Joel Fox is the Editor of Fox & Hounds and President of the Small Business Action Committee.

Word out of Los Angeles on Friday was that the Los Angeles City Council voted to cut business taxes for Internet based firms. In the middle of a catastrophic city budget shortfall? How could that be?

The City Council was not reckless as it might appear. In fact, the tax cut measure will benefit the city’s treasury over time.

The City of Los Angeles taxes business according to the type of business carried out, with different categories paying different tax rates. For example, businesses that fall into the category of “multimedia businesses” pay a gross receipts tax based on a rate of $1.01 per $1,000 of gross receipts. A business that falls in the “business and professions” category pays a rate of $5.07 per $1,000 of gross receipts.

While I have problems with the Los Angeles business gross receipts tax, let’s put that aside for the moment and see why, despite the big budget shortfall in the city, council members chose to lower the tax on Internet firms.

It’s not hard to figure. The Internet firms were told they would be shifted from the “multimedia” category to the “business and professions” category. The response from the businesses: We’re out of here! Many said they would leave the city. That would put an even bigger hole in the city budget.

The Los Angeles Times article linked to above cited the chief financial officer of one Internet company,, with 100 employees, that had already explored a move to surrounding cities which did not impose punitive business taxes. The tax increase would have cost this one company up to $3 million over the next five years

There are approximately 1400 businesses affected by the tax change. Even if a small percentage left the city, the tax revenue “gained” by shifting these businesses to the higher tax category would soon be wiped out by losing tax revenue from businesses fleeing the city.

Council members decided the businesses were not bluffing.

There is a lesson here for California government at large. Continue to burden business with higher tax rates and businesses have the option to move. And they will. We have seen it time and time again. Whether they choose to pick up and move across city lines or across state lines, California government treasuries will suffer.

As stated here before, the answer to the state and local government fiscal problems is to encourage business; to be business friendly; to create and to keep jobs. That is the way to solve our financial woes.