TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Tuesday, September 25, 2018

Dependence On Income Tax Revenue Leaves California Vulnerable; Budget Experts Call For 'Political Unicorn' Of Real Tax Reform

L.A. Times, Dependence on Income Tax Revenue Leaves State Vulnerable:

While Democrat Gavin Newsom and Republican John Cox campaign on their visions for the state’s next chapter, it’s the financial success of residents in Palo Alto’s 94301 and a handful of other affluent ZIP Codes that will determine whether promises to build more houses, overhaul healthcare or invest in schools can actually be kept.

The state scooped up just under $1 billion from nearly 9,000 tax returns filed in 94301 in 2016 — more revenue than from any other ZIP Code in California.

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Much is made of the widening gap between California’s very rich and very poor. But just as significant is how the fate of the latter depends heavily on the former.

“We are very dependent on millionaires,” said Mike Genest, former budget director for Gov. Arnold Schwarzenegger. “If the millionaires get a cold, we all die of the flu.” ...

“It wouldn’t take a recession to create a budget crisis,” said Justin Garosi, an economist with the nonpartisan Legislative Analyst’s Office. “If the stock market were to have a really poor year, if it greatly reduces the amount of revenue from capital gains — that would create a budget hole even if the regular economy were fine.”

The vulnerability stems from the state’s lopsided reliance on personal income tax — including taxes on capital gains — to fund its budget. Nearly 70% of California’s revenue comes from personal income tax, according to the Legislative Analyst’s Office. That share has steadily risen since the 1950s, while other sources of revenue, such as sales and use tax and corporate tax, have declined in significance. And personal income tax revenue is especially concentrated among the state’s top earners. In 2016, the top 1% of filers paid out nearly 46% of income tax revenue.

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When that top 1% is doing well, the state does very well. When Facebook went public in 2012, for example, the resulting surge in capital gains revenue injected at least $1.4 billion in revenue directly associated with the initial public offering in the subsequent three years.

Some budget experts said the state could better manage the risk of relying so heavily on the wealthy.

Ana Matosantos, who served as the top budget official for Schwarzenegger and Brown, said checks on volatility include budget reserves, avoiding ongoing spending commitments, and good planning. Reducing taxes on the rich would be more stable, but would also mean less money in state coffers — a combination that would “make inequality worse,” she said.

“Progressive tax policies are reflective of the growing wealth and income inequality,” Matosantos said. “It is appropriate and fair to consider ways to calibrate tax policy to reflect the growing demands on public services caused by extreme wealth inequality. If we want a tax system that raises more revenues, we need taxes to apply where the money is.”

As governor, Brown has spouted a less optimistic view of California’s dependence on the rich.

He has relished raising alarms about unpredictability, displaying large charts at budget news conferences to show the jagged peaks and valleys of capital gains revenue over the decades.

Yet under his tenure, the state has grown more dependent on high-income earners. In 2012, he convinced voters to approve new income taxes on the wealthy — starting with those earning $250,000 a year — as well as new sales taxes to stave off billions in cuts to education.

Key to that successful campaign was the promise that those taxes would be temporary. But in 2016, labor groups representing teachers and public employees were victorious in their push to extend the income taxes until 2030. The tax rates generate up to $9 billion in additional revenue each year, enabling the state to spend more on programs.

To guard against budgetary whiplash, Brown has preached limiting spending on new programs, leading to perennial battles with legislators. He also championed a revamped rainy day fund, sequestering a portion of capital gains revenue that is above historic norms. ...

A sweeping overhaul of California’s tax structure could make the state’s revenues less volatile, but it would also mean imperiling a herd of sacred cows.

Broadening the tax base would shift the dependence away from high-income earners, but would in turn put an additional burden on low- and middle-income residents — an unpopular prospect anywhere, but particularly in liberal California.

Revisiting Proposition 13, the landmark 1978 initiative that slashed property taxes and capped the annual increase in assessments for residential and commercial properties, could mean a gusher of revenue to local governments and schools, easing the need for the state to spend so heavily in those areas. But the law, particularly on residential taxes, remains politically untouchable, at least for now.

A handful of options have long been under consideration in Sacramento. State Sen. Bob Hertzberg (D-Van Nuys) has repeatedly called for a sales tax on services. A partial revision of Proposition 13 — a so-called “split roll” that would tax commercial properties based on market value, instead of purchase price — has gained popularity in liberal quarters and may be on the ballot in 2020, but it faces stiff resistance from business interests. Environmentalists have encouraged a tax on extraction from California’s oil or natural gas reserves, a move fiercely opposed by oil companies. ...

“Getting real tax reform done would be the political unicorn of policy change,” said Dana Williamson, a Democratic consultant and Brown’s political adviser. “It would take a lot of money, a coalition of competing interests and a popular governor willing to make this their top priority at a time when voters aren’t clamoring for change.”

https://taxprof.typepad.com/taxprof_blog/2018/09/dependence-on-income-tax-revenue-leaves-california-vulnerable-budget-experts-call-for-political-unic.html

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Comments

When state income tax on capital gains is 13.3% ("only" 9.3% at middle incomes), tax revenue becomes volatile. Duh.

Posted by: AMTbuff | Sep 25, 2018 4:01:43 AM

One good earthquake and there goes half their revenue.

Posted by: ruralcounsel | Sep 25, 2018 4:08:49 AM

UCLA is 90024. I used to rent, but profs couldn't afford to buy there.

Posted by: Eric Rasmusen | Sep 26, 2018 7:18:45 PM