(May 13, 2008) -- On May 10, 2008 four Southland Assembly Democrats -- Betty Karnette (D., LB), Warren Furutani (D., Carson-LB), Hector De La Torre (D., South Gate) and Jose Solorio (D., Santa Ana) -- came to Long Beach to conduct an Assembly-sponsored public event on what they called "CA's Fiscal Emergency."

Facing a deficit (spending exceeding revenue) now estimated at roughly $15+ billion, they criticized Governor Arnold Schwarzenegger for proposing "all cuts" that don't spare education and blasted Republicans for fighting removal of what Dems called a "yacht tax" loophole.

The Assembly Dems said they favor a "balanced approach" that includes extending CA's sales and use tax to "services." Assemblyman Solorio indicated such items might range from law firm and accounting services to concert tickets and theme park admissions.

Yet when asked if they favor repealing a 2003 sales/use tax exemption in which CA taxpayers currently subsidize the sale and use of a gross polluting fuel source worsening air quality in LB and across the South Coast air basin, they suddenly became less certain (details below).

In 2003, Sacramento lawmakers approved legislation exempting high-polluting ship bunker fuel from part of CA's sales and use tax. Bunker fuel is used by shippers because it's cheap, taken from (literally) near the bottom of the petroleum barrel. Reinstating the exemption on part of the CA sales/use tax bunker fuel bought here but used outside CA was sought by a lengthy list of industry interests.

SB 808 was enabled by three Port-area co-authors: then-State Senator (now Assemblywoman) Betty Karnette (D., LB), Assemblyman (now State Senator) Alan Lowenthal (D., LB-Paramount) and Senator (now Senate President Pro Tem) Don Perata (D., Oakland).

LBReport.com provides the full list of SB 808's supporters as indicated in a committee analysis of the bill. We also list the Senate and Assembly recorded votes on the tax break.

The three state lawmakers used Sacramento's notorious "gut and amend" procedure that evades normally required Committee hearings (and the debate and attention that accompanies them) by deleting text from an unrelated bill and cut and pasting new, previously undiscussed text in its place. The sales and use tax exemption sailed through both houses of the state legislature without serious discussion and was signed into law by soon-to-be-recalled Gov. Gray Davis.

How much is the Karnette-Lowenthal-Perata bunker fuel tax break costing CA taxpayers each year? A 2003 Senate Rules Committee analysis of SB 808 (caveat: now half-decade old figures) said:

The fiscal effect of the bunker tax exemption has been the subject of great controversy. At issue is the degree to which the imposition of sales tax on bunker fuel causes water common carriers to fuel out-of-state rather than in California. An analysis of this bill was not available from the State Board of Equalization (BOE) at the time this committee analysis was prepared. However, in an analysis of a similar bill, SB 145 (Perata), from the 2001-02 Legislative Session, BOE estimated that repealing the sunset date on the bunker fuel exemption would result in a total state and local sales and use tax loss of between $22 and $36 million (between $13.5 and $21.5 million General Fund losses and between $8.9 and $14 million local revenue losses). The range in BOE's estimates reflects uncertainty over the degree to which the sales tax causes water common carriers to fuel out-of-state.

According to this bill's proponents, the bill should result in relatively minor sales tax revenue losses, because the taxation of bunker fuel suppresses sales at California ports. This bill's proponents also assert that the imposition of sales tax on bunker fuel reduces overall economic activity at California ports. They argue that restoring the sales tax exemption will bolster economic activity, both by increasing sales of products purchased by vessels that choose to bunker and by reversing employment losses among businesses that serve bunkering ships (e.g., ports, pilots, barge operators, boom operators, and marine suppliers).

Proponents of the tax break argue that modern ships have large fuel tanks, enabling them to fill-up on bunker fuel where cost is less. They argue that without the tax exemption, shippers will buy the bunker fuel outside CA while still burning the high polluting fuel along CA's coast and in the Ports of LB/L.A. The sales/use tax exemption promotes local jobs by encouraging its purchase here, supporters say.

That policy had unintended and costly consequences in November 2007 when -- as LBReport.com was first to report -- a container ship topped off its tanks with bunker fuel purchased in LB...and then headed up to San Francisco...

