U.S. Tax Plan--Is State a Loser? : Reagan Proposal Raises Concern Among California Lawmakers

Californians are a special breed. They earn more and they spend more on homes and consumer goods than those in most other states. They also pay higher taxes and incur more long-term debt to support an impressive array of public services.

These same characteristics also make it likely that Californians will not fare as well as most others under President Reagan’s plans to overhaul the federal tax system, tax experts say.

Preliminary findings of several government agencies and private taxpayer groups suggest that while individual taxpayers may come out ahead under the President’s plan, the state’s economy is likely to lose on several fronts.

Administration plans to eliminate deductions for local and state income taxes, end tax exemptions on most bonds that are used to finance public facilities and low-cost housing, and limit deductions for second homes are all expected to hit California harder than many other states.

No definitive studies have yet been completed on the California situation. But the belief that the state will be hit harder has aroused concern among state lawmakers, prompting, among other efforts, a Republican-sponsored bill that would create a one-time loophole in the federal tax proposal for some California taxpayers.

“The Administration acknowledges that the proposals have their heaviest impact on high-income states such as California,” state Treasurer Jesse M. Unruh, a Democrat, said recently of the federal tax plan. “The results of (the Reagan plan) must be carefully weighed to see if the President has offered tax reform or a tax shift. I suspect the President’s package is a very bad deal for California.”

Among the chief reasons for concern is Reagan’s proposal to eliminate deductions for state and local taxes.

Californians, according to the U.S. Department of Commerce, earn more than residents of 45 other states, allowing them to spend more, but also pushing them into higher tax brackets. The deductions for state income and sales taxes and local property taxes are among the few tools available to most taxpayers for reducing the federal tax bite.

A recent Senate analysis of the President’s plan indicates that, for those who itemize deductions, the loss of the state and local tax deductions would add $1,100 to the federal tax bill of an average California family of four.

(Only about a third of California taxpayers--mainly those in upper-income brackets--itemize deductions on federal tax returns. The other two-thirds, who do not itemize, would not be hurt by the loss of the state and local tax deductions.)

The total loss to taxpayers in this state, the analysis says, could amount to as much as $5 billion yearly--a figure that some believe has been exaggerated.

“California and a couple of other states are being singled out,” Senate President Pro Tem David A. Roberti (D-Los Angeles) said in unveiling the analysis.

But because the plan would lower overall tax rates, that in itself could more than make up for loss of the deductions for some taxpayers who itemize, according to defenders of the tax plan.

Some defenders say that it would increase spendable income, lower interest rates and improve the economy overall.

One recent analysis of 18 actual tax returns by a Southern California income tax firm suggested that in 15 of those cases taxpayers would come out ahead.

The state Franchise Tax Board, in its own study of the Reagan plan, reportedly has come up with preliminary indications that California taxpayers as a whole would see a major reduction in their federal taxes. The Franchise Tax Board’s unexpected conclusion caused board analysts to delay release of the study Friday while they take a second look at their figures.

Even those who expect to see their federal tax bill fall are likely to see less of a reduction than their counterparts in other states, however. In those states where local taxes already are lower, the loss of the deduction means less.

An average California family that itemized deductions in 1982, for example, saved $970.71 in federal taxes as a result of the deductions for state and local taxes, according to a study by the National League of Cities. By contrast, an average family in Texas, where taxes are relatively low, saved $404.27 by utilizing the same deductions. With the deductions gone, clearly Californians and others from high-tax states would feel the bite.

Defenders of the Reagan tax plan do not deny that the proposal affects states differently. But they argue that federal tax policy should not protect states that raise their own taxes beyond the national average.

Opponents, however, have been quick to point out that California took its biggest step to becoming a high-tax state under then-Gov. Reagan. Shortly after taking office, Reagan pushed through a nearly $1-billion tax increase at a time when the entire state budget totaled $5 billion. The measure, carried by then-Sen. George Deukmejian, boosted sales taxes, income taxes and corporate taxes, as well as levies on liquor and cigarettes.

It quickly propelled California to the No. 2 spot among high-tax states. The state dropped back to 13th position largely because of the so-called taxpayers’ revolt that spawned property tax-slashing Proposition 13 in 1978 and eventually did away with taxes on gifts and inheritance.

California officials who fear that they will be saddled with the political fallout for higher taxes under the Reagan plan are bitter about the President’s role. “We’re exactly where (Reagan) left us when he left (California),” said John Hendricks, a spokesman for Roberti. “So who does that indict?”

