California Begs the Courts to Save It from Itself

California Begs the Courts to Save It from Itself

The following commentary/forecast is one I wrote in my capacity as a senior fellow at “the nation’s oldest consumer protection agency,” Consumers Research, where, among other things, I compile a weekly letter for public pension-fund managers.  I am sharing it here today because I thought it might be useful to some of you.
*Many thanks to my friend Scott Shepard, the director of the Free Enterprise Project for his help in clarifying and articulating the likely course of the legal challenges to the legislation detailed below.


California Screaming

On March 27, 2002, President George W. Bush engaged in a remarkably cynical act of political theater.  Not wanting to appear hostile to the cause of campaign finance reform (what kind of monster is opposed to “reform,” after all?), Bush signed the Bipartisan Campaign Reform Act of 2002, despite having serious misgivings about its constitutionality.  Not to worry, Bush wrote in his signing statement, the courts will strike down the bad stuff in the law, and then, everything will be fine:

[T]he bill does have flaws. Certain provisions present serious constitutional concerns. In particular, H.R. 2356 goes farther than I originally proposed by preventing all individuals, not just unions and corporations, from making donations to political parties in connection with Federal elections.

I believe individual freedom to participate in elections should be expanded, not diminished; and when individual freedoms are restricted, questions arise under the First Amendment.

I also have reservations about the constitutionality of the broad ban on issue advertising, which restrains the speech of a wide variety of groups on issues of public import in the months closest to an election. I expect that the courts will resolve these legitimate legal questions as appropriate under the law.

But a funny thing happened on the way to the courts resolving “these legitimate legal questions.”  They didn’t.

Recently, elected officials in the state of California staged a revival of Bush’s two-decade-old paean to political cynicism.  Two weeks ago, the California legislature passed SB-253, the “Climate Corporate Data Accountability Act” and SB-261, “Greenhouse gases: climate-related financial risk,” which together comprise the “California Climate Accountability Package.”  Last week, Governor Gavin Newsom announced his intention to sign both bills, which will require companies doing business in California to report their greenhouse gas emissions data.  The package is either extremely comprehensive or draconian, depending on one’s perspective (emphasis in original):

While these bills are similar to the climate rule proposed by the Securities and Exchange Commission (SEC) in March 2022, the bills reach further on several fronts….

Because the bills would apply to both public andprivate companies over certain revenue thresholds, they are expected to significantly broaden the number of companies required to publish public climate disclosures.

In summary, SB 253 requires disclosure of and independent third-party assurance on all global greenhouse gas (GHG) emissions – Scopes 1, 2 and 3 – for any entity “doing business in California” with global annual revenues exceeding $1 billion. SB 261 requires disclosure of climate-related financial risks, in accordance with recommendations from the Task Force on Climate-Related Financial Disclosures (TCFD), for entities doing business in California with global annual revenues exceeding $500 million.

In theory, these two bills could have a serious and significant impact on business, not merely in California, but nationwide as well.  The inclusion of Scope 3 emissions among the required reporting data virtually ensures that the laws would be exceptionally burdensome and would require significant, business-threatening compliance costs from several times as many businesses in far more industries and of far less capability than the legislators have suggested.  The emissions reporting regime will cast a massive net that will ensnare business far and wide:

“Doing business” in California is defined as having annual sales exceeding $610,395, or more than $61,040 in property or payroll, in the state. Almost any medium-sized business with a single worker in California would have to report its emissions….

About three-quarters of the estimated 5,300 companies that would be covered by the bill are private. Small businesses that are suppliers, contractors or customers of covered businesses might also be compelled to calculate emissions. Farms that sell to wholesalers doing business in the state could have to calculate how much CO2 their livestock and fertilizer generate.

Clients of large accounting, legal, insurance and financial firms could be ensnared too. “Know your customer’s CO2 emissions” could soon become the new banking industry mantra.

In reality, however, the California Climate Accountability Package is likely to have no impact on business whatsoever.

Although this may be a (distinctively) minority opinion, it seems quite possible that California’s foray into emissions reporting is a case of Virtue Signaling by Legislation.  This “package” is intended to intimidate businesses into adopting reporting practices and, more to the point, prod the Securities and Exchange Commission to release its long-delayed emissions reporting rule.  But like George Bush’s campaign finance law, it is not intended ever to go into effect.

Because of the “excessive” burden the new law will place on businesses throughout the country, it will inevitably be challenged on constitutional grounds, citing what’s known as the Dormant Commerce Clause, which “refers to the prohibition, implicit in the Commerce Clause, against states passing legislation that discriminates against or excessively burdens interstate commerce.”  If the law is not immediately tossed out, then the strategy will get complicated and will rely on “Red” states passing their own laws requiring their own onerous disclosure requirements, thereby forcing the courts to adopt an “all-or-nothing” approach to excessive non-pecuniary disclosures.  Whatever the case, it seems rather unlikely that California’s disclosure regime will be allowed to stand and will ever be implemented.

Not coincidentally, one suspects that the elected officials in California know as much and, like President Bush, are counting on the courts to let them maintain their pretense of having done the right thing, even as they escape the consequences of their actions.

By now, it is common knowledge that, for the first time in its history, California is losing residents.  Over the last three-plus years, nearly a million former Californians called it quits and left the Golden State for greener pastures.

What is less well-known but equally telling is that California has, over an even longer period of time, been hemorrhaging businesses:

In 2021, California business headquarters left the state at twice their rate in both 2020 and 2019, and at three times their rate in 2018. In the last three years, California lost eleven Fortune 1000 companies, whose exits negatively affect California’s economy today. But California also is risking its economic future as much smaller but rapidly growing unique businesses are leaving, taking their innovative ideas with them.

Despite its inarguable beauty, its spectacular weather, and its ample natural resources, California has, over the last decade, become one of the least hospitable climates for business.  It has the third-worst tax climate for business.  It ranked “50th in 2021 Chief Executive’s list of the ‘Best and Worst States for Business’ Survey, 33rd in CNBC 2021 ranking, and 43rd in Forbes’ ‘Best States for Business’ 2019 list.

All of this will be exacerbated exponentially by the new emissions reporting statutes.  Companies will understand – or, more likely, understand already – that the most effective ways to address this onerous and politically motivated new reporting requirement is to avoid doing business in California altogether, to avoid employing Californians, to avoid supplying companies that do business in California, and so on.  Obviously, not all companies will be able to make such changes to their business models, but enough will that it will sting California, causing further deterioration in its business climate.

California lawmakers may be among the most ideologically captured in the nation, but they are probably not suicidal.  They know full well that this legislation will damage their state, perhaps permanently.  They are, therefore, undoubtedly hoping that the SEC and the courts ride to their rescue, enabling them to back down, with both their “virtue” and the state’s economy intact.

Stephen Soukup
Stephen Soukup
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Steve Soukup is the Vice President and Publisher of The Political Forum, an “independent research provider” that delivers research and consulting services to the institutional investment community, with an emphasis on economic, social, political, and geopolitical events that are likely to have an impact on the financial markets in the United States and abroad.