‘Buffett Rule’ a bust in California

If President Obama really wants to see the “Buffett Rule” in action, he should look at California’s tax system. The state has been plagued by it for years.

The revenue stream is unstable and the state budget has been a deficit disaster.

Soaking the rich — relying heavily on them for income taxes — has resulted in a precarious revenue roller coaster ride. It’s either boom or bust in Sacramento, depending on how the wealthy are faring in the stock market and their other investments.

Billionaire investor Warren E. Buffett’s rule is that he shouldn’t be paying a lower income tax rate than his secretary or any middle-class taxpayer.

“Legislators in Washington,” Buffett complained in a New York Times opinion piece last month, “feel compelled to protect us [mega-rich] much as if we were spotted owls or some other endangered species…. My friends and I have been coddled long enough by a billionaire-friendly Congress.”

With rhetorical flourish, Obama incorporated the Buffett Rule into the deficit-cutting plan he announced Monday, declaring that people earning more than $1million shouldn’t be allowed to pay a lower tax rate than middle-income families.

In California, we’ve got what you could call a Buffett Rule-Plus. There’s an extra tax bracket — at 10.3% — for income exceeding $1million.

According to the state finance department, families with adjusted gross incomes of between $1 million and $2 million, on average, paid an overall state tax rate of 8.4% in 2008, the last year for which data are available. The average rate rose as incomes did to 9.3% for those earning $5 million and up. (There were 3,757 of them.)

Families earning between $200,000 and $300,000 paid, on average, 5.5%. The rate fell sharply as incomes tailed off: 1.4% at $70,000 to $80,000, and only 0.2% at $40,000 to $50,000.

California secretaries generally aren’t paying higher rates than their billionaire CEOs or even their six-figure bosses.

There are two principal reasons why Buffett can get away with paying at a lower federal rate than his secretary — but couldn’t if he had to pony up for state taxes in California.

One is that capital gains and dividend income are taxed by the federal government at lower rates than ordinary earnings. That’s not true for California taxes. Here, it’s all taxed as ordinary income.

Second, the feds have their payroll taxes. The Social Security tax eats up a much bigger share of a middle-class family’s pay than it does a million-dollar earner’s. That’s because only the first $106,800 of earnings is taxed for Social Security.

Capital gains is a biggie. At the federal level, a taxpayer could be in the top 35% bracket and still pay only 15% on capital gains earnings.

California used to offer preferential tax treatment for capital gains and dividends, but eliminated it in 1987 to conform to a new federal “reform” law. The feds later reinserted their preferences, but California never did. Consequently, California relies heavily on rich investors for its income tax revenue, which fuels half of the general fund.

Some examples of this over-dependence, based on the 2009 tax year:

• The top 1% earned 18% of California’s income but paid 37% of the income tax.

Illustrating the volatility of the California income tax, however, the top 1% paid 48% of the total take in 2007 before the stock market collapsed. In the next two years, the state’s income tax revenue fell 25%.

• The top 10% earned 45% of the income but paid 72% of the taxes.

• During the recession, the middle class paid a slightly larger share of the declining income tax take. Those earning between $45,000 and $84,000 kicked in 11% of the total revenue in 2009, compared to 9% two years earlier. But one could argue they still were under-taxed. They earned 19% of the income.

“The real people who don’t get taxed enough in California are the middle-income folks,” says Steve Levy, director of the left-leaning Center for Continuing Study of the California Economy.

To make the tax system less volatile, he says, “that’s where you’d have to go. You’d have to get it from the people making $50,000 $100,000. And I’m not unalterably opposed to that.”

But Levy rejects the notion that the low- and middle-wage earners don’t pay a lot already. Other taxes — especially the sales tax — are regressive and hit the poor the hardest, he says.

“I’m buried under by idiots writing that half the people don’t pay taxes,” he says. “They pay the vehicle license fee, sales taxes, alcohol.”

A study this year by the labor-backed California Budget Project found that “measured as a share of family income, California’s lowest-income families pay the most in taxes.”

The bottom 20% of families pay 11% of their earnings in state and local taxes, executive director Jean Ross calculated. The top 1% pay about 8%.

Politicians, professors and pundits have been arguing over California tax reform for years.

My no-brainer solution, for starters: A capital gains preference. Broaden the sales tax to include services. A rainy-day fund to hoard boom-time money for bust periods.

Meanwhile, if Buffett really wanted to live by his own rule, he could leave Nebraska, move to California and pay our state taxes.

george.skelton@latimes.com