Now's the Time for California Tax Reform
When budget crises occur, Sacramento goes into tax reform frenzy. Commissions are appointed and elected officials travel the state touting reform ideas. Then, the economy recovers - and with it a boom in tax revenue - and the Commissions' reports get stacked on bookshelves to collect dust, while those same elected officials revise their talking points toward program spending in lieu of reform. In Sacramento, short-term memories trump advancing good public policy.
Last week, the Hoover Institution released its July-August 2015 issue of Eureka, which explored California's revenue rollercoaster - specifically, 1) what tax reform attempts have looked like, 2) how reliance on capital gains income creates volatility, 3) whether the futures of Propositions 13 and 30 affect tax reform, and 4) how Californians can simultaneously elect pro-tax Democrats while holding anti-tax views. As a previous RealClearMarkets piece makes clear, California's revenue problem is straightforward: an over-reliance on a very progressive personal income tax, which itself is dependent on volatile capital gains revenue. California may have been able to get away with its boom-and-bust revenue and budgeting, but recent circumstances make tax reform even more imperative.
Silicon Valley Dominates the Economy: While California, for much of its history, has been economically diversified, today, Silicon Valley is singularly dominant. California's economic future depends immensely on Silicon Valley's. This plays a huge role in the budget as well. The greater Silicon Valley region accounts for 34 percent of the state's total assessed taxes, while representing just 17 percent of the state's population. Thus, factoring in population, Silicon Valley's per capita assessed taxes equal $3,340, which is 2.5 times the level of Greater Los Angeles. And this doesn't even account for Silicon Valley's corporate tax and sales and use tax contributions. With such a significant amount of California's state revenue coming from one region, California's budget doesn't have a Plan B if something were to financially hinder Silicon Valley's economy.
The Tech Industry is Particularly Volatile: And if history is any guide, Silicon Valley's tech industry isn't going to experience explosive expansions forever. While California is currently reaping the benefits of a Valley-centric economy - with a bull stock market and the social media and sharing-economy boom - the tech industry is particularly volatile compared to other established industries. During the late 1990s, Sacramento made long-term funding bets - best characterized by Governor Gray Davis' generous retroactive public employee pension increases - based on a belief that the dot-com boom was the new normal. It wasn't and California suffered as a result. But in the early 2000's, California was economically diversified, so it could bounce back more quickly. Today, with an economically less-diversified situation, a slight downturn in the tech industry could have devastating effects on state revenue and hence, on program funding.
Despite Past Experiences, Sacramento's Behavior Hasn't Changed: As Albert Einstein once quipped, "Insanity: doing the same thing over and over again and expecting different results," describes Sacramento quite well. California's underlying revenue problem isn't a secret. And yet, Sacramento conveniently always forgets the budget woes of yesterday when revenues recover. But with Silicon Valley tax receipts driven by California's categorization of capital gains income as ordinary income, it doesn't take a clairvoyant to predict that California's boom-and-bust budgeting will result in deep budget deficits sometime in the future. Boom-and-bust budgeting is completely preventable and yet, it operates as if on auto-pilot. While Proposition 2's Rainy Day Fund will help force legislators to save some of the excess capital gains tax revenues, its reserves can't prop up state spending during long economic downturns. And despite Governor Brown's fiscally prudent reputation, California's total state spending (not including federal funds), has increased $24 billion or 17 percent in real terms since Governor Brown's first budget in his second go-around as Governor.
If California were to broaden its tax base, align it more closely to the dynamics of the economy, and remove the components creating the volatility, not only would the tax reform promote economic growth, it would also make budgeting more predictable - and that is a good thing for education funding, social services funding, transportation infrastructure funding, and other spending priorities. There is no good time for tax reform, but the current economic dynamic in California makes it even more important to reform California's antiquated tax system than ever before.