...where it grazed a Bay Bridge abutment, spilling an estimated 58,000 gallons of its water-fouling bunker fuel into San Francisco Bay.

Photo source: US Coast Guard

On May 11, 2008 LBReport.com asked Assemblymembers Karnette, Furutani and De La Torre (who'd variously criticized Republicans for resisting repeal of the "yacht tax loophole") if they favored maintaining or repealing the bunker fuel sales/use tax break.

Assemblywoman Karnette -- one of SB 808's co-authors -- said she'd think about it.

Assemblymembers Furutani and De La Torre (who weren't in the legislature when the tax break was enacted) said they wanted to look into the issue and would get back to us.

The issue has drawn a distinction between two LB City Council Dems dueling in the June 2008 Dem primary for the opportunity to succeed term-limited Karnette. Councilwoman Tonia Reyes Uranga and Vice Mayor Bonnie Lowenthal voted in opposite directions on a January 22, 2008 item (agendized by Councilwoman Gerrie Schipske) recommending that the Council's State Legislation Committee consider supporting reinstatement of the full sales/use tax on bunker fuel.

Councilwoman Reyes Uranga supported the motion...while Vice Mayor Bonnie Lowenthal voted against it. (The motion failed 3-6: Yes: Schipske, Reyes Uranga, Gabelich; No: B. Lowenthal, S. Lowenthal, DeLong, O'Donnell, Andrews, Lerch).

On May 12, 2008 we asked a staffer in the office of Sacramento's Republican legislative caucus if they had a position on the issue. The staffer indicated an email response would be forthcoming; we'll webpost it here as received.

The state's partial subsidy for the sale and use of the acknowledged high polluting fuel was first reported by LBReport.com in October 2005 when CA Air Resources staff proposed rules to curtail the use of "bunker fuel" as threat to residents' health.

In November 2006, LB Councilwoman Schipske publicly confronted Sen. Lowenthal about the pollution-subsidizing policy at a Nov. 2006 CSULB conference. Sen. Lowenthal indicated he'd think about it...and the tax exemption wasn't touched by lawmakers in 2007 (motivating her eventual Council motion).

On August 9, 2007 Sen. Boxer held a hearing on federal legislation that would require use of cleaner fuels in U.S. Ports...and LBReport.com asked one of the committee witnesses, Mary Nichols, chair of CA's Air Resources Board., what she thought the sales/use tax exemption.

Noting that she was speaking for herself to us [not necessarily for the Schwarzenegger administration], chair Nichols told us, "I think it would be a nice thing to repeal that legislation."

In November 2007, the State Legislative Analyst's Office (LAO) delivered a report to the Senate Committee on Revenue and Taxation and Assembly Committee on Revenue and Taxation Joint Legislative Budget Committee. In that report -- which discussed matters strictly from a tax perspective, not from other policy perspectives -- the LAO acknowledged that the bunker fuel partial sale/use tax break "reduces state and local revenues by tens of millions of dollars annually" but says this is offset by some unspecified amount by "bunker fuel sales and related economic activities." During periods when the sales tax was completely enforced [not partially as today], the LAO report said revenue increases "are likely to have been in the range of $20 million to $30 million in 1991-93 and $30 million to $40 million in 2003-04" but said these revenue increases "would have been partially offset by declines in other associated fees, such as fuel wharfage and oil spill prevention fees."

However the LAO said that when evaluated solely as a matter of state tax policy, CA's partial state/use tax exemption on bunker fuel is justified...and should be made permanent (removing its current sunset of 2014):

[LAO report excerpted text]

Background and Summary

Nature and History of the Exemption

Bunker fuel refers to fuel that is used to propel ships. Like most tangible products sold in the state, bunker fuel is subject to the state’s SUT. However, the state currently provides a partial SUT exemption of bunker fuel sales. Specifically, it does not tax fuel consumed after the first out–of–state destination of the ship has been reached.

California’s tax treatment of bunker fuel has changed back and forth over time. Namely:

• From July 15, 1991 through December 31, 1992, and again from January 1, 2003 through March 31, 2004, the state fully taxed all bunker fuel sales in the state.
On April 1, 2004, pursuant to Chapter 712, California reinstated the partial exemption that had been allowed prior to July 1991 and from January 1, 1993 through December 31, 2002. This partial exemption is now scheduled to sunset January 1, 2014.

