Tax Reform Kabuki Theater Ready to Take Center Stage

Tax Reform Kabuki Theater Ready to Take Center Stage

Last month, the Legislature sent 600 bills to Governor Jerry Brown for his signature (or veto). Senator Bob Hertzberg’s SB 8 was not among them.

Hertzberg created a buzz when he introduced his proposal in late 2014. Los Angeles Times columnist George Skelton wrote Hertzberg’s proposal “points the way to needed reform”; San Francisco Chronicle editor John Diaz called SB 8 “the most ambitious endeavor in the state Capitol this session.”

Hertzberg characterizes his bill as a “tax-reform plan to modernize state taxes,” but is SB 8 real “tax reform”? Or is it merely a tweak, albeit a very expensive one?

Forward Observer compared SB 8 with two tax reform plans released in the past six years. Our full report is here.

Governor Schwarzenegger’s Commission on the 21st Century (known as the Parsky Commission, after Chairman Gerald Parsky) released its 400-page report in 2009. The Parsky Commission recommended eliminating the state sales tax over a five-year period and gradually replacing it with a European-style Value-Added Tax (VAT) that would tax all businesses, regardless of whether they provide goods or services, at a low rate of 4 percent. The Parsky Commission recommended using this new revenue to lower personal income tax rates and eliminate both the minimum franchise tax and corporation tax. “These reforms,” Parsky and his fellow commissioners wrote, “are designed to encourage economic growth while retaining a fair and equitable distribution of the tax burden.”

In his 2010 campaign for governor, Jerry Brown promised:

“Recently the Parsky Commission took on the difficult task of reviewing California’s complicated tax structure and made recommendations for significant change. Unfortunately, no consensus was achieved. While I am fully aware of the difficulties of ever changing our tax structure, I would try again by establishing a similar commission that could build on the hard work already completed. I would be actively involved to ensure the high level focus needed to arrive at consensus.”

The Pacific Research Institute published Eureka! How to Fix California, by economists Dr. Arthur Laffer and Dr. Wayne Winegarden, in 2012. The centerpiece of their tax reform proposal was “a revenue-neutral single low rate flat tax with two tax bases upon which the single low tax rate would be applied.” The flat tax rate of 5.8% would apply to both business and personal income. Most tax credits and deductions would be eliminated, although taxpayers would continue to deduct mortgage interest and charitable contributions. Eureka! also called for allowing renters to deduct rent on their primary residence, in the name of equity between home owners and renters. According to Laffer and Winegarden, their plan would “eliminate much of the inefficiency from California’s tax system by both broadening the tax base and significantly lowering the highest marginal tax rates”.

It is worth noting that Laffer was an informal advisor to Jerry Brown’s 1992 presidential campaign. Brown proposed a federal flat tax of 13 percent on all personal income and businesses, predicting “the stock market will go through the roof, businesses will thrive and millions of Americans will get back to work.”

The most talked-about policy change in SB 8 is the extension of current statewide sales tax from goods to services. According to Sen. Hertzberg, “Eighty percent of California’s economy is now providing services, not goods, and most of these services are untaxed, making California more dependent on personal income taxes, which fluctuate year to year.”

Both the Parsky Commission and PRI addressed volatility in state revenues. “California relies more heavily than most other states on the volatile revenue stream from highly progressive personal and corporate income taxes,” wrote Laffer and Winegarden. The Parsky Commission concluded, “The lack of adjustments in the tax system has contributed to the increased volatility of the state’s revenue”, and has led to “an excessive dependence on a small pool of taxpayers with volatile income.”

But the Parsky Commission and PRI took a different path than SB 8 to address this volatility.

Both recommended eliminating the statewide sales tax, not extending it from goods to services.

Parsky and PRI recommended replacing the statewide sales tax with a VAT. The Commission recommended capping the new tax at 4% and gradually phasing it in over a 5 year period, while Eureka! sets its Business-Value Added Tax at a rate of 5.8%.

The Parsky and PRI tax reform plans are both revenue neutral – another key difference, as SB 8 outlines $10 billion in new spending. (Note: SB 8 does include a provision that would potentially lower taxes on income and business, but only “when it is clear that new revenues are sufficient to replace any revisions.”)

Sen. Hertzberg has said his bill “will eventually take the form of a statewide ballot campaign.” But the next word on tax reform may come from State Controller Betty Yee’s Council of Economic Advisors, appointed this April. Yee directed her Council to “asses the workability of proposals including practical effects, unintended consequences and prospective alternatives”.

Hertzberg once compared legislating to Kabuki Theater – the ancient Japanese art of highly stylized and dramatic performances designed to keep the audience guessing the outcome.

As California’s tax reform drama plays out next year, perhaps a few additional actors need to take the stage.

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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.