Supporters of the measure will cite dramatic cuts made to California’s education and health and human services in recent years, and the critical need to reinvest in the state’s infrastructure. Opponents will claim the new taxes represent a fatal body blow to an economy that is already overtaxed and overregulated. And the wealthy (so called job creators) will flee the state en-masse.
Claims on both sides are overstated. To supporters of the tax increase, I say yes, California’s budget has had to shrink quite a bit in recent years, but the state has been more inclined to cut local funding and program spending rather than tackle other sources of savings, such as reducing salaries for public workers or reducing the cost of the bloated public pension system. California teachers, for example, rank third in the nation for pay, even though per pupil spending here ranks among the lowest in the U.S.. And past episodes of windfall gains have not only been used unproductively, the slack has allowed inefficiencies to remain in the system, with extra money often being spent on special interests rather than pressing needs.
I, for one, would be more comfortable with the proposed tax increases if there were some guarantees as to how the additional money would be spent—specifically that it would not be spent on expanding current pay levels or pension benefits, or on the folly of the current high speed rail plans. Additionally, I would be more readily supportive if there was some plan in place to create an ongoing strategy to improve efficiency in state operations.
To the other side, opponents of the tax increase, I’ve said it before and I’ll say it again – California is not a high tax state. State and local taxes and fees added up to about 16% of state personal income in 2008-09, compared to 15.5% for the U.S. overall. Direct spending by the public sector in 2009 was 9.5% of state GDP, ranking California 27 out of the 50 states (New Mexico ranks number one at 13.6%). Yes, California does have the highest marginal tax rate on high-income earners, and it has for a while. Yet we are still home to the largest number of high-income households in the nation, according to the 2010 census.
And it is not just high taxes that these households face. California is expensive in many ways. Housing in California is some of the most high priced in the nation. Texas, besides not having a personal income tax, also has housing that on average costs half of what it does in California. If cost-of-living was the sole determinant in deciding where to live, the state would have emptied out years ago. Yet, California continues to grow, because along with those taxes and expensive housing, comes one of the best climates and most spectacular natural environments in the nation. Not to mention cultural resources and institutions of higher learning that few places rival. The Governor’s proposal may be the final straw for some wealthy residents, but for the most part it is unlikely that it will have any dramatic short-run impact on the demographic makeup of the state.
This isn’t to say that the personal income taxes have not had a negative impact on the state’s economy. They surely have. But these effects are already in place, and the marginal changes now being proposed will not change them much.
If I had to weigh the pros and cons, I would say that I am reservedly in support of the proposed plan. But ultimately, I am disappointed that the Governor did not step back and take an approach that might fix California’s budget woes as it simultaneously makes the state a more tax friendly place. It starts with the basic proposition that small taxes on large bases are better than high taxes on small bases. In general, California is overly reliant on sales and personal income taxes because it under-taxes large swaths of the economy. Where are these untapped potential revenue sources? Consider two simple ones (although far from simple politically)—a sales tax on services and getting rid of Proposition 13.
First the sales tax. It is clear that a goods tax is ultimately a bad place to look for new revenues. Over the past 30 years goods purchases have decreased as a share of the average consumer’s budget. This is in part because international trade and technological advances have pushed prices for products down relative to services, and in part because the average household only needs so many appliances. Tapping service expenditures not only expands the current tax base, but provides a revenue source that grows in proportion to the population base. And since the service sector typically has a larger profit margin than the goods sectors, a sales tax would likely have a smaller impact on economic activity.
Prop 13 is similarly obvious. How such a regressive and patently unfair law ever made it past the equal protection clause of the state constitution is beyond me. That two homeowners with similarly valued houses, receiving the same public services, should pay completely different tax rates based on how many years they have lived in their home is nonsensical.
Some have argued that retired households need the protection since they do not have the financial wherewithal to pay higher taxes. Prop 13 was built on the urban legend that thousands of seniors were losing their homes due to rising property taxes. I say legend because for the most part these households tend to be sitting atop lots of home equity in the first place unlike their younger newer neighbors who are bearing the brunt of property taxes. And logically an increase in property taxes only comes with an increase in the value of the property and thus the available equity that could easily be accessed to pay said increase in property taxes. And in any case, Prop 13 is not applied to retirees only.
In the commercial space, Prop 13 creates an unfair playing field for newcomers trying to grow their businesses in California. And the abuses are more widespread in the commercial space—since a variety of legal maneuvers can be used to dodge reassessment of property values even if the property changes hands.
Shifting to these two sources of new revenues would have other advantages. Spending on services and real estate taxes are nowhere near as cyclical as income taxes on high-income earners and sales taxes on goods. As such, the budget bust that occurs during economic downturns would be smaller. Moreover, revenues would be easier to forecast on an annual basis. Income taxes on high-income earners come largely from capital gains. Forecasting these for budget purposes is difficult during the best of times, since it requires some idea of where the stock market is heading. Indeed, consider the current disagreement between the state’s Legislative Analysts Office and the Department Of Finance as to the amount of new revenue that would end up being created under Governor Brown’s tax proposal.
But there are political third rails; touch them and die. This is why elected officials in the state’s legislative bodies will never propose such obviously beneficial reforms. But the Governor, with his current proposal, is already bypassing the House and Senate and going straight to the electorate. The state’s population has, for the most part, been fairly wise in its choices. If the argument is made in clear terms, and the benefits explained, why not let the voters decide? California just might do the right thing.