Democrats Are Seeking Reshuffle in Tax Game

The state’s Democrats have launched a game of fiscal chicken with Gov. Schwarzenegger, proposing a budget that includes hikes in the top tax rates charged to California’s wealthiest residents.

That means we’ll be facing at least a month of public debate over the effect of tax rates on the state’s overall economy, not to mention the relative justice of extracting funds from those most able to pay (i.e., the wealthy), rather than those who are scraping by.

The Democrats’ proposal is to raise the top tax rate to 10% from today’s 9.3% on married taxpayers earning from $285,000 to $570,000, and to 11% on incomes over that. The proposal, which is supposed to produce about $1.8 billion a year, is sure to elicit the usual claim from the governor and other taxophobics that raising tax rates always brings in less money than forecast, and even leads to general economic decline.

I’d like to save the governor the expense of a television campaign to market this argument by demonstrating in advance that it’s drivel -- although it’s certainly tenacious drivel.

For example, the Sacramento Bee’s political columnist, Dan Weintraub, made this very argument in his weblog on June 1. As proof, he pointed to the three-year tax increase enacted in 1991 under Gov. Pete Wilson, which generated a mere fraction of the money expected. Weintraub observed that income tax revenue growth during the period was among the slowest in state history, and didn’t take off until after the increase was rescinded in 1995. He seemed to be suggesting that raising the top tax bracket to 11% from 9.3% had actually suppressed economic growth, supposedly substantiating what he called the “much-maligned ‘supply-side’ theory on taxation.”

Leaving aside that this point has been made in nearly identical terms by the California Taxpayers Assn., a conservative anti-tax lobby in Sacramento, the analysis is accurate as far as it goes -- the Wilson tax hike did fall short of expectations. The problem is that the analysis doesn’t go far enough.

Neither Weintraub nor Cal-Tax mentions the other major state tax hike of postwar vintage -- the Reagan hike of 1967, which remained in force until 1985.

Their amnesia about Reagan’s increase is unsurprising: It destroys their argument about Wilson’s. Tax revenue during the Reagan era rose at a record pace of more than 15% a year, pushing California’s annual receipts from $627 million to $11.4 billion. The resulting unexpected surplus stoked the citizen discontent about taxes that drove Proposition 13 to victory in 1978.

That doesn’t prove that tax increases are invariably over-productive, any more than the Wilson experience proves that they’re invariably disappointing. Indeed, one of the great flaws of supply-side tax theory is that it assumes taxes are raised or lowered in a vacuum; the truth is that, depending on such circumstances as the prevailing rates at the time and the condition of the overall economy, tax increases sometimes inhibit economic activity, sometimes stimulate it, and sometimes are irrelevant.

Indeed, the real reason that tax revenue stalled during the Wilson regime has nothing to do with higher rates, but with an economy that was tanking. California lost 500,000 jobs from 1991 to 1993 in the longest recession in its postwar history.

No responsible authority blames this recession on tax policy, because the real cause was national. “California was hit hard by defense cuts at the end of the Cold War,” explains Michael Bazdarich, senior economist at the UCLA Anderson Forecast. “We were 12% of the national economy, but we had 20-25% of defense activity and sustained 50% of the defense cuts.”

Nor did the recovery of the late 1990s have anything to do with the tax rollback. It was associated with the dot-com boom inspired by new technologies. (Weintraub does acknowledge the role of the dot-com boom in the late-decade revenue surge.)

State tax policy is teeming with assumptions that should be exploded and sacred cows that should be slain. Today’s crusaders against a hike in the top tax brackets show great solicitude for California’s richest residents. The Schwarzenegger line, as it was once outlined for me by his finance director, Tom Campbell, is that these are the people who make decisions about where to build factories, and if they’re provoked to leave the state, we’re through.

Is this a plausible concern? The average state tax bill of Californians earning between $500,000 and $5 million annually was $85,000 in 2002; if the top rate for all of them were raised to 11%, their average additional tax would come to about $15,000. (I am leaving out the 2,500 taxpayers who reported even larger incomes, because they would push the average misleadingly high.)

It’s fair to note that these taxpayers have reaped the lion’s share of the Bush tax cuts, which are worth an average $68,000 a year to them, and that their additional state taxes would be deductible on their federal returns.

One oft-overlooked point in the tax debate is the salutary effect on the body politic of spreading sacrifice widely. Schwarzenegger’s budgets haven’t spread it at all, but piled it on the middle class and the poor. Parents of schoolchildren are dipping into their own pockets to pay for the programs their districts have been forced to eliminate; home healthcare workers are being cut back to minimum wage, which isn’t good for them or their clientele; motorists are driving on crumbling highways. These sacrifices might be somewhat easier for them to bear if they didn’t see an impregnable wall being erected around the 1% of state taxpayers who report incomes higher than a half-million dollars.

Will these wealthy taxpayers treat a modest tax increase as the last straw, and relocate en masse to the deserts of Nevada? That sounds like a bluff, and I think we should call it.

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Golden State appears every Monday and Thursday. You can reach Michael Hiltzik at golden.state@latimes.com and read his previous columns at latimes.com/hiltzik.