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What’s Wrong with the Parsky Panel Tax “Reforms”

Sep14

threecardmonteBy Jean Ross
Special to Calbuzz

The Commission on the 21st Century Economy,  the “blue ribbon” panel chaired by Republican Gerald Parsky and charged with recommending changes to California’s tax system, appears poised today to  recommend a massive shift in the cost of financing public services from the wealthy and corporations to middle-income families.

The biggest winners would be the state’s millionaires, who would receive personal income tax breaks averaging $109,000 per year. The biggest losers would be middle-income families who would receive a tiny, if any, reduction in their personal income taxes and who would pay substantially more for goods and services due to the new “value-added” tax the Commission proposes to replace revenues lost due to the tax cuts for the wealthy and repeal of the corporate income tax.

The magnitude of the shift proposed by the Commission is nothing short of stunning. The changes to the personal income tax structure alone would reduce income taxes paid by the poorest 62 percent of California taxpayers by $4 per year, on average, while providing six-figure breaks to the millionaires. The bottom 81 percent of the income distribution – the vast majority of all Californians – would receive 10 percent of the personal income tax cut, while the top 0.2 percent would receive 27 percent of the benefits.

And that’s the “good news.” The Commission would repeal the corporate income tax and the state’s portion of the sales tax and replace it with a new tax on business net receipts – a tax that has never been tried anywhere in the US – that the Commission’s own consultant notes would raise prices of goods and services, while exerting downward pressure on wages and benefits.

The Commission’s proposal is designed to tax a broader range of goods and services than the state’s existing sales tax. That’s not entirely a bad idea. There are many services that could and probably should be taxed in order to eliminate some of the biases of the state’s existing sales tax. But the Commission would throw the good “loopholes” out with the bad. It would, for example, tax groceries to finance tax cuts for millionaires, while taxing child care so that oil companies would no longer have to pay the corporate income tax.

The new tax would also encourage relocation of California jobs to foreign firms that would be beyond the reach of California’s tax collectors. Incentives for offshoring could be created by provisions rooted in a highly technical, but extremely important, area of tax law. So-called “nexus” issues are among the most contentious in tax law and govern what activities states can and cannot legitimately tax.

There are considerable grounds to worry that courts would constrain the state’s ability to tax service providers – such as call center operators or consulting firms – located entirely outside of California. Should the courts rule against the state’s ability to collect the tax, billions of dollars of revenues – sorely needed to balance an out-of-balance budget – could be lost, and businesses would receive substantial tax savings from moving jobs out of California.

A letter signed by some of the of the nation’s most prominent tax policy experts notes the potential for the new tax to be challenged based on the “nexus” issues discussed above and notes that “there is almost no experience in the United States or abroad” with a tax similar to that proposed by the Commission. [Note: This important letter, dated Sept. 5, is NOT posted on the Commission web site, where public correspondence is posted only up to Sept. 4.]

Some might be willing to support these changes if they ended California’s persistent budget crises. But again, the Commission’s own estimates predict that revenues raised by the new tax system would grow more slowly over time than those raised by the state’s current tax system. Thus, the Commission’s recommendations would lead to larger, not smaller, budget shortfalls in the future.

Over the five-year period covered by Commission estimates, the difference in revenue growth would be substantial – the increased deficit under the proposed tax code would be approximately equal to what the state spends for today for the University of California and California State University systems combined.

Finally, it is important to note that the Commission totally side-stepped straightforward options for aligning the state’s tax system with the 21st economy that could be accomplished without shifting taxes from the top to the middle or imposing an entirely new, very risky, tax regime.

The Commission could have encouraged lawmakers to aggressively pursue collection of sales tax on out-of-state retailers that currently go untaxed, leaving California businesses at a competitive disadvantage. It could, as noted above, have recommended extending the state’s existing sales Jean-Ross-smalltax to a broader array of services and using the additional revenue raised to lower the sales tax rate.

Similarly, the Commission could have used tax policy as a tool to mitigate, rather than exacerbate, the widening gaps between the top and middle- and top and lower-income households. This, alas, is the path not taken and an opportunity for real progress foregone.

