Can a Flat Income Tax Fix the State’s Messed-Up Finances?

When Arnold Schwarzenegger convened his council of economic advisors for a couple of hours of chitchat early in the recall campaign, one individual I expected to see in the group was conspicuously missing.

Where, I wondered, was Arthur Laffer?

One would think that the economist was perfectly cast to serve on Schwarzenegger’s Economic Recovery Council. He’s a longtime California resident and observer. His name is synonymous with the supply-side economics of the Reagan era and with largely (if not exclusively) Republican tax policy.

Only later did I learn the likeliest explanation for his exclusion: Laffer has been on the outs with former Gov. Pete Wilson, the eminence grise of the Schwarzenegger campaign, for years. I learned this from Laffer himself when I visited him last week at his office in San Diego.

Our nominal subject was not his absence from the Schwarzenegger inner circle (in fact, he says he spent an hour consulting with Schwarzenegger and a “stone-faced” Pete Wilson the week before the economic summit), but rather a provocative proposal for a California flat tax that Laffer has been pressing, most recently in a Wall Street Journal op-ed article.

The proposal is essentially to abolish every state and local tax in California, replacing them with flat-rate income taxes on personal and corporate income. Only minimal deductions, such as for mortgage interest, would be allowed.

Laffer contends that these levies could meet California’s state and local revenue needs with a rate of 5.85% to 6%. He says that by avoiding the volatile revenue swings resulting from the existing progressive tax, this would temper the cycles of overspending and painful cutbacks that afflict the California budget.

“The progressive tax magnifies revenues, so you get some years with lots of revenues and others with crushing deficits,” he says. Laffer’s contention is that this volatility invites the creation of lavish new programs in fat years that can be sustained only by tax increases in lean years.

Followers of Laffer’s career will recognize a few familiar themes here. One is Laffer’s hostility to progressive taxation. Progressive taxes, he says, provoke high-earning economic decision makers to make choices that are self-interested but detrimental to the community at large, such as moving businesses out of state. He further contends that progressive rates fail to redistribute income efficiently from rich to poor because the poorest of the poor have no earned income and thus can’t exploit a tax exemption.

Then there’s the plan’s apparent mathematical simplicity. This was a characteristic of Laffer’s most famous formulation: the “Laffer curve,” a graph designed to show that at a certain point the raising of tax rates would produce lower total revenues.

Laffer’s formulas have sometimes been criticized as too elegant as well as politically impractical. One can certainly debate why, or whether, our society has tended to prefer progressive taxation to a flat tax, what degree of progressivity is “right,” and even how progressivity should be measured.

But whatever the cavils, by proposing a dramatic change in California’s taxes Laffer has put his finger on an important issue. The state’s revenue-raising system is out of whack. Local governments can’t raise what they need from property taxes, thanks to Proposition 13. So they rely on handouts from Sacramento to pay for schools and police departments. Meanwhile, the state is subject to so many spending directives that to balance its own budget it dips into local revenues, depriving cities and counties of even more money.

California’s leaders don’t have to accept Laffer’s proposal in full in order to heed his call to rework this incoherent system. This sort of thing was on his mind when we talked last week.

I found Laffer a youthful-looking 63, presiding over a squadron of financial analysts at Laffer Associates HQ. The decor is best described as paleontological, reflecting Laffer’s devotion to collecting fossils as a hobby; the gaping mandibles of a pterodactyl greet visitors turning the corner into his office. Sharing wall space with this collection are artifacts from Laffer’s nearly 30 years in the public eye: photographs of him with Presidents Nixon and Reagan, Gov. Jerry Brown and a host of lesser political figures.

The Reagan years in Washington marked the high water of Laffer’s public career. At home in the 1990s, he found himself crossing swords with Republican Gov. Wilson after he publicly blasted Wilson’s tax increases. “Pete Wilson was a catastrophic governor,” he says. “He caused more pain and hardship and death by that mistake than wars have.”

On his tax proposal, Laffer was perfectly willing to concede that its pure form might be politically inexpedient. Indeed, the plan can achieve its mathematical elegance only by begging a lot of political questions. Take the relationship between the state and local governments. Combining all existing taxes into a single levy administered from Sacramento would surely turn every county, city, school board and sewer district into a supplicant to Sacramento for its fair share of the big pot.

Laffer seems unfazed at the internecine bickering this arrangement would produce. He says he would write into the constitution a concrete formula for revenue sharing based on such factors as each locality’s population, income, children and historical revenue share. As for the lessons of history, which tell us that one community’s fair distribution of state funds is another’s intolerable rip-off, he says: “That’s politics. Constituencies are always battling over who gets how much of which pie and who gets gouged and who gets subsidized.”

Plenty of other elements of the plan are subject to question. Laffer is spoiling to debate them all. But no one should expect him to back down from his contention that ending progressive taxation is the only way to make California business-friendly again. “To me, the key here is how you do the most good for the most people.... If you don’t do the flat tax, you’re going to be writing this story again.”

*

Golden State appears every Monday and Thursday. Michael Hiltzik can be reached at golden.state@latimes.com.