Previous LAO Findings on the Exemption

The LAO released a statutorily required study on bunker fuel pursuant to Chapter 615, Statutes of 1997 (AB 366, Havice), entitled Sales Taxation of Bunker Fuel (January 2001). Our major findings were:

• The bunker fuel industry experienced a decline in California in the 1990s.
• The decline stemmed from many factors including: a recession, the temporary revocation of the SUT bunker fuel exemption during this period, declines in refining capacity, changes in shipping technology, and the development of alternative bunker fuel facilities outside of California.
• The revocation of the SUT exemption from July 1991 through December 1992 likely resulted in the loss of 100 to 200 jobs in the industry and increased state–local SUT revenues by a total of between $20 million and $30 million.
A partial exemption for bunker fuel is an appropriate tax policy.

Updated Findings

The fundamentals of the bunker fuel industry and the effects of a partial SUT exemption have not changed since our last report. In our review below, we find that:

• The partial SUT exemption for bunker fuel is still an appropriate tax policy.
• The revocation of the SUT exemption on bunker fuel during 2003 and 2004 produced impacts similar to those that occurred during the early 1990s.
If anything, because of recent increases in fuel prices, revoking the SUT exemption now would likely have an even larger adverse impact than it did previously.

Analysis of the Bunker Fuel Exemption

How Should Bunker Fuel Be Treated From a Tax Policy Perspective?

Underlying Rationale for the SUT. The traditional public finance rationale for the SUT is that the provision of public services by governments facilitates, either directly or indirectly, the conduct of economic activity, including the buying and selling of goods. Thus, this rationale holds, levying a tax on the exchange of goods is a reasonable basis on which to partially fund governmental costs. An important element of this rationale is the presumption that final goods purchased by Californians will also be used in California, and California’s existing SUT provisions generally reflect this philosophy. For example:

• Final purchases by California individuals and businesses for in–state use are taxed unless specifically exempted. Even in instances where the SUT is not collected by sellers or paid by taxpayers—such as on some mail order and Internet sales—this reflects the failure of taxpayers to comply with and remit the tax, not the state’s failure to impose the tax.
Conversely, exemptions are often allowed under the SUT when it is presumed that a good’s regular usage will occur out of state. For example, an exemption is granted for the sale of new or manufactured trucks for out–of–state use.

A Partial Exemption Is Theoretically Sound. Given the above, on tax–policy grounds, a strong argument can be made for the current partial exemption. Generally, items purchased in California that are subject to the SUT are presumed to be used in the state, while sales for export are usually exempt from the SUT. Bunker fuel purchases fall somewhere in between, since bunker fuel purchases are used both outside of and within state boundaries, suggesting that there is a sound basis for a partial SUT bunker fuel exemption.

Fiscal and Economic Effects of the Partial Exemption

The economic and fiscal effects of the bunker fuel SUT exemption—including its impacts on jobs and on state and local tax revenues—depend largely on how it affects the amount and location of bunker fuel sales occurring in California. This, in turn, depends primarily on how the exemption affects bunker fuel prices and the response of shipping companies to price changes. These responses are determined by the relative importance of fuel costs to overall operating costs as well as the flexibility that such shippers have in buying fuel at California versus non–California locations. Understanding these factors requires knowledge about the bunker fuel market’s characteristics and how it functions.

The Bunker Fuel Market—Characteristics and How It Works

The Market Is Relatively Competitive. The bunker fuel market is a global market characterized by a generally standardized product and a high degree of price competition among suppliers. Prices at various ports generally fluctuate in a fairly narrow band although small differences in prices can occur due to supply issues, costs associated with different ports, and other market factors. While some quality differences do exist among different types of bunker fuels, these differences generally are either minimized through the refining or blending process, or more typically, are clearly identified in the contract process and accounted for in the pricing of the fuel.

The market is characterized not only by the fairly significant number of industry competitors, but also from the competitive uses that exist for the residual fuels from which bunker fuel is derived. The residues from the refining process are used to produce various types of fuel oil, only one version of which is bunker fuel. If other types of fuel oil increase in price relative to bunker fuel, bunker fuel production typically declines until the net returns to bunker fuel refinery activities rise and are thereby brought into equilibrium.

