The Folly of California’s Income Tax

August 01, 2012

Highly Volatile Revenue Sources Lead to Fiscal Crisis

Washington, DC, August 1, 2012— Gov. Jerry Brown signed a new California budget in June that depends on voters to approve $15.7 billion in new taxes, including a retroactive increase in the income tax on high earners. Even if Gov. Brown gets his way, however, the state could be in for more rough fiscal times ahead. The volatile nature of revenue from the Golden State’s most well-off taxpayers could make it more difficult to fund government services long-term, according to a new analysis from the Tax Foundation.

The tax increases, which will be sent to California voters in November, will appear on the ballot as Proposition 30.  The package of tax increases raises the California sales tax rate by 0.25 percent to 7.5 percent for 4 years and raises income taxes on those making above $250,000 for 7 years. The income tax increase is retroactive and would apply to all income earned after January 1, 2012.

“While Governor Brown contends that the income tax increase is necessary to prevent cuts to popular government services, the historical record shows that California’s budget has grown steadily in recent years,” said Tax Foundation economist Scott Drenkard. “Additionally, the plan’s heavier reliance on high income earners will only further exacerbate California’s troubles with revenue volatility, impacting the state’s ability to fund future government programs.”

California’s state income tax applies the same rate to capital gains and dividends and labor income (unlike the federal tax code) and is highly dependent upon the revenue from these sources, which is heavily impacted by market fluctuations. California also gets roughly 54.5 percent of its personal income tax revenue from earners with incomes greater than $200,000 and over 33 percent from earners making more than $500,000, a group which comprises less than 0.67 percent of all tax returns.

“California has staked its fiscal solvency on the backs of a tiny percentile of the population with the most volatile income,” said Drenkard.

Tax Foundation Fiscal Fact No. 324, “Governor Brown’s Tax Proposal and the Folly of California’s Income Tax” by David Block and Scott Drenkard, is available online. More on California’s tax system available here.

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