The seven lean years

California’s Proposition 30, officially titled “Temporary Taxes to Fund Education,” is celebrating its second anniversary this November. The greatest anniversary gift would be to repeal it.

California needs sustainable and robust economic growth. Strong economic growth creates jobs, raises families’ incomes and improves our standard of living. And, while economic growth has been sub-par nationally, it has been worse in California.

Take job creation. While pundits complain that too few jobs have been created nationally, California’s job creation has been even slower. Part of the reason is California’s anti-growth policies – especially Proposition 30.

Prop. 30, the millionaire’s tax, was passed on Nov. 6, 2012. It raised the state’s sales tax rate to 7.5 percent; and the top marginal income tax rate to as high as 13.3 percent on those individuals with incomes of $1 million and above. This latter tax was applied, retroactively, to Jan. 1, 2012. These tax rate increases are supposed to be temporary for seven years. But, politicians have a tendency to morph temporary tax hikes into permanent tax increases.

Prop. 30 reduces the return from saving, investing, or working in California. And, these adverse economic incentives matter for economic growth.

When profits for an entrepreneurial venture are high in California, people have an incentive to work and invest in California. Alternatively, people have a strong incentive to avoid California when entrepreneurial profits are low.

High taxes in California reduce profits and, therefore, diminish the incentive to save, invest or pursue entrepreneurial activities in the state. By discouraging these activities, taxes reduce California’s rate of economic growth.

Business migration away from California exemplifies the negative impact from its punitive tax policy. For instance, Toyota closed its Torrance, California complex, which employed 5,300 people, and moved to Dallas, Texas in April 2014. Other emigrants include Occidental Petroleum, and CKE restaurants, which plans to expand the number of Hardees and Carl’s Jr. restaurants in Texas, but not California.

The incentives to leave California are not confined to businesses either. Although pro golfer Phil Mickelson quickly apologized for claiming that Prop. 30’s tax rate was excessive, those tax increases cost him $1.8 million in 2012. On the other hand, Tiger Woods’ 1996 move from California to Florida saved him $7.5 million in 2012 taxes alone.

At the time of Prop. 30’s passage, California’s tax burden was already among the highest in the nation, and the top marginal income tax rates were the highest state tax rates in the nation. Prop. 30 made California’s tax code even less competitive compared to the other 49 states causing California to be an even less attractive place to do business.

Possibly worse, Prop. 30’s premise – that additional state revenues were necessary – was simply false. The state’s inflation-adjusted per capita expenditures were near all-time highs at the time of Prop. 30’s passage. Between the 1984-85 budget year and the 2013-14 budget year, total expenditures in California, adjusted for inflation and population, grew 2.1 percent a year. In other words, for the last two decades, the California legislature has increased real spending per Californian by 2.1 percent a year, each and every year.

California’s problem was never about revenues – it was, and continues to be, about a lack of effective budgeting. Overly-restrictive budget rules and lack of spending control in other budget areas (especially health care) are driving California’s budget problems and crowding out spending on everything else – including education. Just like a pay raise cannot save a shopaholic from bankruptcy, tax increases cannot solve California’s budget rigidity problems.

The consequences from Prop. 30 have been a further slowdown in California’s employment growth, greater pressure for businesses and people to migrate to other states, and increased difficulty managing the state budget in the long run.

These adverse incentives will persist until the tax rate increases and additional budget rigidity Prop. 30 created are repealed.

Which brings us back to Proposition 30’s anniversary. The best way to celebrate is to make Prop. 30’s second anniversary its last anniversary.

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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