A Tax Windfall We Can’t Afford : Roll Back Part of the Rate Relief for Upper Brackets

Would you vote to strip $800 million a year from schools, colleges, health and law enforcement to pay for an $800-million tax windfall for California’s wealthiest taxpayers? Of course you wouldn’t. But that’s exactly what Gov. George Deukmejian and the Legislature are about to do this year under the guise of avoiding a tax increase. More than half of this $800-million-a-year windfall would benefit only 5% of California’s taxpayers--those who earn more than $100,000; the rest would benefit the next wealthiest, about 15% of the taxpayers.

Thus far the debate on this issue has been focused on who gets blamed for advocating tax increases. This characterization is unfair, and only tells half the story. Here’s what actually happened:

A year ago the federal government changed its tax laws. In Sacramento the governor and the Legislature approved a “tax conformity bill” to make our state’s tax structure the same as the federal scheme. In doing so they closed several loopholes and estimated that our wealthier taxpayers would be forced to pay more than $1 billion a year more in state taxes. To compensate for these projected increases and keep the whole package from effectively raising taxes, the tax bill lowered the top tax rate for these same wealthy taxpayers from 11% to 9.3%--a reduction of more than $1 billion a year. Was this reduction justified?

Our lawmakers were right about some of the extra tax increases, and therefore a portion of the income-tax decrease was justified as compensation. However, it appears that they grossly miscalculated the amount of extra taxes that they expected to be paid by the wealthy on capital gains when they sold their assets.

Last year the state increased the capital-gains tax to conform to the federal law. The California Department of Finance estimated that people would sell almost as many capital assets this year as they had in the past, and thus would pay increased taxes because of the higher rates. But taxpayers didn’t act that way. Many held onto their assets and never paid the additional taxes. Thus a significant portion of the tax relief given to wealthier taxpayers was unnecessary. What started out to be a fair plan for tax relief to compensate for additional taxes turned out to be an $800-million windfall for taxes that were never paid.

What’s the obvious solution? Rescind a portion of the reduction in top tax rates equal to the tax relief that is no longer warranted. State Sen. Alfred E. Alquist (D-San Jose) has proposed just that. Instead of lowering the top tax rate from 11% to 9.3%, his bill would adjust the rate back up to 10.3%, which should restore the original intent and keep the tax package revenue-neutral. Other Democrats have put forward alternative solutions.

A month ago, when all this became apparent, the governor at first proposed to correct the mistake. He then reversed himself after receiving national and state political pressure against “raising taxes.” He should have stuck to his guns. Now he is vulnerable to being attacked for cutting needed services for all Californians in order to provide a windfall for the rich.

Some people argue that the failure of wealthy taxpayers to sell capital assets is a temporary phenomenon and that these assets will eventually be sold and thus will generate the higher revenues at that time. Other people contend that we are not 100% certain that slower capital-asset sales are the main culprit for reduced revenues. The truth is that no one knows yet if the shortfall is permanent or temporary, and almost everyone believes that lower sales of capital assets are the cause of the shortfall. What we do know is that the additional taxes projected have not yet been paid, and consequently the full tax reduction is premature. A fair and prudent solution would be to wait for two years until we have more accurate information about how much extra taxes will be paid and give compensatory tax relief then, if needed.

Last year the governor, with the concurrence of the Legislature, gave a one- time rebate of more than $1 billion that could have been used to improve our schools, health, law enforcement and roads. All Californians will suffer for the failure to invest those funds in building our future. At least, then, all taxpayers got some money back. Now it appears that the governor is going to insist on, and the Legislature will acquiesce in, returning $800 million this year, and $800 million next year--and possibly every year thereafter. This time, while only a few wealthy taxpayers will receive the windfall, all of us will pay the price in deteriorating schools, colleges, roads, health and law enforcement.

Only when we garner the political will and courage in Sacramento to admit the miscalculation and correct the situation will we break this budgetary impasse and prevent our government “leaders” from jeopardizing California’s future.