Californians already carry the nation’s heaviest state income tax burden by far. That’s especially true for the wealthy. But President Trump and Congress could make it a lot more onerous.
They’re mulling the notion of eliminating the ability to deduct state and local taxes on federal 1040s. It’s a plan hatched by House Republicans. Trump is drafting his own tax “reform” after indicating while running for election that he’d keep those deductions.
But the president is eager for any big congressional victory, especially after the Obamacare embarrassment. And no one seems to know precisely what policy he’s committed to beyond blocking immigrants from the Middle East and building a Mexican border wall.
Scrapping the state income tax deduction would particularly torment some blue states that voted for Hillary Clinton and rely heavily on the levy — places such as New York, Oregon, Massachusetts, Maryland and California.
In California, the ability to deduct state and local taxes saved federal taxpayers $101 billion in 2014, the latest year for which there are data, according to the nonpartisan Tax Foundation.
California’s state income tax is very high and progressive, with rates ranging from 1% to 13.3%. The state with the second-highest rate, 9.9%, is Oregon. But unlike California, Oregon doesn’t also impose a state sales tax.
Californians are projected to fork over roughly $83 billion in state income taxes this year, supplying 69% of the general fund. Imagine the howls if we could no longer deduct that hefty levy on our federal returns.
This came to mind last week as I glanced at the latest report of who pays what in California state income tax. We really like socking the rich.
The Franchise Tax Board reported that for 2015, the latest year analyzed, the top 1% paid nearly half — 47.6% — of the total state income tax. These people earned 24% of the taxable income. They represented only about 161,000 tax returns out of a total 16.1 million.
On the lower end, the bottom 60% supplied just 2.2% of the tax take while earning 16.8% of the income.
California is a Bernie Sanders dream. He ran for president preaching that the wealthiest 1% should pay much more. They provided 37.8% of the federal tax in 2013, significantly less than one-percenters sent to Sacramento.
Leaning heavily on the rich to finance state government may or may not be fair. That’s not the issue. The problem, as I’ve written many times, is that it’s a dangerously volatile fiscal strategy. It invariably jeopardizes vital programs such as education, healthcare and public safety.
California’s state tax system is a rickety relic of the mid-20th century. And it’s long past time to lift it into the 21st. The revenue stream has become unreliable because it depends too much on high-income earners, especially their capital gains. During an inevitable recession, capital gains go bust and the revenue slows to a trickle, creating massive budget deficits.
Example: During the recession in 2008, a 3.7% decline in the California economy resulted in a 23% plunge in state revenue.
What’s sorely needed is a more reliable tax system that doesn’t resemble a yo-yo. That means perhaps reducing the top income tax rate at least a couple of points, taxing capital gains at a lower rate (as the feds do) and easing the sales tax rate while extending it to services, like other states do.
California taxes sales of retail goods, but not services. Certainly not lawyer and accountant services, let alone Dodgers tickets. And California’s economy now is reliant mainly on services.
Neither Gov. Jerry Brown nor either party in the Legislature has a stomach for seriously addressing this dilemma. Raising some taxes, even while lowering others, would be highly controversial. There’d be winners and losers. And it would be fought to the death by special interests.
But that’s where the possibility of the feds killing state and local tax deductions comes into play. If state income taxes can’t be deducted, that might provide a new incentive to lower them while extending the sales tax to services. The sales tax already basically isn’t deductible for Californians.
“We’d be protecting California from Trump,” says state Sen. Bob Hertzberg (D-Van Nuys), who has been on a crusade to make state taxes less volatile but hasn’t found many followers. Since all the Washington talk, however, some lawmakers have started showing interest, he says.
State Controller Betty T. Yee has been a tax reform advocate. But, she says, “I’ve kind of pulled back a little bit, waiting to see what Trump is going to do.”
Trump should scrub the state and local tax deductions. Why should the federal government subsidize California’s high taxes by reducing their pain?
President Reagan tried to do it.
“I don’t believe that we can justify a system that forces taxpayers in low-tax states to subsidize the big-spending policies of a few high-tax states,” Reagan said, speaking not only as president but a former California governor. “That really is taxation without representation.”
Reagan succeeded only in dumping the sales tax deduction. Then states with no income tax to deduct complained. One was Texas. And when Texan George W. Bush was elected president, taxpayers were given an option to deduct either the state income or sales tax.
Reagan was right. Eliminate them all. Lower the federal rates. And inspire weak-kneed Sacramento politicians to bring state taxes up to speed.
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