Gov. Jerry Brown released his budget Tuesday amid what the media called an “uncertainty” in Washington that will could an effect on the state’s finances. The fear is that the Republican White House and Congress will punish California for its political rejection of Donald Trump by holding back federal funds.
But the more important story has nothing to do with Trump or Republicans. The bigger problem is the state’s broken tax system, an issue Brown discussed at the beginning of the briefing but never returned to, and which was largely ignored by the Sacramento press corps.
As any Democrat would, Brown hailed California’s status as having “the most progressive tax system in the United States,” which forces the wealthy to pay more than everyone else. But he undercut his point when he immediately admitted it is also “one of the most unreliable” tax structures in the country.
The bulk of California’s tax revenue is produced by personal income taxes, accounting for nearly 70 percent of collections for the general fund. This gives lawmakers great power to grant favors to friends and punish enemies, but a system based on steep income taxes on the rich is vulnerable to economic swings in the state and the stock market. It’s a volatile arrangement that feeds the fisc in good times and starves it in the lean years. Brown said just “a modest recession will cost California $18 billion a year for three years.”
Last year Moody’s Investor Services ranked California as the state that was least able to handle the adversity of a recession. Alan Auerbach, director of the Robert D. Burch Center for Tax Policy and Public Finance at the University of California, Berkeley, has found that California’s tax revenue is more erratic than most other states. His research also showed that the state’s economy has had more ups and downs than the nation as a whole in recent decades. As a consequence, California has had a surplus only five times since the 2000-2001 budget. And as Brown said, they have been modest when compared to the deep deficits.
Lawmakers have toyed with the idea of making long overdue changes. The California Council of Economic Advisors on Tax Reform, established in 2015 by State Controller Betty T. Yee, says the legislature has considered 4,600 tax proposals over the last 20 years. That’s an average of about 245 a year. But a complete makeover is needed and lawmakers haven’t been inclined to take that step.
As the Council said in its “Comprehensive Tax Reform in California: A Contextual Framework” plan, systematic “tax change is difficult.” Yet it is necessary, and not just so the budget analysts in Sacramento will have easier jobs. Any overhaul has to deliver a system that will promote economic growth. It has to expand economic liberty, as well.
And it must find balance. There are 10 different brackets and a punitive 13.3 percent rate – the highest in the country – on those earning more than $1 million a year. The top 10 percent of income earners pay nearly 75 percent of all income taxes. All this puts an unfair burden on the most productive Californians and renders those with lower incomes non-participating bystanders.
A flat tax with lower rates – Pacific Research Institute scholars Art Laffer and Wayne Winegarden suggest a single 5.8 percent rate in “Eureka!: How to Fix California” – is the starting place. The Laffer and Winegarden proposal also eliminates sales and use taxes. These are, of course, radical changes. But the tax regime must be completely remade and have no less of a revolutionary impact than Proposition 13, the 1978 measure that limited California’s runaway property taxes.
What reform can’t be about is raising more revenue. The state would automatically receive a windfall from lower rates and a broader base. That’s just the way supply-side economics work. But no longer can Sacramento continue to spend as if it doesn’t matter. The benefits of economic growth that will be generated by reform will replace the many programs that were created to lift the poor but in reality has kept them there and increased their numbers. The more resources the private sector has to invest, the better the economic consequences.
Until this hard work is done, Brown and the governors who follow will have to come before the people of California every January and explain away yet again the state’s shabby tax system.