Jean Ross is the executive director of the California Budget Project (CBP). The CBP’s analysis of the Commission’s proposals is available here.


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There are 6 comments for this post

  1. avatar Andy says:

    so much for the commission – Seppuku

  2. avatar patwater says:

    I’ve always found it interesting that liberals will claim that the rich pay far less than their fair share under the current tax system because of the numerous loopholes for the wealthy to exploit. But then when someone proposes flattening out the tax code and eliminating those loopholes, it’s always to benefit the rich. Well if tax loopholes are that big a deal, wouldn’t that hurt the rich? Which way is it guys?

    Also, where are you getting this figure from: “The biggest winners would be the state’s millionaires, who would receive personal income tax breaks averaging $109,000 per year.” I’m no expert but it seems that it’d be freakin’ tough to factor in all the changes to credits and deductions to create an “average” like this. I’m willing to bet you just looked at the marginal change in the nominal rate.

    • avatar jeanmross says:

      The numbers are the commission’s own and are based on their analysis of tax return data – see http://www.cotce.ca.gov/ – Descriptive Information About The Proposed Personal Income Tax Changes. They keep the “big ticket” deductions used at the high end: charitable deductions, mortgage interest, property taxes – while eliminating things like medical expense deductions and the child care tax credit.

    • avatar patwater says:

      Jean, I really appreciate your response. I couldn’t find the data you referred to, but I’ll take your word for it. But I’m still not sure this fact is a bad thing. Let’s consider what working class Californian’s will pay under this plan (from the commissions description of its proposed package):

      “1) Tax rate of 2.75% for income up to $56,000 for joint filers ($28,000 single filers) and 6.50% for incomes above that amount.
      2) Standard deduction of $45,000 for joint filers ($22,500 single filers).”

      If I’m reading this right, wouldn’t this mean that a family making $45,000 or less would pay zero state income taxes? Compared to the current system, where that same family is paying 8% on their last dollar earned, this seems like it’s pretty good from their perspective.

      So let’s say we look at this from a Rawlsian perspective and not from a “lets-soak-the-rich-one” (btw I say that last bit purely in fun). That is lets think about how this proposal impacts the poor of society across generations. You lament, for example, the deduction for charity since that deduction helps rich people more with their taxes than the poor. But that money is going to charity, what should be a good cause and likely will help the poor of society (at least more than another yacht for a millionaire). Seems good so far. The property deductions are indeed lamentable (from this perspective), but I would argue they are just a political reality we have to deal with. Homeowners vote—a lot. Of course, there is also the argument that this new, simplified system will be better for California’s economy. I think generally that reducing information asymmetries and transaction costs increase economic growth. Notice I haven’t talked about the scarily new business net receipts tax, which you seem to fear so much. That is supposed to be better for economic growth by taxing all businesses, not merely the one’s that succeed. Of course, all of this neglects the awesome social benefit of not having people waste hours of their time on tax returns.

      You raise a lot of good points. Your worry that the tax revenue under this system won’t equal the current take is a very legitimate concern. But, as I understand the new system, there are triggers to deal with precisely that possibility. The Business Net Receipts Tax is new and untested. However, at the end of the day, the only people I see attacking this proposal (so far) are ideologues from the right and the left. Sounds like good policy to me.

  3. avatar sqrjn says:

    Arn’t you just assuming that middle class and working poor Californian’s deduct more for health care and children? Thats highly dubious. How do you Know! that they aren’t endowing fellowships at SFMOMA and writing off their downtown commercial real estate? Do you have numbers to back that up? I thought not.

  4. avatar jeanmross says:

    The distribution of the personal income tax breakdown is on page 9 of

    http://www.cotce.ca.gov/meetings/2009/9-14/testimony/documents/9-14_Presentation-final.pdf

    The fact that the proposed system would grow more slowly is in:

    http://www.cotce.ca.gov/meetings/2009/7-16/testimony/documents/STAFF_PRESENTATION_7-16-09.pdf

    And the triggers wouldn’t take care of the slow growth issue.

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