Windfall for Wealthy

All available evidence now indicates that California is in a billion-dollar budget fix primarily because wealthy taxpayers have reaped a massive, unexpected, unintended tax windfall. The evidence is not precise, but, if correct, the equitable way to correct the situation is to get some of those taxes back. Unless that happens, Californians of average and lower income could get stuck with the burden through heavy cuts in state services that they need most. The situation makes no sense, but that is the box that the governor and Legislature have gotten into during this election-season budget fight.

Neither side seems willing to yield. A continued impasse means that Gov. George Deukmejian will have the final say through his line-item budget veto power. Legislative overrides are possible, but unlikely.

The upshot could be about $800 million in cuts by the governor from a budget that was stingy in the first place. The preferred alternative is to increase revenues by about $800 million by restoring some of the 1987 tax cuts and to have no further budget reductions. Even then California still would have the largest public-school classes in the country, the lowest per-capita spending in the nation on highway construction, less funds for local government and constant rollbacks in health care and other services. And the most affluent taxpayers still would be paying less than they had been.

While there still is some uncertainty, most state fiscal experts now believe that the major reason for the stunning $1-billion revenue shortfall discovered in May is a dramatic falloff in taxes paid on capital gains, a tax source paid primarily by wealthier taxpayers. One reason for this was the massive sale of assets in late 1986 as taxpayers sought to beat the Jan. 1, 1987, effective date of the new federal tax-reform legislation. Beginning in 1987, capital gains--mostly from the sale of property, stock and other securities--were taxed at the same rate as other income. Until then, most capital gains were taxed at a lower rate.

The huge 1986 turnover meant that a lot of capital-gains transactions that normally would have occurred in 1987 did not. So the state’s anticipated income from capital-gains activities in 1987, gleaned from returns filed by April 15, 1988, was sharply reduced.

Meanwhile, the Legislature was conforming state tax law to federal law changes. One change that legislators made was to lower the top state tax rate from 11% to 9.3%. This break for the wealthiest was designed to offset higher taxes that they presumably would have to pay on capital gains. But, during 1987 at least, capital gains were markedly lower than expected. Thus the wealthy got the benefit of the tax break, but not the supposedly offsetting penalty of higher capital-gains levies.

Still, the governor opposes anything that might be perceived as a tax increase. But there may be a way out. This is to convert to the accrual method of accounting of state sales-tax and withholding receipts--money that already has been collected at the source but not yet turned over to the state.At present it is not counted until it is actually in the state treasury. Such a conversion, talked about as a logical step even before the shortfall was discovered, could provide up to $1 billion in the next budget year. It’s a bit of a gimmick, but a sensible gimmick that could provide a one-time solution to what most likely is a one-time shortfall, without great political cost to anyone.