The most obvious thing about the big, complicated tax reform scheme that will go to the Legislature this week is that millionaires would save an average of $109,000 a year. Taxpayers making between $40,000 and $50,000 would save $4. This is not a typo.
The plan, still awaiting a final draft, is the work of the grandly named California Commission on the 21st Century Economy, which held its final official meeting last Monday. But it’s been clear from the beginning that Gov. Arnold Schwarzenegger, in setting it up last fall, was aiming to do precisely that: enact big cuts for upper-income taxpayers and create what’s become a pea-under-the-shell tax system to make up the lost revenue.
The system the commission proposes includes the elimination of both the state sales tax and the corporate income tax, a flattening of the personal income tax by eliminating the top brackets, and replacement of the lost revenue with a novel, untested business net receipts tax, or BNRT.
The official rationale for the creation of the 14-member commission, half appointed by the governor, half by leaders of the Legislature, was to reduce the volatility in state revenues resulting from excessive reliance on the state income tax, and especially on those upper-bracket taxpayers. That volatility, in the view of the governor’s office, drives Sacramento to wild spending in good times, when fat stock dividends, capital gains and other boom-era windfalls push up tax receipts, and leaves the state broke, as now, when the economy tanks.
But in the process of trying to plan a system that will even out those cycles, the commission -- chaired by Gerald Parsky, head of a Southern California investment firm and a heavyweight in Republican politics -- has created an economic Frankenstein’s monster whose behavior even the commissioners are unable to predict. Last week, underlining the doubt, nine leading tax economists and lawyers sent the panel a detailed letter citing “the numerous uncertainties relating to the administration, compliance, legal challenges and economic distortions of such a tax.” With one possible exception, no state has a tax system remotely like the BNRT, and that exception, Michigan, imposed its new business tax so recently that it can’t possibly be a model.
At least two commissioners, Santa Cruz County Treasurer Fred Keeley and tax law expert Richard Pomp, have said they won’t sign the plan, and several others are likely to join them. In recent weeks, major business groups have attacked it. On Monday, Jean Ross, head of the liberal California Budget Project, tore into it as “a massive shift in ... financing public services from the wealthy and corporations to middle-income families [that] is nothing short of stunning.” Even some of the commissioners seem to sense that the chances of the Legislature adopting it are slim.
It’s surprising that the panel members, including liberals such as the highly respected Chris Edley, dean of the Boalt Hall law school at UC Berkeley, would endorse a plan that’s so uncertain and regressive. It’s “absolutely” not a tax system he’d design, Edley said, but somehow Sacramento’s inertia had to be broken.
Under the commission’s BNRT proposal, all California businesses would pay a tax, probably about 4%, on their net receipts, which would be calculated by subtracting the cost of the goods they’ve purchased from their gross receipts. That makes it roughly like a VAT, the value-added tax used in most of Europe, but not similar enough to be comparable. Under the BNRT, there would be no deduction for labor costs, not even for employee health plans.
That element alone creates incentives for firms to purchase parts from abroad and, depending on how the courts rule on a string of unsettled legal issues regarding taxation of out-of-state entities, maybe even from Oregon or New York, rather than making them with their own workers in California. “It appears to be a tax on employees,” wrote the state Chamber of Commerce and other groups. And because the tax is built into the price of California goods and services, it also could make them less competitive in other states and abroad.
Nor is anyone sure what portion of the burden of the BNRT would be borne by employees in reduced wages, how much by consumers in the prices they pay and how much by investors. What’s sure is that the tax would be built into the price of goods and -- unlike under the current sales tax -- that food, child care and medicines would not be exempt.
While the contemplated 4% BNRT rate would be much lower than the present state sales tax -- normally 7.25%, currently 8.25% -- it would cover not only goods but all services, including healthcare. Those costs too would hit low-income people the hardest. (Under the plan, local sales taxes would remain unaffected.)
There’s long been a need to expand the sales tax, as many other states do now, to certain services -- lawyers, accountants, auto repair -- which already represent the largest share of California’s economy. And there are good reasons for concern about the state’s excessive reliance on the volatile income tax.
But other states have found ways to cover services without instituting an untested new system, just as there are other means of evening out the roller-coaster tax effects of economic swings. The Parsky Commission itself is proposing the creation of a constitutionally protected rainy-day fund to capture money from revenue spikes to use in years when revenues are low.
In any case, fate didn’t decree California’s heavy reliance on the income tax. It resulted from the sharp limits imposed on local property taxes by Proposition 13 in 1978. In most other states, the property tax, a steadier source of revenue, produces a much larger share of state and local revenues. But despite pleas from reform groups, the commission refused even to consider a split property tax roll, under which commercial property would be taxed on a different basis than residential property and thus represent a steadier (and expanding) source of revenue.
That refusal, as well as the panel’s refusal to consider an oil severance tax (even as it discussed expanded offshore drilling), pretty much clinches the case. This group was created by people who wanted a flat income tax under which all Californians, rich and poor, would pay at the same rate. Under pressure from the panel’s liberals, that got compromised into a two-bracket system: 2.75% for incomes up to $28,000 ($56,000 for joint filers) and 6.5% above those levels, compared with today’s progressive six-tier system with a top rate of 9.3%. (Plus 1% for millionaires, as now).
But that hardly turns this sow’s ear into a silk purse.