'Taxifornia' Needs to Flatten Its Revenue Roller Coaster
Newsflash: California has a revenue problem. Yes, California has been raking in record tax revenues, but that is exactly the problem. Relying on an overly progressive personal income tax, which itself is dependent on wealthy earners' reliance on capital gains income, has left California with a rollercoaster-style up-and-down revenue collection system. When the economy is doing well, revenues overwhelmingly flow into the state coffers, but even at the scantest of downturns, tax collections crash.
Coupled with the fact that legislators think short-term and would rather spend than save, the result is boom-and-bust budgeting. Government programs prosper during good times only to be slashed, mostly haphazardly, when the economy suffers.
However, while the problem and its cause are clear, agreement on what to do about it is not. Next week the Hoover Institution will release the July-August 2015 issue of Eureka featuring commentary on California's revenue conundrum. The issue attempts to answer 1) why reliance on capital gains income isn't just the wealthy's problem, 2) what long-term tax reform should look like, 3) what will happen to two of California's signature tax initiatives, and 4) what Californians actually think about taxes and tax reform.
Reform Can't Happen Without Capital Gains Reform: It is California's insistence on taxing capital gains income as ordinary income coupled with personal income taxes representing over 50 percent of total state tax receipts that creates California's volatile revenue rollercoaster. Capital gains taxes fluctuate wildly, from 20 percent of state revenues at the height of the economic expansion to just 5 percent at the bottom of financial crisis. Needless to say, it is impossible to budget appropriately for state programs when revenue is flailing around. While Proposition 2's Rainy Day Fund will help to stash away some of the extra capital gains tax revenue, it cannot be a substitution for reform.
Reform Discussions Should Start With The Parsky Commission: The Commission on the 21st Century Economy, colloquially known as the Parsky Commission after its chairman, Gerald Parsky, was Governor Arnold Schwarzenegger and the State Legislature's answer to the budget crisis of 2008-2009. The bipartisan Commission dove deep into California tax system and recommended California 1) reduce personal income tax rates and reduce or eliminate most deductions, 2) eliminate the corporate income tax and state sales and use tax, and 3) replace those with a broad-based, business net receipts tax. Despite a bipartisan endorsement, legislators balked. While this particular reform may not be the right one now, it is definitely the best place to start the discussion.
The Futures of Proposition 30 and Proposition 13 Play an Important Role in Reform: Passed in 1978, Proposition 13 has become the "third rail" in California politics. But labor unions and progressives are eager to gut its provisions in hopes of boosting local and state tax revenue. The problem with this is while Proposition 13 does restrict property tax revenue collections, it does ensure that the property taxes are the most stable form of government revenue generation in the state. Moreover, some want to extend or make permanent Proposition 30's tax increases. But Proposition 30 doubles down on California's already deficient tax system, making state revenues even more dependent on the very taxpayers who ensure California is plagued with rollercoaster revenues. Attacking Proposition 13 and promoting Proposition 30 will only make California's revenue rollercoaster wilder.
Californians Might Be Ready For Reform: While California is nicknamed "Taxifornia" and the "left coast," Californian voters are not as knee-jerk responsive in favor of new and higher taxes as their elected officials are. In aggregate, between 1990 and 2012, Californians have rejected tax-related ballot propositions 52 percent to 48 percent. More importantly, while Californians overwhelmingly tend to reject new and higher taxes that appear on the ballot, they tend to support tax decreases. Reasons for this reluctance to endorse new or higher taxes are that by 12-to-1 likely voters believe Sacramento wastes a lot of the tax revenue Californians pay and 53 percent of likely Californian voters believe they pay more in state and local taxes than they should. If presented with a smart tax reform agenda, Californians may be more willing to bite than most think.
In 2009, state legislators used the recession as an excuse not to reform California's tax system; now, it is because of the recovery. Truth is, there will never be an optimal time for reform, but that doesn't mean it doesn't need to happen.
For a more in-depth look at these topics, keep your eye out for the July-August 2015 issue of Eureka at hoover.org/publication/eureka to be released on Tuesday, July 21.
