As California’s state coffers are bulging at the seams with this year’s surplus, conditions are ideal to slim down on state taxes, among the highest in the nation according to a recent report.

The Small Business Survival Committee, a Washington, D.C.-based trade group, issues an annual index revealing how well or poorly states treat businesses. An extremely high capital gains, personal income, and corporate tax as well as stringent regulations on businesses puts California among the ten worst states in which to own a business this year. Ranking at the bottom of the Western states, California places a lowly 41 out of the 50 states.

California’s top personal income tax rate of 9.3 is the fourth highest in the country. The corporate income tax top rate of 8.84 percent comes in 14th. And the capital gains tax, at a top rate of 9.3 percent, is the second highest in the nation. Clearly, California has a lot of work to do to foster a friendlier business climate.

Of all the high tax rates in California, the capital gains tax is the most detrimental to the economy because it raises the cost of investment and entrepreneurship, which are the sources of economic growth. By taxing investments first under the personal or corporate income tax, and a second time under the capital gains tax, the state burdens investors with double taxation.

During his campaign in late 1998, Governor Gray Davis voiced his support for elimination of the state capital gains tax, saying, "I think it’s the government’s responsibility to live within the resources the economy generates." But the legislature has done little over the past year to fulfill that promise.

In June of 1999, Governor Gray Davis passed a law that provides a permanent extension of a 50-percent capital gains tax exclusion to those who have held small-business stock for more than five years. But in an economy driven by small business and entrepreneurship, more must be done to lighten the tax burden on investors. Here, California legislators can take a lesson from the Feds.

Congress last cut capital gains taxes in 1997, from 28 percent to 20 percent on most long-term holdings—the lowest rate achieved in six decades. Just following the cut, the economy expanded, putting more money in government pockets.

The real economic growth rate was a healthy 3.8 percent in 1997, 3.9 percent in 1998, and an estimated 3.9 percent in 1999, far surpassing the meager 1.9 annual average from 1990 to 1996. And according to a recent IRS report based on preliminary data, the capital gains tax cut as well as the rising stock market caused capital gains tax revenue to rise 38 percent, from $251.9 billion in 1996 to $347.9 billion in 1997.

Critics of pro-growth tax cuts often argue that cutting the capital gains tax would benefit only the rich. What they don’t realize is that the middle class is responsible for a large part of capital gains realizations. According to a 1997 Congressional Budget Office (CBO) report, half of U.S. families own assets that generate capital gains, and nearly two-thirds of those families earn less than $50,000 per year.

The Legislature’s financial adviser recently reported that next summer, after it pays the bills, California will still have a $2.6 billion surplus. Most of the surplus will come from Personal Income Tax revenue, which will have risen an estimated 11 percent over the past year. An expanding economy has forced a jump in wages, bonuses, and the stock market value of stock options for the highly compensated, particularly in the high-tech field. If the economy is doing so well, then why not give Californians a tax cut?

This year, the California legislators need a lesson in giving. Instead of spending every last penny of taxpayer money, government should give some back with a tax cut to benefit Californians of all income levels. Abolishing the capital gains tax would be a good place to start.