California's Special Tax Commission Proposes Significant Reform
California's Commission on the 21st Century Economy unveiled their final report yesterday. The bipartisan commission was appointed last December by Gov. Schwarzenegger and Democrat leadership to propose an overhaul of the state's tax code with the goal of promoting economic growth, increasing competitiveness, and reducing revenue volatility. The commission's final recommendations agreed to by 9 of the 14 commission appointees, calls for sweeping changes to the state's tax code and while not perfect, represents a vast improvement from the current system assuming it would be revenue neutral as was necessary under the commission's guidelines.
California's highly progressive income tax structure, in which 1% of the population provides half of the state's revenue, is the primary cause of the state's highly volatile cash flow. The commission addresses this by proposing an across the board reduction in personal income tax rates and reduces the number of tax brackets from 6 to 2 (plus the 1% millionaire surtax). Income above $56,000 for joint filers ($28,000 for individuals) would be taxed at a rate of 6.5%. Earnings under that amount would be taxed at a rate of 2.75%.
The commission also calls for the elimination of the state's corporate tax and abolishes the 5% of the state sales tax that goes to the general fund. Both recommendations would go a long way to make the state more competitive and encourage companies that have fled for Washington, Nevada, and elsewhere, to come back to the Golden State.
The corporate tax and sales tax would be replaced with a value-added tax (VAT) on business net receipts capped at 4%. ATR is opposed to efforts at the federal level to impose a European style VAT to pay for Obama Care, noting that on the whole VAT rates have increased in European countries since their imposition in the 1960's and 70's and yielded bigger and more bloated government. However, in conjunction with elimination of the state's sales and corporate tax, along with simplification of the income tax structure, the commission's plan, VAT included, would improve the state's tax code. Additionally and importantly, California's 2/3rds vote requirement to raise taxes will prevent the proposed VAT from ratcheting up as it has in Europe. However, it is important to keep in mind that there is a concerted effort by spending interests in CA to get rid of the 2/3rds requirement. Senate President Steinberg said as recently as July that the 2/3rds requirement "isn't working." Well the fact that it doesn't "work" for legislative Democrats who want to raise taxes is precisely why it is so important and necessary. It has been reported that efforts are underway to raise the funds necessary to put a measure to eliminate the supermajority requirement to raise taxes on the ballot. Removal of the supermajority requirement would be disastrous for California taxpayers and would make the proposed VAT more problematic.
The commission's plan would be a step in the right direction for California and would do much to correct the perennial budget shortfalls and boom and bust revenue cycles that have plagued the state. However, the plan would also need to be accompanied by some form of spending cap. Gov. Schwarzenegger, despite having served as a model of fiscal profligacy, likes to boast that spending has increased less rapidly during his tenure than in previous administrations. However this is nothing to brag about. Since Pete Wilson was in office in 1991 state spending has increased 300%. The Reason Foundation points out that had their been a spending cap tied to population growth and inflation since then, the state would have a $15 billion surplus as opposed to the $42 billion deficit it had at the beginning of the year, underscoring the need to address the spending side as well.
Gov. Schwarzenegger will call the legislature back into session in October to take up the commission's recommendations. The legislature would be wise to seriously consider them. Revenue collections since the July budget band aid are already falling well short of projections. As of this month the FY 10-11 budget is already estimated to have a deficit of at least $7.5 billion. Expect that figure to grow.
Given the track record of tax commissions in California and elsewhere, coupled with the stranglehold that public employees unions have on Sacramento, one shouldn't hold out too much hope for meaningful and necessary reform.
For a copy of the commission's final report: Click Here