Facing a shortfall that Gov. Arnold Schwarzenegger has estimated at $20 billion, Democratic lawmakers in the Capitol are looking for a way to raise tax revenue. They might want to adopt and modify an idea advocated by a conservative think tank – and increase tax revenue while lowering tax rates.
California’s tax rates currently top out at 10.3 percent for individuals and 8.84 percent on corporate profits. But a report by the Pacific Research Institute says a flat, 3 percent rate would collect the same amount if the state also eliminated all of the deductions that now riddle the income tax code.
The institute is officially nonpartisan, but it leans toward conservative principles. The author of the study, Robert Murphy, says his plan would help moderate the state’s notorious revenue roller coaster, provide incentives for economic growth and draw more high-earning individuals and companies to the state. He’s not in favor of raising taxes.
But if the 3 percent rate he describes would be revenue neutral – bringing in the same amount the state collects now – a slightly higher rate would bring in enough money to wipe out much of the deficit. Just as an example, a 3.5 percent rate applied to all income would probably mean an extra $10 billion to the treasury. Would all the economic advantages Murphy cites from moving to a flat, simple tax would disappear if the rate were just one-half of 1 percent higher than he recommends? Murphy seemed taken aback when I asked him about that possibility during a panel discussion on his idea in Sacramento this week. Yet in California’s current political climate, his plan is going nowhere anyway. One way to salvage its best elements would be to combine it with the Democrats’ desire for more revenue to avoid deep cuts in education, health and social programs.
Various players in the Capitol are already considering more limited moves in the same direction. The state’s nonpartisan legislative analyst has recommended repealing or limiting several credits and deductions to raise about $2 billion more per year. Schwarzenegger says he is open to closing what he calls “tax loopholes.” The newly elected Assembly Speaker, Karen Bass of Los Angeles, meanwhile, says she plans to appoint a bipartisan commission to explore fundamental tax reform for California.
“The state of California is in a crisis,” Bass told the Associated Press. “I want to set up a commission outside of the Legislature that will look at more long-term solutions and evaluate whether the tax structure we have now makes sense given that it was devised in the 1930s when we had an entirely different economy.”
That’s where Murphy’s idea comes in. His proposal has two main elements. One is to simplify the tax code by essentially wiping out all deductions. The other is to apply a single flat rate to all income, rather than the progressive, graduated system California uses now.
“The benefit of the flat tax,” Murphy says, “is its simplicity.”
Although the two ideas – a flat rate and a simple tax code – needn’t go together, Murphy’s proposal weds them to form a system he says would allow people to do their taxes in five minutes. All you would need to know is your annual income, which you would multiply by the tax rate, and that’s how much you would owe. Someone making $100,000 in a year, for example, would multiply that by 3 percent and pay $3,000.
Politically, the idea is a double-edged sword. Most voters would probably love the concept of eliminating all the tax breaks that the wealthy and the well connected use to reduce what they owe the state. But the tax code also includes some biggies that help the middle class. The most obvious are the deduction for home mortgage interest and the tax credit families get for each child in a household.
And Murphy’s plan, as he has laid it out, would tax all income at the same rate, from the first dollar on up. Today, a couple with two children generally pays no income tax in California until the family’s earnings top $50,000. Under Murphy’s system, the same family would pay 3 percent, or $1,500 in taxes.
Murphy concedes that his plan in its purest form is probably not doable politically. A serious proposal along these lines would likely exempt the first portion of everyone’s income, perhaps as much as $20,000 or $30,000 a year, so that the poor would pay proportionately less than the wealthy. And it would probably leave intact, at least in some form, some of the most popular tax deductions.
Democrats already are looking at broadening the sales tax base by applying the tax to services rather than only to goods. They’ve said they might want to combine that change with a move to lower the rate.
Murphy’s proposal for the income tax follows the same path. Democrats shouldn’t dismiss it – even if they might want to bend it to serve their different goals for the size and scope of state government.
About the writer: Call The Bee’s Daniel Weintraub, (916) 321-1914. Readers can see his California Insider political blog at CapitolAlert.com.
*This article was reprinted in the following publications. Title may vary.
Democratic Underground, May 17, 2008
Oakland Tribune (Oakland, CA), May 10, 2008
Press-Telegram (Long Beach, CA). May 10, 2008
Argus (Fremont, CA) May 10, 2008
San Jose Mercury News (San Jose, CA), May 9, 2008
Daily Breeze (Torrance, CA), May 8, 2008
Tribune (San Luis Obispo, CA), May 8, 2008
TMCnet.com, May 8, 2008
Scripps Howard News Service, May 8, 2008