Learning from neighbors, Palo Alto prepares to adopt ‘headcount’ tax

“To tax or not to tax?” is a question that Palo Alto seemingly answered in September, when the City Council indicated its intent to place some kind of business tax on the November 2020 ballot.

On Monday night, the council began to wrestle with two thornier questions: What should the tax look like? And how should the money be spent?

City leaders know all too well that wrong answers can doom the entire project. In 2009, a proposed business tax based on gross receipts died at the ballot box, leaving Palo Alto as one of few cities in the region that still doesn’t tax its employers. Yet council members also have a few reasons to feel optimistic this time around: a healthy economy and a new resident survey that shows a sizable majority of voters supporting a business tax, even if the details remain murky.

Emboldened by the data, the council voted 4-2, with council members Greg Tanaka and Liz Kniss dissenting and Vice Mayor Tom DuBois absent, to focus on a tax based on employee headcount — the most common method used in the area. The council also agreed that the tax would be a general tax, which requires a simple majority for passage, and that it would be primarily focused on transportation projects, including but not limited to improvements at rail crossings.

The council’s approach was informed by a new survey from the city’s polling firm, FM3 Research, which showed that a solid majority of Palo Alto voters would likely support a November measure that establishes a business tax, even if they have a range of views about how that money should be spent.

The survey showed 64% of roughly 500 responders saying they would likely vote yes on a business tax for general city services. This included 28% who said they would definitely vote yes and 31% who said they would probably vote yes (the remaining 5% said they were undecided but leaned toward supporting the measure).

Of the three business taxes that the council has been considering, a tax based on a building size proved the most popular option, with 70% of the respondents saying that they either strongly support such a tax (34%) or somewhat support it (36%). A tax based on employee count was slightly less popular, with 65% of the respondents expressing support (27% in the “strong” category and 38% in the “somewhat” category). A proposed payroll tax lagged far behind, with support from just 53% of the respondents.

The support, however, comes with several caveats. Most residents said they favor giving small businesses a break. Seven in 10 responders supported creating exemptions — or lower rates — for small businesses. By contrast, a majority of respondents said they do not believe retail businesses, hotels or restaurants should get exemptions or lower rates. And 78% said they prefer tiered rates over a flat tax, with smaller businesses or those with lower revenues paying less.

Voters also indicated that they aren’t completely sold on the idea of a general tax, which has a lower threshold for passage and gives the council a wide latitude on how to spend the funds. More slanted toward a special tax, which dedicates funding to specific projects and requires a two-thirds majority for passage.

While the margin was relatively small (43% supported the former while 46% the latter), FM3 determined that, after responders heard messages advocating for each type of tax, support for a special tax rose by 8%.

Not surprisingly, the two issues that the surveyed voters identified as their priorities for a special tax were transportation and housing: 84% supported improving transportation; 71% chose providing more housing; and 27% picked improving safety at railroad crossings.

For the council, the ongoing effort to redesign the rail crossings is the main driver for moving ahead with the tax measure. Council members are in the midst of finalizing their preferred design for “grade separation,” the redesign of rail crossings so that the tracks do not intersect with streets. While the city is expecting to get some funding for the project from the Santa Clara Valley Transportation Authority’s Measure B, a 2016 tax measure that allocated $700 million for grade separation projects in Palo Alto, Mountain View and Sunnyvale, the county funds are not expected to cover the complex and expensive effort. Hence, the proposed tax.

But while council members are focused mostly on trains, residents seem to be more concerned about housing. When asked to choose among the three priorities, 41% of the survey takers picked housing over transportation improvements (29%) and railroad crossings (14%). Younger responders tended to pick housing, FM3 found, while those older than 65 leaned toward transportation improvements.

The council, however, recognized that while affordable housing is a critical priority, a business tax is neither a sufficient nor an appropriate vehicle to create it. Because employees directly contribute to traffic, the council saw it fitting that companies help solve that problem.

Council members also noted that while the city can subsidize housing, it doesn’t actually build residential developments. As such, it wouldn’t be clear how tax funds would be spent and what they could achieve.

