business license fee revenue would do, is reduce the payroll tax. what it would do is reduce the payroll tax in a progressive way. so basically it reduce the base payroll rate to 1.5% for big businesses -- and when you include the duductible of $100,000 in payroll, you get an effective rate you see on the slide that can go from 0.45% up to between 1% to 1.2% for the

biggest businesses in the city. so basically, what's happening here is, businesses that have less than $100,000 in payroll still don't pay the payroll tax. businesses between 100 and $250,000 pay a small payroll tax and now they pay nothing. businesses that are small but currently pay the payroll tax would wind up paying less in payroll tax and the bigger businesses would be paying less in payroll tax, as well. i'll show you the breakdown in a second of big versus small. it would be simpler than for me to try to talk about it in the details. let me walk through the costing of each of these proposals. this is also a revenue neutral proposal. but this is what each of these changes to the payroll tax would cost and bring it to make it revenue neutral. we think incorporating the payroll of sole proprietors and partners would bring in $4 million a year, net of the $100,000 payroll deductible. we think eliminating the small

business exclusion as it is now would bring in about $30 million. we think the business license fee increase that we've outlined would bring in about $65 million and including non-profits in the business license fee would bring in about seven. in terms of costs, the $100,000 deductible for all businesses would cost $15 million. the payroll tax holiday would cost $13 million and the reduced rate that i went through would cost about $77 million a year. the stock based compensation wouldn't cost anything because it's smoothing the same expense over multiple years. in in terms of the impact on hares, currently under the payroll tax, i showed you the pie chart by sector. this is the pie chart by business size. those businesses that have over $3.3 million in payroll that are pairs of the business license fee, between their

business license fee and their tax, they pay 73% of the total business tax revenue. under this alternative, it would fall to 62%. the sole providers and partners to pay $25 per year, that is less than 1% of our tax revenue. their share would go to 9% under this proposal to. small businesses that do pay the payroll tax and pay a $150 business license fee now pay 8% of the total. their total would increase to 14%. the middle sized businesses that pay $250 would see their share go from 19% to 15% of the total. i will conclude and take questions after this slide. as i said, most of these proposals that at some of the weaknesses of our current payroll tax system. when we evaluate tax systems, we

look at four criteria, the job impact upon what does this particular tax and do two jobs. as i said, the payroll tax currently does poorly on that. even a revenue-neutral gross receipts tax would create jobs for. the payroll tax alternative gets the same amount of revenue but is spreading the burden around to different businesses. it is unlikely to create many jobs. that is a break even. a second issue is administer ability -- administrability. hear, the payroll tax is simpler. the gross receipts alternative is a far more complex tax. if we were to switch to gross receipts, we would have to be mindful that there is more complex before the tax collector

and payers. a learning curve and inherent, multiple schedules, wills, tears. you cannot get a good tax without introducing some of that complexity of. as i mentioned before, the second thing people look for in a tax system, the third thing is stability. we think both of these proposals would lead to a more stable revenue stream because more businesses would be paying into it. the same thing goes to equity. it would address -- there are lots of ways to talk about tax equity. the issue in which less than 10% of the businesses pay all of the tax would be addressed in these proposals, both of which broadened the tax. that is our initial breakdown of the impact of each of these proposals. in their own way, each of them does try to get to some of the shortcomings of our current business tax. i would be happy to take any questions.

commissioner dwight: thank you for that for presentation. i do have one question, on the gross receipts alternative, andy administrability of it is more complex. i presume that with more complexity comes an increase in administration cost. if it is revenue neutral but cost the government more, than it is not going to be a neutral situation. >> that is true. it goes to how you would define revenue neutral. we have not taken any sides on that question. our indication from the treasurer's office, who would be responsible for administering the tax, and i would not speak for them, but our understanding is that the additional expense would be fairly small in context of the revenues we were talking about. in the low single-digit millions at the most.

we could either decide to absorb that cost or decide to factor that into the system and make sure that we recover that additional cost. but i would agree with your point that it is -- it comes at a cost. but the cost in context of the dollar values we are talking about are fairly small. commissioner dwight: it seems to me when every budget is under scrutiny and downward pressure that any plan of this nature which a knowledge is that it has a higher administration cost, even if it is thought to be minimal, should make a plan for that in its implementation. ultimately, it has to come from somewhere. if the costs go up here, it will have to come from a budget someplace else. i would just plan ahead. even if it is a minimal amount, make sure it is covered.

president adams: commissioner ortiz-cartagena triet commissioner ortiz-cartagena: when i hear complexity, the loophole bill starts ringing for me. if i am a restaurant, i know what i am going to pay. the two or three sectors that are potentially going to grow or pay more payroll, they are complex as well. have you thought the loopholes they can create to not pay and the like, that is the law and we are not paying. >> we do have to be careful in terms of defining gross receipts, particularly in financial services, which is complex in that context carry it one of the advantages that we would have in a gross receipts system is we would have the collective experience of many of the cities that are struggling with the same question of how to get a fair amount of tax revenue from different industries.