Of immediate concern to local governments is a provision in the Administration’s tax plan that would remove the tax exemption from many types of long-term bonds.

Last year, local governments in California issued more than $15 billion in tax-exempt bonds--more than any other state in the nation--to finance projects such as nonprofit hospitals, low-income housing, transportation facilities, power plants, pollution control systems and education.

Bonds for purely governmental operations such as prison construction would not be affected.

But any bond issue that directly benefits particular individuals or private firms would lose the tax exemption and therefore, presumably their attractiveness to investors. According to the California Public Securities Assn., that includes 83% of the bonds issued by government agencies in the state. The association says the loss of exemptions would add $373 million yearly to the cost of financing these facilities.

“The municipal bond provisions in the President’s plan would increase the borrowing costs of local and state governments by 30%,” said Jack Gualco, a Sacramento lobbyist who represents the association. “This will also mean increased user fees for services such as water and sewage disposal. Electric bills will rise, as will health care costs.”

The loss of the exemptions also is expected to have a dramatic effect on the state’s housing market, where prices already outpace the rest of the nation.

The state’s Cal-Vet program, which has used bond financing to provide low-interest home loans for 370,000 California veterans since 1921, would be all but eliminated, a program spokesman said. Likewise, the California Housing Finance Agency, which provides below-market financing for low- and moderate-income buyers, would be forced to drastically curtail its activities.

“That’s a major impact on housing especially for first-time buyers,” said Marilyn Brazell, the agency’s director of government relations. “I’m sure the tax-exempt bond programs were one of the major things that allowed first-time home buyers to break into the expensive housing market in California.”

These two programs pale by comparison with efforts by numerous city and county agencies in California that have depended on bond financing to underwrite the cost of affordable housing.

The Construction Industry Research Board estimates that 10% of all residential construction in California is financed by industrial development bonds and mortgage revenue bonds that would lose their tax-exempt status under the plan. For rental housing, the threat is more pronounced.

Kenneth Rosen, chairman of the Center for Real Estate and Urban Economics at UC Berkeley, estimated that 40% of all apartment construction in California depends on tax-exempt bonds for financing. The end of the tax exemptions, he said, would result in 40,000 fewer apartment units each year, many of them for low- and moderate-income renters.

Existing real estate would be affected as well.

According to Rosen, rental units that are privately financed would lose value because of the tax plan’s proposals to stretch out depreciation and limit mortgage deductions on investment property. The likely result, Rosen added, is that apartment owners would attempt to regain lost profits by boosting rents 10% to 20% over the next few years.

The effect on single-family homes is less certain. Real estate experts say the loss of deductions for property taxes would make home ownership less attractive, particularly for first-time buyers. While that might reduce demand and prices for some homes, most analysts say that the ability to continue deducting mortgage interest payments would maintain the value and much of the tax advantage of home ownership.

However, potential homeowners in high-cost states such as California need all the help they can get, including the property tax deduction, some analysts say.

“In general our concerns focus on the fact that the tax plan seems to have a greater (negative) economic effect on areas with high housing prices,” said Joel Singer, chief economist for the California Assn. of Realtors. “But we think the impact on home ownership will be significantly less visible (than on apartment ownership).”

For vacation areas like Palm Springs and other resort towns, proposed limitations on mortgage interest deductions for second homes are expected to put further pressures on an industry that already is suffering under high interest rates and, in some cases, overbuilding.

An estimated 5% of California residents own second homes as compared to 2% nationally. Some experts predict these properties could lose as much as 20% of their value.

Not all experts agree with such dire predictions. Bradley Inman, vice president of the Bay Area Council, a private group that studies housing, transportation and economic development, said many analysts only look at narrow aspects of the tax plan and fail to take into account “counterbalancing factors” such as lower interest rates and more spendable income that could result.

“I’ve seen good figures that the relative advantage of owning versus renting that exists now would be reduced,” he said. “But I don’t conclude that this would be terrible for rental housing quite yet or terrible for home ownership.”

Other balancing factors cited by some experts are portions of the plan that might help California’s economy in general, such as those which favor the state’s booming high-tech industries over the heavy manufacturing most prevalent in the industrial Northeast.

