On State Tax Policy, Everyone Has a Formula for Reform

Golf superstar Tiger Woods began his career seven years ago with a pair of shrewd financial maneuvers: He signed a $40-million endorsement deal with Nike, then announced that he was moving from his native California to Florida, one of seven states without a personal income tax.

In shaping state tax policy, soaking the rich is an idea that’s popular with politicians and the public. Yet every time California lawmakers consider raising taxes on the wealthy -- as they’re doing now -- business groups and other opponents warn of the Tiger Woods Effect, a stylish way of saying the rich will take their money elsewhere.

Pick any tax and you’ll hear the same sort of back-and-forth. In fact, for every fee, tax and tax credit, there’s a committed band of defenders and detractors, including some of the most powerful players in Sacramento.

“I don’t see a lot of common ground,” said Bill Leonard, a longtime Republican legislator who now helps supervise state tax collections as a member of the Board of Equalization. “Structural tax reform means something different to probably every legislator.”

That’s the hard political reality that awaits any effort to reshape the tax structure that pays for state and local services, an undertaking that Gov. Gray Davis, local government officials and others are advocating as California confronts a historic fiscal crisis.

Advocates of change say that the state’s dire financial condition not only underscores the need to refashion the tax code, but also offers Davis and the Legislature a rare political opportunity to pull it off.

There’s just one problem: California has been down this road before, and it’s riddled with potholes.

As past discussions of the tax code have demonstrated, there’s little agreement on what, if any, changes are needed. Even the goal of tax reform is a subject of dispute: Should it broaden the base by eliminating exemptions and making more people pay taxes? Should it reduce the overall tax burden? Tap new sources of revenue? Provide a more consistent flow of tax dollars?

“Everyone has such a different view as to what the appropriate taxes are and what we need to do,” said Larry McCarthy, president of the California Taxpayers Assn., the voice of business interests in the tax debate.

Setting aside arguments over the size of state government, the question becomes: What’s the best way to raise the billions of dollars needed to operate schools and universities, build roads, pay for social programs and provide hundreds of state and local services?

Like the federal government, California does this through an intricate mosaic of taxes, fees and levies -- about $75 billion this year. The largest source of revenue is the personal income tax, expected to generate about $32.9 billion in the fiscal year ending June 30. Sales and use taxes will bring in $24.7 billion more, according to state Finance Department projections.

The rest will come from corporate income taxes (about $6.5 billion), vehicle license and registration fees ($3.8 billion), vehicle fuel taxes ($3.3 billion), and taxes on insurance, tobacco, alcohol, horse racing and inheritances and gifts ($3.8 billion). Not in the mix are property taxes, which are collected by counties, schools and special districts.

Republican lawmakers have set tight parameters for any changes to this mix. The overall tax burden on Californians can’t increase, they say.

Democrats, in general, see restructuring as an opportunity to find new sources of revenue.

Both sides are facing pressure from city and county officials, police officers and firefighters to build a more stable tax structure.

“We’ve been out there screaming that the system is broken for many years now,” said Pat Leary, lobbyist for the California State Assn. of Counties. “On a bipartisan basis, stability and predictability are what everyone is looking for. That’s the starting point.”

Personal Income Taxes

One criticism of the California tax structure is that it relies too heavily on the personal income tax, a volatile source of revenue as the general economy expands or contracts. State income tax collections, in fact, have plunged 26% during the downturn of the last two years.

California’s dependence on the tax is a relatively recent phenomenon, a result of Proposition 13 -- the historic 1978 ballot measure that capped property taxes -- and the growth of corporate tax credits and exemptions.

In California, middle- and upper-income earners shoulder most of the state income tax burden. Of the 13.4 million personal income tax returns filed in 2001, 4.5 million -- one in three -- showed that filers owed no taxes, most because they had earned too little. The typical family of four must make more than $39,359 a year before owing any state income tax.

In tinkering with the tax, there aren’t any new ideas. But an old idea plays well with politicians and the public: raising taxes on the wealthy.

Two recent Republican governors did it: Ronald Reagan in 1971 and Pete Wilson in 1991.

Last month Davis, a Democrat, indicated he would like to follow suit by proposing restoration of the 10% and 11% top brackets that Wilson approved on a temporary basis during his first term. The top tax rate currently is 9.3%.

Democratic lawmakers support raising the rate. So do 70% of 800 likely voters who responded to a January poll by the Feldman Group, a Washington, D.C.-based Democratic organization that asked a range of budget-related questions.

Jean Ross, executive director of the California Budget Project, an advocate for the state’s low-income residents, says it’s the fairest way to raise taxes because low- and middle-income households already pay a larger percentage of their income in taxes than wealthy people.

Republicans and conservative taxpayer groups say it’s a terrible idea. Hardest hit would be small businesses that pay their taxes under the personal income tax code, opponents say.

Another argument against asking the wealthy to pay more is that high-end taxpayers quickly find shelters or take their money elsewhere.

One example is Woods, who grew up in Cypress and then moved to Florida after signing the contract with Nike.

