Tuesday, March 15, 2011

Controller's Office Economic Impact Report: Payroll Expense Tax Exclusion in Central Market Street and Tenderloin Area

BOMA San Francisco Members:

Please click here to review the Payroll Expense Tax Exclusion in Central Market Street and Tenderloin Area: Economic Impact Report.

Main Conclusions

San Francisco levies a 1.5% payroll expense tax (or "payroll tax") on all businesses that operate in the city and whose annual payroll expense exceeds $250,000. The proposed legislation would establish a zone, south and west of the financial district, within which businesses could exclude new payroll from the payroll tax for up to six years. In other words, businesses with premises in the area would be responsible for paying only their base year payroll tax, and could increase their payroll without additional tax for up to six years.

The proposed legislation can be understood as a variation on the policy of enterprise zones. These policies have been criticized for using tax revenues to subsidize business location in a depressed area, without stimulating a genuine process of long-term economic development that can survive the expiration of the subsidy. Unlike traditional enterprise zones, however, the possibility that Twitter might move to the Central Market area would likely increase its attractiveness to other businesses, leading to job and tax revenue growth after the expiration of the legislation.

Twitter is growing rapidly and reportedly needs a new location. It is said to be choosing between the San Francisco Mart building, at Market and 10th Street, or locations in San Mateo County. Analysis of rent, commuting, labor, and tax costs suggests that San Francisco's higher business tax could create a significant incentive for Twitter to leave the city. San Francisco's payroll tax covers all compensation to employees, including stock options. Twitter is currently valued in secondary markets in excess of $7 billion, after being valued at only $250 million in February 2009. The compensation associated with its stock options could be sizable in the future, and the accompanying payroll tax could reach into the tens of millions of dollars. If that is the case, it would appear to make a San Francisco location more expensive for the company than an alternative in San Mateo County.

Because of this, the legislation was analyzed based on the assumption that Twitter would leave the city if it was not enacted, and would move to the SF Mart if it was. Under these two scenarios, the long-term payroll tax growth associated with the formation of an technology industry cluster in the Central Market area outweighs the payroll tax growth that could reasonably expected to occur without Twitter, by approximately $2.7 million per year on average over twenty years. In addition, the legislation can be expected to lead to higher job growth and property values in the area, which will also increase sales, hotel, utility user, property, and transfer tax revenues.

This research suggests that two changes to the proposed legislation could reduce risks of an adverse economic impact, and increase the benefit to the General Fund while maintaining its economic benefits. In addition, two related policy ideas are offered for the consideration of decision-makers.

1. Requiring multi-location businesses to apportion their payroll, such that they are only eligible to exclude net new payroll within the area.

2. Removing large commercial properties, other than the SF Mart, from the area. If the large properties were excluded, the net payroll tax gain for the City would rise to an estimated $5.5 million a year, as the City would no longer lose the payroll tax growth that would happen at these properties naturally.

3. As a policy idea that is not directly tied to the proposed legislation, the City could structure a parcel tax on vacant commercial property, which would not apply to occupied commercial property. This would encourage owners of vacant commercial property to be flexible on rent, and thereby maximize occupancy and employment in the city. This tax could not be included in the proposed legislation, as it would have to be submitted to the voters pursuant to Proposition 218. Nevertheless, it is mentioned here as a future policy consideration.

4. Finally, this analysis suggests that an important variable in the fiscal and economic success of the proposed legislation is Twitter's decision to locate in the Central Market area instead of moving out of San Francisco. In turn, Twitter's potential future payroll tax liability associated with its stock options appears to be the largest cost factor weighing against a San Francisco location. The City should consider modifying the payroll expense tax, to reduce the incentive for successful technology companies to move out of San Francisco.

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