Capital Gains Suspected as Culprit in Shortfall

Gov. George Deukmejian and legislative leaders began conferring privately Wednesday on the governor’s plan to correct the state’s $2.3-billion revenue shortfall as fiscal experts increasingly pointed to the tax on capital gains as the chief culprit.

A report prepared for the Franchise Tax Board by a private consulting firm concluded that 90% of the tax shortfall reported by Deukmejian late last month was the result of miscalculations by the governor’s budget advisers regarding capital gains revenues.

The report by the Policy Economics Group, an arm of Peat Marwick Main & Co., estimated that the Deukmejian Administration overestimated capital gains revenues by $900 million. It qualified its findings by saying that the exact reason for the tax loss will not be known until all 1987 tax receipts are tabulated sometime later this year.

The drop-off in capital gains may be due to errors in estimating the impact on state taxpayers of sweeping changes in federal tax law that went into effect in 1986 and the impact of the 1987 stock market crash, the report suggested.

Many taxpayers, anticipating the federal tax changes, sold off investments to take advantage of the old law’s more favorable treatment of capital gains, which in turn produced a sharp drop-off in capital gains in 1987, experts said. The problem was compounded by investor losses in the market crash.

Board’s Report

The report came on the heels of another study, this one by the staff of the Franchise Tax Board, which concluded that a proposal being made by the Republican governor to raise $410 million by halting inflation adjustments in tax rates would fall heaviest on poor and middle-income taxpayers. It would be less painful on Californians with incomes of $100,000 or more, the board said.

The study showed that taxpayers earning between $10,000 and $40,000 would have an average tax increase of 5%. For people earning between $40,000 and 50,000, the bite would be 4%. It would be 3% up to $100,000 and 1% over that.

Both reports were released by Democrats, who used them as ammunition to question the fairness of Deukmejian’s budget balancing plan. Basically, the Democrats argue that if most of the tax loss is attributable to a windfall by persons paying taxes on capital gains--generally the most affluent taxpayers--then they should bear the brunt of the tax increase.

Assemblyman Johan Klehs (D-San Leandro), chairman of the Assembly Revenue and Taxation Committee, said, “If the problem is in capital gains, then maybe we should correct the problem there. That is what we are wrestling with. People who pay capital gains and people who make more than $100,000 are the governor’s constituency, and I can understand why he treats them more favorably.”

Democratic state Controller Gray Davis, a possible candidate for governor in 1990, charged in releasing the report prepared for the Franchise Tax Board that the governor’s plan was a “regressive tax increase proposal.” He urged Deukmejian to take “a go-slow approach.”

Deukmejian Defends Plan

Deukmejian has been defending his budget-balancing plan as a fair proposal that does not place the burden for making up the revenue shortfall on any one area of the budget. Deukmejian’s plan would raise taxes by $800 million, make $450 million in budget cuts, reduce next year’s planned budget reserve by $500 million and hope that a rosier economy produces an extra $500 million in tax revenues.

Deukmejian press secretary Kevin Brett said, “It is a balanced plan. It solves the problem without Draconian budget cuts.”

Brett also said the tone of comments by Davis and Klehs was decidedly different from the tone set at the private meeting between Deukmejian and four legislative leaders--Senate President Pro Tem David A. Roberti (D-Los Angeles), Assembly Speaker Willie Brown (D-San Francisco), Senate Republican Leader Ken Maddy of Fresno and Assemblyman William P. Baker (R-Danville), the chief budget negotiator for Assembly Republicans.

The lawmakers reportedly indicated to Deukmejian that they were cool toward individual parts of the tax increase-budget cut package but may ultimately go along.

Republicans said they were concerned about the proposed tax increases, and Democrats said they are worried about budget cuts, particularly Deukmejian’s plan to reduce planned benefit increases for welfare recipients by half.

Roberti said the proposed welfare cuts are a major concern. But he said he thought any political obstacles could be overcome. “We are committed to getting a budget out on time,” Roberti said. The Legislature’s legal deadline for approving Deukmejian’s proposed $44.5-billion budget is June 15.