By electing to go with the headcount tax, Palo Alto is taking a road well traveled. Redwood City, San Jose and Santa Clara all tax their businesses based on employee counts. Mountain View joined the club in November 2018, when 71% of its voters approved Measure P.

Mayor Adrian Fine and Councilwoman Alison Cormack each made a pitch for the headcount tax, which they noted is the easiest to administer and which has the strongest connection between the impacts of the business community and the services that the city is trying to fund. Cormack noted that 85% of people who take Caltrain to Palo Alto do so for work. She also proposed having a tier, with “minimal” rates for small businesses and no escalations. The tax would raise about $10 million annually, or a little less than 5% of the city’s general fund.

Cormack also supported a general tax and noted that the city’s needs change over time, which means the council needs to have flexibility on how to spend funds. Ten years ago, she said, people weren’t really talking about grade separation.

“Ten years from now we may be absolutely panicked about sea level rise,” Cormack said. “I think it’s appropriate for it to be general.”

The prevailing motion, which Cormack crafted, calls for the measure to charge small businesses a “minimal amount.”

The survey also asked voters a general question about their highest priorities. Emergency communication topped the charts, with 73% of the responders calling it “extremely important or very important.” Reducing traffic congestion, ensuring earthquake-safe fire stations and maintaining city streets also scored high.

Tanaka suggested that the survey was misleading. Including issues like emergency communication was disingenuous, he argued, because such wording erroneously implied that the city is like a “third-world country” when it comes to dispatching technology.

After City Manager Ed Shikada clarified that the question was intended only to get a sense of the voters’ priorities — not to identify a problem — Tanaka continued to complain about the survey, calling it “deceitful to the voters.”

Tanaka also took issue with questions on the survey that featured arguments in favor of each type of tax. Though these questions were included only for the purposes of gauging effectiveness of various types of arguments that would be made during a potential campaign, Tanaka demanded that these arguments be backed up by data.

“If we do make a statement like that, it should be true,” Tanaka said, even after Shikada assured him that the sentence is not intended to be a statement of fact.

Breaking from the council majority, Tanaka proposed moving ahead with a specific tax, focused on transportation. Kniss agreed, though she argued that housing should also be added as a possible focus for the funds.

In advocating for a special tax, Kniss observed that a general tax makes it easy for agencies to change course and shift priorities.

“I can’t support it if it isn’t a specific tax because I’ve seen (it) so often with organizations that pass a general tax and then there’s some kind of emergency,” Kniss said.

She cited as an example of the historical tendency of the VTA (Santa Clara County Valley Transportation Authority) to shift revenues from its tax measures to BART projects in San Jose.

So far, business leaders aren’t sold on the proposed tax. Charlie Weidanz, CEO of Palo Alto Chamber of Commerce, decried the city’s lack of outreach to the business community and argued that the various tax options on the table are unfair.

“Rather than working with businesses, the business community has been excluded from this process,” Weidanz said.

Dan Kostenbauder, vice president for tax policy at the Silicon Valley Leadership Group, told the council that not having a business tax gives Palo Alto a “competitive advantage.” He pointed to the relatively low percentage of survey responders (33%) who said they believe the city needs more funds.

“I think it’s important to realize there is pretty limited support for the idea the city does need more revenue right now,” Kostenbauder said.

Others, however, argued that the new tax is badly needed. Resident Bob Moss pointed out that Palo Alto is an exception in the region, where just about every city has a business tax. Because businesses are responsible for some of the city’s toughest problems — namely, traffic — the fact that the city doesn’t have a business tax means residents have to pay more to solve these problems.

Former Mountain View Mayor Lenny Siegel submitted a letter to the Palo Alto council maintaining that a headcount tax is relatively simple to administer because it’s easy to count the number of employees at a company at the same time each year. And because most successful companies pay their professional employees six-figure salaries, the tax represents “a tiny fraction of company payroll,” he wrote.

“If we don’t tax those who have the capacity to pay, our communities will suffer even worse traffic and residential displacement, but employers — start-ups as well as big names — will also be stifled because there is no place nearby for their employees, particularly new ones, to live and no efficient way for those with long commutes to get to work,” Siegel wrote.