Don’t Kill the Recovery Before It Takes

It is the conventional wisdom that tax cutting is good politics. But it is not good government--certainly not now in California.

California government is only beginning to recover from its years of austerity. Schools face daunting tasks that require many billions in new investments. Counties continue to suffer at the hands of the state. Infrastructure repair and investment is way overdue. Prisons will inexorably expand. Like many businesses, the public sector retrenched during the deep recession and has delayed many vital long-term tasks.

No matter. Sacramento is debating tax cuts large and small. The mantle of fiscal responsibility now rests with those who used to be called “big-spending liberals,” who bravely try to prevent a flood of special interest tax breaks and middle-class tax cut demagoguery.

The facts are close to a litany: California is at or below the national average in tax burden as a share of income since the early 1980s. Once we were a high-tax, high-spend, high-growth state. Now, we’re lower than our competitor Western states. In a recent study, San Francisco and Los Angeles had the lowest business tax burden among major U.S. cities. In any case, state and local taxes are a minuscule cost of doing business, 2% of total business costs.

If government is to be “run like a business,” as conservatives would have it, we would pay as close attention to our revenue streams as our public expenditures. Instead, Gov. Pete Wilson’s tax cut plan is only the latest in attacks on the progressive income tax, the healthiest, fairest part of California’s tax system. Cutting the personal income tax has the initial detrimental effect of sending 20% to 25% of the cut out of California to Washington, since state income taxes are deductible from federal taxes.

Far worse, proposed income tax cuts undermine the one tax that responds significantly to economic growth. The state’s recent revenue growth has been primarily fueled by the income tax; if cut, the state will never catch up to future demands.

In fact, the source of California’s fiscal troubles lies in the lack of responsiveness of revenue to economic growth. Even in a rapid recovery, state spending has fallen to $7 billion under the state’s Gann spending limit, set by the voters in 1990 to prevent the tax burden from growing.

For local government, property tax revenue behaves in a lopsided manner. Local government revenues took serious hits in the recession from downward reassessment. But in the recovery, reassessment above the base year occurs only upon change of ownership, not higher land values. This Proposition 13 protection, while critical for homeowners, is absurd for business, which benefits from huge loopholes in determining when business property actually changes ownership. Many of California’s fiscal problems could be solved with a simple change in Proposition 13: nonresidential property should be periodically reassessed at market value.

California’s sales tax, one of the highest rates on one of the narrowest bases of any state, also responds poorly to growth. As we get richer, we consume more untaxed services. The sales tax burden falls disproportionately on lower- and moderate-income families with children, who pay a higher share of their total income in taxes than better-off families. If tax relief is justified, it is as an earned income tax credit for these lower-income working families.

For the longer term, the state’s sales tax rate should be lowered while the base is broadened, which would help both local government and the responsiveness of the sales tax to growth.

The corporate tax also has languished and been eroded, as the recession-induced drumbeat about the state’s business climate led to new investment tax credits and a corporate rate cut. The dollar amount of the corporate tax is at the level it was in 1987, with future growth likely to be small.

California’s competitive strength in the modern world will stem from investments, which ensure a productive and intellectually advanced labor force, a high quality infrastructure and a high quality of life. Massive tax cutting in this environment is a form of unilateral disarmament in the competitive battle.