By reducing the maximum tax rate on capital gains, the Reagan tax plan is expected to make more venture capital available for high-risk but potentially high-growth companies, such as the electronics and communications firms that fill California’s so-called Silicon Valley in the Palo Alto area.

What the state’s political leadership fears most about the tax plan is that it will put pressure on state government to reduce its taxes to make up for the additional federal tax burden. There also is concern that local governments--which might be hurt badly by the elimination of tax exemptions on many long-term bonds--would turn to the state for a financial bail-out.

Unlike many states that are suffering financially, California, for the first time in years, is projecting more than a $1-billion surplus, which could be used to grant some form of tax relief.

But even many Republicans who support Reagan’s efforts bristle at the prospect of cutting state revenues so that more money can flow into Washington’s treasury.

So far, there appears to be broad support for a Senate resolution calling on Reagan to retreat from his plan to eliminate deductions for state and local taxes.

A more direct challenge to the President’s plan is contained in a bill by Sen. Marian Bergeson (R-Newport Beach) that, in effect, would create a one-time loophole for California taxpayers who face higher federal taxes. It would allow residents to pay their 1986 state income taxes in 1985 while the federal deduction for local and state taxes still is in effect.

The measure was sent to the floor of the Senate on a bipartisan vote of four Democrats and two Republicans, including Senate GOP Caucus Chairman John Seymour of Anaheim.

The state Department of Finance, however, opposes the measure, saying it would undo efforts to resolve the federal budget deficit while limiting tax relief to wealthy individuals who can afford to pay their income taxes early.

Bergeson said her measure is not intended to undo Reagan’s tax plan, but to “enable California to move through a transition . . . with a little less pain.”

Like many other Republicans, Gov. George Deukmejian, who has strongly supported most of Reagan’s fiscal policies, is cautious about his reaction, refusing to take a public stand on the tax proposal until the Department of Finance completes a study.

But a small, vocal minority of the Legislature welcomes the new tax plan and its uneven treatment of California as a way of pushing for a new taxpayers’ revolt.

“California has taxes that are too high,” said Assembly Minority Leader Pat Nolan of Glendale. “This will just highlight the fact.”

CALIFORNIA AND THE REAGAN TAX PLAN

Californians, who earn more, on average, than residents of 45 other states, according to the Department of Commerce, may be harder hit by President Reagan’s proposed income tax changes than those in most states. Here is a look at how some would be affected:

INDIVIDUAL TAXPAYERS

The Reagan tax plan would eliminate the traditional deductions for state and local taxes.

* A recent Senate analysis estimates that elimination of these deductions would mean that the average California family of four that itemizes (about 30% do in California) would pay $1,100 more in federal taxes.

* The Senate analysis says that loss of deductions for state income taxes, sales tax and property taxes would cost individuals in California as much as $5 billion a year.

* Proponents of the Reagan tax plan say these losses would be at least partly offset by reduced tax rates.

STATE AND LOCAL TAXES California vs. U.S. (U.S. average follosed by an *)

PER $1,000 PER CAPITA IN INCOME Year Amount Rank Amount Rank

1973 $734 (2) $149 (5) 577* 129* 1979 $1,057 (10) $120 (25) 994* 120* 1983 $1,337 (13) $108 (24) 1,216* 111*

PUBLIC BONDS

Local governments worry about a proposal that would remove the tax exemption from many types of long-term bonds. Last year, governments in California issued more than $15 billion in tax-exempt bonds to finance construction of hospitals, low-income housing, transportation facilities, power plants, pollution control systems and education.

* Bonds for purely governmental operations such as prisons would not be affected.

* Bonds that include private sector participation--about 83% of those issued in California--would lose the tax exemption. The California Public Securities Assn. says the loss of exemptions would add $373 million yearly to the cost of financing these facilities.

HOMES

* With the loss of state and local tax deductions, there could be less demand for homes and a lower return on investment for apartment owners, say some analysts. These analysts say that could mean a drop in price for some single-family homes, particularly starter homes for first-time buyers, and a boost in rents.

* Officials say elimination of tax exemptions on certain long-term bonds could mean an end to long-term, low-interest mortgages provided by the state’s Cal-Vet program and by the California Housing Finance Agency.

* Vacation areas like Palm Springs see proposed limitations on mortgage interest deductions for second homes creating pressures on the housing industry. An estimated 5% of California residents own second homes as compared with 2% nationally. Some experts predict these vacation homes could lose as much as 20% of their value.