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California Learns That Taxing Only the Rich Is Not Enough

July 26th, 2009 . by economistmom

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This week’s Economist magazine reports that California is learning the hard way that their very progressive tax structure (especially for state-level taxes) is an “unreliable” source of revenue:

What is to blame for California’s recurring, humiliating budget crises? The state’s Byzantine tax system, says Gerald Parsky, a private-equity investor. Mr Parsky is also the chairman of the bipartisan Commission on the 21st Century Economy, which was set up by the governor, Arnold Schwarzenegger, last year with a mandate to think bold thoughts about taxation.

The commission has two goals. The first is to end California’s notorious revenue volatility. This is a result of the state’s heavy reliance on personal income taxes and in particular on capital-gains taxes paid by the rich (see chart). In good years, such as during the dotcom boom, revenues soar and politicians happily spend. In bad years revenues plummet and the budget cracks open. The second goal, as the commission’s name implies, is to modernise the tax system. The sales tax, for instance, applies only to goods, even though California has become a service economy…

So what kind of tax system would be less volatile, providing a revenue base with enough potential growth and resilience to handle the burden of rising health care costs (a reliable trend even if health care reform is passed)?  Not any surtax on the rich, that’s for sure.  The California tax reform commission has some ideas we’ve heard before in the federal context (emphasis added):

At first the Parsky commission leant towards a flat tax. That, however, raised hackles about shifting the burden to poorer people just as the state was cutting back on benefits in the teeth of a recession.

The latest plan would eliminate the state sales and corporate taxes entirely, and would make personal-income taxes so simple [i.e., broad based] that a return would fit one page. Courageously, it might nibble at Proposition 13, by letting commercial property be taxed more. But the main innovation is a “business net receipts tax” on the difference between gross sales and purchases from other firms. Mr Parsky says that this will be similar to a value-added tax, but “does not exist in exactly this form anywhere in the world.” California may be just the place to try it out.

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