Property Taxes

One of the biggest potential sources of revenue in any effort to reshape the tax burden is the property levy, experts say.

In 1978, Proposition 13 cut property taxes by more than 50% and instituted tight controls on rates and assessments. It also required that any future tax increase pass the Legislature by a two-thirds “supermajority” and mandated a popular vote on most local taxes.

Now the Howard Jarvis Taxpayers Assn., which led that fight for property tax relief, views the calls for reform as “code for attacking Proposition 13,” said the group’s president, Jon Coupal.

In fact, some Democrats and their allies are quietly talking about the need to “update” Proposition 13. Fourteen leading economists and tax scholars urged the Legislature this month to consider “reform of the commercial and residential property tax distortions that have accumulated since the passage of Proposition 13.”

Most of the talk about change is focused on how commercial property is assessed.

Under current law, all property is reassessed when a change of ownership occurs. It’s simple to determine the sale of a residence: The old owner moves out and a new owner moves in. But it’s more difficult to determine in the case of a commercial property that is held by a publicly traded company: If the company itself is sold, for example, the property may land in the hands of new corporate leaders, but its thousands of stockholder-owners usually remain largely the same. So, the new managers argue that the property’s ownership hasn’t really changed.

“There are hundreds of games” that owners of commercial property “can play to avoid reassessment,” said Lenny Goldberg, a veteran Sacramento tax-reform advocate. “It’s the great hidden secret and scandal of our tax system.”

Two proposals being pushed by Democrats would alter that.

One would redefine a change of ownership to include a cumulative turnover of at least 50% of a company’s stock by multiple owners, not merely the acquisition of more than 50% by one owner. The other would establish a “split roll” system that would apply a higher tax rate to commercial property than to residential property, a common practice across the country.

Steven M. Sheffrin, director of the Center for State and Local Taxation at UC Davis, says a good solution is to assess business property at market value, but to place limits on how high local governments could raise rates. That could generate an additional $3.3 billion a year for California, experts estimate.

Republican lawmakers and business groups oppose any changes to Proposition 13, which they say makes California more attractive to companies. Significantly, though, the Howard Jarvis Taxpayers Assn. says it is “looking at” the proposals.

“If it comes down to corporations or grandma, this organization is going to be on grandma’s side every time,” Coupal said.

Rewriting the commercial property reassessment guidelines would require a constitutional amendment approved by a two-thirds margin. The chances of that happening seem slim: Only 48% of respondents in the Feldman poll favored reassessing commercial property more frequently.

Sales Taxes

Perhaps the area where the greatest consensus for change exists is the sales tax, which is riddled with exemptions. Combined state and local sales tax rates range from 7.25% to a high of 8.5% in San Francisco. The rate in Los Angeles is 8.25%.

Davis hopes to add 1% to the sales tax as part of his solution for the budget shortfall, a proposal that 52% of respondents in the Feldman poll said they favor.

Many experts and policy advocates, however, say the state should instead broaden the base by taxing exempted services and Internet sales.

Broadening the tax to cover consumer services such as health clubs, movie tickets and hair salons could raise as much as $2 billion a year, experts say.

About $3 billion or $4 billion more could be collected by taxing lawyers, accountants and other business services. That’s a more complicated idea because of the difficulties of tracking income earned by law and accounting firms that do business in multiple states.

Some conservative taxpayer groups say they would be willing to consider broadening the base if the overall rate were lowered.

In the meantime, Democratic lawmakers are pushing legislation to tax the Internet sales of companies that have retail stores or warehouses in California. Shopping center owners, independent bookstores and other businesses hurt by online retailers support the idea.

Corporate Taxes

Raising the corporate income tax rate and closing loopholes are also popular with tax experts and the public. Many politicians -- Republicans and Democrats -- support eliminating some of the credits, targeted cuts and other loopholes that permeate California’s tax structure.

These tools have helped corporations reduce their overall share of the tax burden in California from nearly 14% of total state tax collections in 1980-81 to about 8.6% now. Many of the loopholes are “terrible tax law and very confusing,” said Sheffrin, the UC Davis tax expert.

Business groups and their allies say the credits -- which reward companies for moving to distressed urban “enterprise zones” or expanding research and development spending, for example -- bring California jobs.

Given the deep differences over changes to the tax structure, the Legislature isn’t rushing to embrace such a debate. Business organizations and conservative taxpayer groups also are reluctant to join in, fearing that the talk of reform is a pretext for raising taxes.

“I don’t know if there are the guts to do it,” said Sen. Bruce McPherson (R-Santa Cruz). “You’re going to alienate a lot of people.”

Taxpayers may not wait for the Legislature and special-interest groups to reach a consensus.

In November, L.A. County voters approved a property tax increase to raise $168 million a year for the county’s financially failing trauma care network. Counties and cities are threatening to go the same route this year to designate certain taxes as local government revenues that can’t be touched by the state.

Public employee unions and teachers are contemplating their own ballot initiatives to raise taxes in an effort to stave off spending cuts. There is also talk by unions and other Democratic constituencies of launching a ballot initiative to trim the two-thirds legislative vote requirement for tax increases to 55%.