In addition, the oil residues can be further distilled, through a more expensive process known as “cracking,” which converts these residues into gasoline or other higher–end products. Again, if price ratios for the different products shift, refineries can adjust their production of the various petrochemical products accordingly. For example, if heavy fuel oils (such as bunker fuel) compare favorably in price to other products, refineries will tend to produce more of these fuels rather than less. Alternatively, given opposite circumstances, refineries will typically crack the residues and “squeeze” more light–end products from the crude oil.

Cost Structure of the Shipping Industry. The shipping industry is highly capital intensive and has substantial fixed costs. (These are costs that are incurred regardless of the exact volume of business undertaken—such as for the ships and related capital equipment.) The industry’s major variable (or operating) costs are labor and fuel. Fuel costs are typically a much larger component of operating costs than are labor costs, representing approximately 60 percent of total operating costs. Thus, at current fuel prices and an average SUT of about 8 percent, a full SUT on bunker fuel would increase total operating costs by about 5 percent.

The combination of multiple bunkering ports and long cruising ranges gives shipping companies considerable flexibility in fueling. Larger loaded ships use on the order of 180 tons to 200 tons per day of bunker fuel. Assuming, as an illustration, that a ship has a fuel capacity of 15,000 tons, this would allow it to cruise for 70 days without refueling, or more than one and one–half round trips across the Pacific Ocean. Ongoing improvements in ship fuel capacity as well as the development of new bunkering facilities would tend to increase the impact that small differences in bunker fuel prices can have on port activities.

Because of the substantial contribution that fuel costs make to the overall expense of ship operations, decisions regarding when and where to bunker are made with close attention to relative fuel prices at different ports. Often, differences of as little as 25 cents to 50 cents per ton can separate losing and winning bids for supplying bunker fuel. The shipping industry has traditionally operated on fairly narrow operating margins, and thus relatively small swings in fuel prices can result in large changes in the financial performance of the shipping industry and its individual companies.

Overall Economic Significance of the Industry. A precise count of the individual jobs and businesses associated with California’s bunker fuel industry is not available. For virtually all of the businesses that participate in the industry, bunker fuel–related activity constitutes only a fraction of their activities. For example, inspectors, tug and barge operators, and fuel dealers are involved in many other markets in addition to the bunker fuel market. Overall, however, it appears as though some two dozen different types of businesses are involved in the industry, with something in the range of 1,000 to 2,000 California jobs being directly linked to the bunker fuel industry.

Recent Historical Experience With Full and Partial SUT Taxation

As noted earlier, from July 15, 1991 through December 31, 1992, and again from January 1, 2003 through March 31, 2004, the state fully taxed all bunker fuel sales in the state. During both of these periods, California bunker fuel sales declined. As reported in our earlier–cited 2001 report, in 1992 bunker fuel deliveries dropped by 45 percent for California ports (compared to declines of about 1 percent for non–California U.S. ports). Likewise, in 2003, bunker fuel sales in Los Angeles and Long Beach (which account for most of California’s sales) dropped 30 percent, and in the first quarter of 2004 they were down 22 percent from a year earlier. In contrast, for the rest of 2004, after the partial exemption was reinstated, sales were up 31 percent over the same three quarters a year earlier, and they increased another 20 percent in 2005. While the partial SUT exemption is only one of many factors influencing total fuel deliveries, both of these experiences suggest that the removal of the partial exemption did result in lost business for California bunker fuel suppliers.

Employment and Revenue Effects. In our earlier report, we estimated possible employment losses of 100 to 200 positions due to the application of the full SUT to bunker fuel sales in the 1990s. Job losses during the 2003–04 period appear to have been similar in magnitude. In addition, revenue increases associated with the state and local SUT are likely to have been in the range of $20 million to $30 million in 1991–93 and $30 million to $40 million in 2003–04. These revenue increases would have been partially offset by declines in other associated fees, such as fuel wharfage and oil spill prevention fees.

Bottom–Line Findings. Based on our review of the performance of the bunker fuel market both with and without the partial exemption in place, we conclude that the partial SUT exemption for bunker fuel increases California bunker fuel sales and related economic activities. At the same time, however, it reduces state and local revenues by tens of millions of dollars annually.

