Whitman’s tax plan would benefit some but put California at risk

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Capitol Journal

A major feature of Republican Meg Whitman’s plan to create jobs as governor is to eliminate the state tax on capital gains.

Not merely tax investment profits at a lower rate than wages, as the federal government does, but scuttle the state tax completely.

Most people don’t need to worry about paying taxes on capital gains. They’re not so fortunate. But a relatively few wealthy Californians pump substantial sums into the state treasury, which would leak even more red ink if those payments ceased.

Nine states -- including Florida, Texas and Nevada -- don’t tax capital gains, but they don’t tax personal income either.

It’s part of Whitman’s trifecta of priorities: creating jobs, cutting state spending -- “returning the state to fiscal stability” -- and fixing schools.

The former EBay chief’s jobs agenda also includes other “targeted” tax cuts, such as eliminating the sales tax on manufacturing equipment -- what she calls “the factory tax” -- and scrubbing the new-business start-up fee. She’d increase the R&D tax credit, accelerate equipment depreciation and offer a tax incentive for creating green tech jobs.

Her tax reductions would “prime California’s economic pump,” she contends, and “make California competitive again. . . . grow our tax base and help put an end to the perpetual budget problems in Sacramento.”

But it’s reminiscent of what George H.W. Bush called “voodoo economics” back in 1980, when Ronald Reagan contended he could cut taxes, balance the budget and increase military spending. He couldn’t. He did cut taxes, but then had to raise them and still left the government with a recorddebt.

Atty. Gen. Jerry Brown, the expected Democratic nominee for governor, calls Whitman’s plan “snake oil math.”

But Brown isn’t talking much about taxes, a subject Democrats are learning to avoid. When asked, the former governor promises that under a second Brown administration, there’d be no tax increases unless voters approved them at the ballot box.

Whitman’s underdog Republican rival, Insurance Commissioner Steve Poizner, accuses the front-runner of trying to “pick winners and losers” in the tax system -- as if that weren’t an American tradition. He wants to cut taxes for everyone -- on income and sales -- 10% across the board.

“Only a massive overhaul will do,” Poizner asserts.

“That’s not realistic,” Whitman countered in an interview. “His plan will cost $10 billion -- on top of the [current] $20-billion budget deficit.”

Across-the-board cuts eventually will increase revenue, she says, “but there is a one- or two-year lag. Even for President Reagan, in his second year, revenues were down.”

Whitman says her targeted version of “supply-side” economics “will get people hiring relatively quickly.”

That’s the theory anyway. It would be a huge risk, however, for the funding of such programs as K-12 schools, universities, welfare, healthcare and prisons that rely on the depleted state general fund.

Eliminating the capital gains tax could create a huge budget hole.

Capital gains accounted for nearly 22% -- $10.8 billion -- of the personal income tax in 2007, the latest year for which the Franchise Tax Board has complete data. The income tax supplied roughly 53% of general fund revenue.

But only 20% of income tax returns report capital gains. For most of us -- at least when we’re not in a recession -- the biggest investment profit we ever see is when we sell our house. And both the U.S. and the state exempt $500,000 in profit on home sales for married couples; $250,000 for single people, if they’ve lived in the home for two of the last five years.

It’s mainly multimillionaires -- and Whitman’s billionaire peer group -- that would benefit from eliminating the capital gains tax.

Who pays the tax?

* People with adjusted gross incomes exceeding $500,000 pay 82% of the total capital gains tax. For them, 38% of their earnings comes from investment profits.

* These $500,000-plus earners amount to only 1% of taxpayers -- or about 150,000 returns -- but provide 48% of the total personal income tax.

* People with more than $200,000 in adjusted gross incomes -- 4.4% of filers -- provide 93% of the capital gains tax.

Whitman says that eliminating the tax would “spur innovation, which we have to own in California.”

But, I note, many people realize investment profits merely by buying and selling stock. That hardly induces innovation.

“Right, I agree with that,” Whitman says. But she adds that it is important to stimulate the creation and selling of companies, “to make it more attractive to live here, to keep people here, to keep companies here and them expanding here.”

I’d suggest we start by cutting the capital gains rate by a third, or maybe half. Not completely erase it.

But there’s not much prospect of any of this happening, regardless of who’s governor. Not with a Democratic Legislature and not without a long-overdue overhaul of the entire roller-coaster tax system. And Whitman says that’s not a top priority.