Starving the State of California?

The Parsky Commission Tax Proposals
by Michael Meranze

As Chris noted in an entry last week,the Commission on the 21st Century Economy (COTCE, commonly referred to as the Parsky Commission) is about to issue its recommendations for tax reform to the Governor and Legislature. Although the Commission hasn’t released its recommendations in final form, Staff presentations yesterday,earlier Commission documents, as well as the California Budget Project’s (CPB) analysis of the proposals give a pretty clear indication of the direction and implications of the Commission’s thinking. Although I would urge everyone to read the documents themselves (I am not a scholar of taxation), Chris and I thought that it might be good to provide a short précis and context for the Commission’s recommendations and its implications for our discussions here.

Two things seem clear. First, the Commission is proposing a far more regressive tax system than already exists in California. And second, the Commission’s proposals will likely decrease revenues to the State—thereby effectively reducing government support for programs in social services, aid to the poor, healthcare, and education. The COTCE proposes flattening the income tax, eliminating the corporate income tax, and eliminate the State’s general use sales tax. In its place it proposes to implement what is called a Business Net Receipts Tax (BNRT) a sort of value-added tax. All of these changes would be implemented over several years. As always, the devil will be in the details but the outlines appear relatively clear.

First, a bit of background though. The COTCE was established by Governor Schwarzenegger to propose reforms to the tax code. Although the charge to the Commission did include language that the code should be “fair and equitable,” (Executive Order S-15-09) the main thrust of the Commission’s charge and its central focus has been defined as making sure that State revenues are less “volatile,” i.e. more predictable and less subject to economic upturns and downturns. The Commission appears to have assumed that this volatility is due largely to the State’s reliance on personal income taxes (especially capital gains taxes on the very wealthy). There is little or no sign in the proposals of any great consideration of questions of equity. In part this is because the COTCE has ignored (or thought it was out of their power) the fact that part of the reason for the volatility in the State’s tax base has been the remarkable growth of inequality in the state. That growth has, besides its obvious destructive effects on the society as a whole, made the state increasingly dependent on the investment results of the wealthiest Californians.

As the CBP argues persuasively, the effect of the proposed changes to the personal income tax and the ending of the corporate tax will be to shift the relative burden of taxation onto the poorer members of the community. For example, whereas the full implementation of the COTCE proposals would result in income tax reductions of 39.5% for those making between $100,000 and $200,000, 23.5% for those making between $200,000 and a Million, and 26.8% for those making over a Million a year, the tax reductions would only be 0.2% for those making under $50,000, 2.2% for those making between $50,000 and $75,000, and 7.8% for those making between $75,000 and $100,000 (CPB at 6). While The Commission’s proposal would raise the standard deduction it would leave itemized deductions only for mortgage payments, property taxes, and charitable contributions. The effective tax rates on Californian’s were already regressive. This will only exacerbate the problem. The Commission’s proposals will also continue the State’s practice of lowering corporate tax rates. Whereas corporate profits have skyrocketed over the past decades their tax rates in California have been cut (most recently to the tune of 1.2 Billion dollars in the midst of the budget crisis).

But at the same time by shifting the tax focus to a BNRT the Commission proposes to place even more reliance on consumption. And at least as far as the proposals suggest, the tax would be on consumption with very few limitations. For example expenses on health care or childcare (except where the latter was done by a non-profit) would be subject to the effects of the BNRT. This is because although the BNRT is technically a tax on businesses, businesses will (as they do in other value-added tax locations) pass most of the costs onto consumers. The CBP suggests (based on documents presented to the Commission) that approximately 71% of the tax would be passed onto consumers, about 19% would be passed onto workers in the form of lower wages, and about 10% passed onto business owners and shareholders. This is in distinct contrast to corporate taxes where a much greater proportion is borne by shareholders. In effect, the BNRT would make possible the tax relief that would most benefit the wealthy and corporations.

Just as importantly, estimates show that the new system would produce less revenue for the state than continuing on the present course or increasing corporate tax rates. While the Commission has taken the position that its work should be “revenue neutral”; in practice that has meant that it has agreed not to increase revenues only to cut them. The difference over several years may be up to several billions. As the CBP points out that is as much as the State spends on CSU and UC each year (CBP at 5). Again, to go to the “bottom line” implementation of these proposals will make the tax structure less progressive, likely reduce revenue to the state, and do nothing to address growing inequality.

Politically, it is unclear exactly how these proposals will fare. The Commission is split on some of these points (although our colleague Dean Edley of Berkeley seems to be in support of them ). And in a legislature with a Democratic majority (I hesitate to say Democratic control after recent events) these proposals seem likely to get a critical reception. Many tax experts are cautious about the BNRT proposal and California’s businesses are not necessarily on board. But insofar as the Commission proposals set the agenda for an upcoming special section, and insofar as they represent the wishes of the Governor (which seems clear), they are significant. If the focus of tax reform is on simple volatility without any consideration of progressivity; if the results of tax reform is to lessen rather than increase the State’s revenues, and if taxes are being displaced onto consumption the state is going to be in an even more difficult situation. And the ways in which this Commission mirrors the increasingly unequal division of power and resources within the University is quite striking. These are developments that worth paying the closest attention to as both university employees and also California citizens.

Again, I would welcome any corrections of these comments by those more knowledgeable on taxation and its implications.