LAO Recommendation

While the Legislature clearly must consider the revenue and economic impacts of any changes in the manner in which it taxes bunker fuel, we believe it is also important for such treatment to be consistent with the conceptual basis of the SUT in general. On tax policy grounds, we believe a strong argument can be made for subjecting such sales only to partial SUT taxation. As discussed earlier, items purchased in California that are subject to the SUT are generally presumed to be used in the state, while sales for export are usually exempt from the SUT. Bunker fuel purchases fall somewhere in between, since bunker fuel purchases are used both outside of and within state boundaries. Consequently, a partial SUT bunker fuel exemption—in our view—approximates the treatment given to most other tangible goods and constitutes appropriate tax treatment.

On this tax policy basis, we recommend that the Legislature remove the existing sunset for the current partial SUT exemption for bunker fuel sales, and make the exemption permanent. This would result in the SUT on fuel purchased in California being levied in the future only on the portion which is consumed between California and a ship’s arrival at its first out–of–state destination (as is currently the case). This action would permanently result in treating bunker fuel sales similarly to other export sales and place California ports on par with other out–of–state ports in the nation.

On Oct. 30, 2007, LBReport.com asked one of SB 808's co-authors, Sen. (then-Assemblyman) Alan Lowenthal, for his views on the bunker fuel tax break now. Sen. Lowenthal indicated that in retrospect, he views the legislation as a mistake and would support its repeal but is focusing on his "Port Investment/container fee" bill (SB 974) and wouldn't champion the tax issue.

Sen. Lowenthal indicated that he favors a regulatory approach that addresses the issue by phasing out and ending the use of the worst high polluting fuels in ports.

Meanwhile, in the midst of a double-digit deficit, state lawmakers mull spending cuts and/or expanding CA sales and use tax to new items...while subsidizing the sale and use of a gross polluting fuel at a taxpayer cost estimated in the millions of dollars a year.

A 2003 legislative analysis on the bunker fuel tax exemption by the Assembly's Revenue & Taxation Committee listed the following:

SUPPORT:

American Marine Corporation
American Waterways Operators
Bunkerfuels (10 individual letters from different employees)
California Independent Oil Marketers Association
Carlson Mechanical, Inc.
Chemoil Corporation
China Shipping Container Lines Co., Ltd.
China Shipping Development Co., Ltd.
Clean Coastal Waters, Inc.
Compania Chilena de Navegacion Interoceanica
Dan Baker, Councilmember, City of Long Beach
Don Breazeale and Associates, Inc.
Environmental Maritime Services
Evergreen America Corporation (Los Angeles Office)
GP Resources, Inc.
Hapag Lloyd Container Line
International Council of Cruise Lines
Jacobsen Pilot Service, Inc., Los Angeles and Long Beach Harbors
K Line America, Inc.
Marine Chartering Co., Inc.
Marine Energy, United Arab Emirates
Matson Navigation Company, Inc.
Millennium Maritime, Inc.
MOL (America) Inc.
Ngenia, LLC
Northern California District Council - ILWU
Overseas Wiborg Chartering Company
Pacific Horizon Petroleum Services, Inc.
Pacific Merchant Shipping Association
Pan Pacific Surveyors, Inc.
Petro Diamond Incorporated
Port Hueneme Chamber of Commerce
Port of Sacramento
Premier Marine Fuels Ltd.
Princess Cruises and Princess Tours
Public Service Marine, Inc.
Riley Marine Survey and Consultancy
Sailors' Union of the Pacific
San Francisco Bar Pilots
Sanko Steamship Co., Ltd.
Sea Bunkering Americas LLC
Solar International Shipping Agency, Inc.
Star Shipping, Inc.
Timothy Parker, Maritime Consultant
Tom Flahive Trans-Tec Services, Inc. (8 individual letters from different employees)
Weiss Jones
Westar Marine Services
Westoil Marine Services, Inc.
Westport Petroleum, Inc.
Westport Petroleum, Inc. (27 individual letters from different employees)
World Fuel Services Corporation
Yang Ming (America) Corp.
Zim-American Israeli Shipping Co., Inc.

Perhaps due to the "gut and amend" procedure (which circumvented usual hearings) there was no listed opposition.

The votes on passage were: