Republicans have said that by slashing business taxes, they will supercharge the American economy, benefiting both C-suite executives and the average American. Economists generally expect a short-term boost to growth, though they doubt the cuts will be a game changer for either the larger economy or the typical worker.
But for California, there are particular challenges buried in the tax bill, and some economists believe that could ultimately prove a drag on growth and harm the state’s competitiveness.
“I am a little bit gloomy,” said Dave Smith, an economist at the Pepperdine University Graziadio School of Business and Management.
The downbeat assessments reflect the various ways Republicans have chosen to help offset the cost of their tax cuts for businesses and individuals. Reducing key deductions is expected to raise the cost of living for many middle- and upper-income households in an already pricey state.
The tax plan includes capping the deduction for state and local taxes as well as reducing it for mortgage interest on new loans. Critics say both changes are weapons aimed at Democratic states with high state taxes and housing costs.
Already, Californians are leaving for lower-cost states such as Arizona, where the median home price is nearly $285,000 less than what it is in the Golden State, according to data from Zillow. Last year, 105,037 more people left for another state than moved here from elsewhere in the U.S., down slightly from the year before but three times the number who decamped in 2012, according to the California Assn. of Realtors.
The tax changes may lead even more people and businesses to pack up, said Edward McCaffery, a tax law expert at USC.
“I think it shifts industries, resources and people away from California,” McCaffery said.
Since emerging from the Great Recession, California has outpaced the nation in job growth, adding 2.3 million new jobs, an increase of 15.5% since 2012, versus 10.3% for the U.S. overall. Home prices have also been booming, especially in Southern California and the Bay Area. The median home price in California stood at $512,800 in October, 68% higher than at the beginning of 2012 — nearly double the increase seen nationally.
Steven Mento, who runs Conatus Pharmaceuticals, a biotech firm out of San Diego, said he isn’t about to flee because of lost tax deductions. But he noted it’s already a struggle to convince “top-notch” people to relocate from out of state.
Reduce a deduction for state income taxes, make a home more expensive, and Mento worries it will be even more “miserable” to recruit employees to work on Conatus’ experimental liver disease drug. “It’s certainly not going to make it easier,” he said.
Under the GOP’s tax bill released Friday — a compromise between plans that previously passed the Senate and House — a strong majority of Californians would pay less taxes in 2019, according to the left-leaning Institute on Taxation and Economic Policy. But the share of people who will pay more is higher in California than in most states: 11%, or nearly 1.9 million taxpayers.
Carl Davis, research director for the group, said the share of residents seeing an increase would rise over the years. The bill changes how inflation is calculated, thus slowly pushing people into a higher tax bracket. By 2027, when most of the individual changes will have also expired, nearly 5.5 million, or 28% of California taxpayers, would see a higher tax bill.
The compromise plan, while hitting California harder than many other states, does lighten the effect on some residents and businesses compared with plans that previously passed the House and the Senate, which respectively were expected to result in 18% and 14% of Californians paying higher taxes in 2019.
For example, under the compromise bill, people buying homes could deduct interest paid on the first $750,000. That’s down from $1 million under current law and the Senate plan, but up from the $500,000 cap in the House bill.
The corporate alternative minimum tax would also be repealed, pleasing Silicon Valley tech companies who feared its inclusion in the Senate bill would hammer their ability to use a research and development tax credit.
Individuals could also deduct up to $10,000 in combined property and state income taxes, rather than up to $10,000 in only property taxes under both the Senate and House bills. That’s important to California, where property taxes tend to be lower than in other states.
That won’t take away all the sting, though. The average state and local tax deduction taken in California in 2015 was nearly $8,500 more than the new proposed cap, according to the Tax Policy Center.
“It slightly softens it,” USC’s McCaffery said. But “the fundamental direction of the tax policy stays the same — it’s an attack on liberal, blue states and their forms of financing.”
Smith, the Pepperdine economist, said there could be a small short-term boost to the economy as taxes fall for businesses and most taxpayers. But tax hikes are likely to be concentrated among people living near the coast — where the state’s high-paying jobs are being created — Smith said. And by adding an expected $1.5 trillion to the U.S. deficit over 10 years, the tax bill is likely to put upward pressure on interest rates.
“I think it could be a little bit of a restraint on growth,” he said. “It won’t necessarily lead us to a turnaround or heading to a negative direction, but it will certainly pull back some of the positive things.”
Potential impacts of the tax bill go far beyond what happens on Californians’ 1040s.
In the future, state and local lawmakers would presumably face heightened pushback if they sought to raise taxes that couldn’t be deducted at the federal level. That would limit the ability of California to tax itself to fund more services or to close a budgetary gap, as it did in 2012 when voters approved higher income taxes on the state’s wealthy residents.
And some national Republican leaders have made no secret about wanting to cut back spending on Medicaid and Medicare to offset deficits. Already, rules that are in place to control deficits are projected to force a $25-billion cut to Medicare in 2018 if the tax plan passes and Congress doesn’t stop the health cuts.
Medicaid spending is highest in California, the nation’s most populous state, topping $81.9 billion last year, according to the Kaiser Family Foundation.
“This is potentially damaging to the fiscal health of the state,” said Chris Hoene, executive director of the California Budget & Policy Center. “The state would have to decide to pick up the tab or reduce the services to those households.”
State officials — including Gov. Jerry Brown — lobbied against the tax bills, arguing that they would harm some of the state’s top priorities.
One example: A provision in the House bill eliminated a tax break on a special type of bond frequently used to fund below-market housing. In a letter sent Wednesday to California’s congressional delegation, the state Department of Finance said that if the cut held, an “important tool” that helped fund nearly 20,000 affordable units last year would vanish.
The compromise bill, expected to be voted on this week, retains the tax-free bonds, though Matt Schwartz of the California Housing Partnership Corp. still expects around 4,000 fewer units to be built annually, because reducing the corporate tax rate would make affordable housing tax credits less valuable.
California’s renewable energy industry was also worried about proposals to eliminate an electric vehicle tax credit and reduce a wind credit. A complicated provision — the Base Erosion Anti-Abuse Tax — was designed to keep profits in the country and was expected to harm a financing tool used for solar and wind projects.
State Finance Director Michael Cohen said in his letter that the proposals would “threaten California’s programs to meet its air quality, climate, and renewable energy goals, and would jeopardize thousands of jobs in these sectors.”
The compromise bill keeps the current wind and electric vehicle credits in place. It retains a version of the base erosion tax that would minimize the harm to solar and wind projects but still make financing harder to obtain, according to the trade group Advanced Energy Economy.
Some economists are more upbeat about the tax bill because they expect an investment boost from slashing the U.S. corporate rate to 21% from 35%.
Lynn Reaser, chief economist of the Fermanian Business & Economic Institute at Point Loma Nazarene University, acknowledged the state’s economy would see less of a benefit than the nation as a whole. But she said the economy should still grow faster than it otherwise would, in part because large tech companies such as Apple would have an incentive to bring home billions of dollars they have stashed overseas.
“California should still end up ahead,” she said.
Skeptics, however, point to research that suggests the benefits of corporate tax cuts flow mostly to shareholders through stock buybacks or increased dividends. Christopher Thornberg, founding partner of Beacon Economics, predicted that’s how most corporations would spend their extra cash this time around.
But Michael Riley said he would invest money from a lower tax bill back into AMRO Fabricating Corp., a South El Monte metal fabricating company he runs. AMRO makes aluminum panels for NASA’s new heavy-lift rocket, the Space Launch System.
Riley said he plans to spend the money on things AMRO has been putting off because they’ve been too costly, such as boosting employee training programs and buying new equipment.
He said a tax cut wouldn’t automatically result in him hiring more people but added that buying new machines could allow his company to bid on projects it otherwise couldn’t.
If AMRO then won those bids, Riley said, he would need more workers.