By 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 tax 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.