How a flat income tax can help California

How a flat income tax can help California

Californians may have paid their federal and state taxes last month, but the Golden State remains in a fiscal crisis, with a projected 2008-2009 fiscal year budget deficit as high as $20.2 billion, according to the governor’s estimate on April 29. Such budget crunches hit California because of its highly punitive tax code. A flat income tax would free California from this revenue roller coaster and spur both economic growth and job creation.

With its millionaire’s surcharge, the top tax rate on income is as high as 10.3 percent, the most of any state. The California income tax code has seven brackets and a complex array of loopholes. As a result, California’s income tax receipts are the most volatile in the country compared to other states that rely heavily on income tax revenues in their budgets.

The exaggerated swings in revenue help explain California’s susceptibility to budget emergencies. When the economy is doing well, state coffers swell, leading the politicians to ramp up popular spending programs. When the inevitable downturn occurs, it magnifies the loss in revenues. Things don’t have to be this way. California could scrap its complicated income tax code, along with the estate and gift taxes, as well as the Alternative Minimum Tax and taxes on corporate dividend payments, and replace them with a simple, flat-rate income tax of 3 percent. Whether a person makes $50,000 or $500,000, the same flat rate would apply. All California taxpayers would be able to complete their return in minutes, and the state would benefit, as well.

The flat tax would yield the state at least the same revenues, on average, as the current setup. The crucial difference is that the revenue would be more evenly distributed between good and bad years. During good years, California’s current arrangement shoves many taxpayers into higher brackets, where they pay higher rates on their large incomes.

During recessions, not only are many taxpayers earning less, but they’re paying a lower rate on their incomes, as well. This gives tax receipts a one-two punch during downturns. Thus, the California tax code exaggerates the natural ups and downs of the business cycle, and leads legislators to dig themselves into a fiscal hole. Flat-tax reform is not mere economic theory; it has been successful elsewhere in the world. When Russian President Vladimir Putin took office in 2000, he pushed through a 13 percent flat tax on personal incomes. In its first year, the new flat tax yielded a 25 percent increase in revenues, even adjusting for inflation. By the end of 2004, income tax revenues had more than doubled. More than 20 other countries are seeing the benefits of a flat tax, including Estonia, Iceland, Lithuania, Macedonia, Montenegro, Romania, Serbia, Slovakia and Ukraine.

In California, a flat tax of 3 percent would slash the rates on the most productive citizens, small businesses and corporations. By letting citizens keep more of the money they earn, this reform would spur economic growth and job creation. The rate of 3 percent will ensure that the state does not sacrifice revenues from the switch.

The current fiscal crisis, meanwhile, is likely to hurt those who may be laid off by the state because of budget cuts. California’s current soak-the-rich tax code hurts the poor because it stifles job growth and leads to a revenue roller coaster and cuts in programs that the poor have become dependent on.

Gov. Schwarzenegger and the Legislature are dealing with that now, to the possible tune of $20 billion. If they want to avoid future crises, they need to implement long-term reform such as a flat income tax for California.

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.