California’s recipe for stagnation

As legislators finished their session and scattered to their home districts this week without a realistic budget plan and two months after the deadline for approving a budget, one cannot help but wonder if our elected leaders truly grasp the depths of economic crisis and despair facing Californians.

Unemployment in the state stood at 12.3 percent in July, the highest on record, going back to the mid-1970s. California has the third-highest jobless rate in country, behind Michigan and Nevada. In 2009 more than one in three California workers were classified as severely unemployed, and that has certainly worsened.

Californians needed a workable plan to balance the budget, achieve tax competitiveness, rationalize government spending, and return value-for-money as a priority in government services. The Legislature failed on all accounts.

Inherent in the budget plan offered by the Democratic leadership and rejected Tuesday is a key economic assumption: Incentives and competitiveness don’t matter. This grossly mistaken assumption is a core reason why California’s economy continues to lag.

First, as any normal person knows, incentives matter. When tax policies discourage work effort, investment, innovation and entrepreneurship, we get less of them. Second, investment capital, skilled workers and entrepreneurs are mobile. When states (or countries) fail to achieve competitiveness on key measures such as personal and corporate income taxes, they attract less investment, skilled labor and fewer entrepreneurs.

To lack economic incentives, while simultaneously coming up short on competitiveness with one’s neighbors, is a recipe for economic stagnation. Welcome to California politics where extraordinary economic potential has been atrophied, resulting in economic mediocrity.

The Democratic budget proposal to raise personal income tax rates while ignoring corporate income taxes is a sure-fire killer of jobs and entrepreneurship. California’s top two personal income tax rates are among the highest in the country. Rather than recognize the peril of high marginal tax rates, the most-recent proposal prefers to stay the course and raise the other personal income tax rates by one percentage point.

California’s corporate income tax rate of 8.84 percent is the ninth-highest in the country and substantially above our neighbors: Washington – none, Nevada – none, Arizona – 6.9 percent, Utah – 5 percent. Economic research consistently confirms that corporate income taxes are one of the most costly and economically damaging ways to raise revenue. Yet the budget proposal remained silent on corporate income taxes.

Finally, the budget proposal included a cut in the state sales tax. No mention was made of reforming the sales tax, which is designed for an economy of the 1950s. A better approach, and one aimed at reinvigorating the state economy, would have called for modernizing the sales tax while cutting the rate at the same time.

California majority-party legislators continue to refuse to acknowledge the costs of being tax uncompetitive and fail to offer a workable plan to achieve an honestly balanced budget. Notably absent are any real plans to reform spending. Legislators thus reinforced the state’s “Closed for Business” sign.

These realities clearly indicate that our elected leaders fail to grasp the depths of our economic crisis. Tuned-in, responsible leadership would turn the budget impasse into a golden opportunity for genuine reform. That would help restore prosperity to a state that should be an economic powerhouse in the nation and the world.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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