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California Governor Floats Flat Tax

2 min readBy: Joseph Bishop-Henchman

As a study commission looks at ways to reduce the volatility of California’s taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. system (caused, in large part, by their overreliance on unstable revenue sources like taxes on high-income earners, capital gains, and corporate profits), California Governor Arnold Schwarzenegger hopes that they will reach for the stars:

Gov. Arnold Schwarzenegger said today that he would like to see such “radical” proposals come out of a commission now studying an overhaul of the state’s tax system. The governor told the editorial board of the Sacramento Bee that he hoped the commission would not be afraid to propose something like “a 15% straight tax.”

“That’s the kind of radical, daring kind of a proposal that I want to see on the table so we can look at it and say, ‘Oh, let’s study this, maybe that is the way to go,’ ” Schwarzenegger said during the discussion, which was webcast.[…]

“I hope and I pray that they don’t think they have to make a political decision,” he said.

It’s hard to know what he meant by “a 15% straight tax,” especially considering that California’s top state income tax rate now is 9.55%, and the highest in the country is Hawaii’s at 11%. (Also, the corporate tax rate stands at 8.84% and the sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. is between 8.25% and 9.75% in most cities, gusting up to 10.75% in South Gate, CA.)

Flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. es usually (1) have one rate applying (2) to all income, without any deductions, exemptions, or credits (except a broadly available standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. ). We crunched some numbers (static score) and found:

  • A 15% flat income tax (without a standard deduction) in California could raise more than $150 billion, well more than the entire $128 billion budget proposed by Gov. Schwarzenegger and presumably enough to eliminate all other state taxes with money left over. The combined federal-state rate would be high, however.
  • A more modest 5% flat income tax with no deductions could raise as much as the current state income tax system (about $56 billion), but be less volatile, less distorting, and more competitive with other states’ tax rates.

Less likely to spur long-term growth is an alternative plan put out that raises $44 billion through tax increases and revenue shifts. The proposal from the American Federation of State, County and Municipal Employees (AFSCME) would:

  • New top income tax rates of 11% and 10%
  • New corporate tax rate of 9.84%
  • Impose oil severance tax of 9.9%
  • Raise car tax to 2%
  • Raise the gas taxA gas tax is commonly used to describe the variety of taxes levied on gasoline at both the federal and state levels, to provide funds for highway repair and maintenance, as well as for other government infrastructure projects. These taxes are levied in a few ways, including per-gallon excise taxes, excise taxes imposed on wholesalers, and general sales taxes that apply to the purchase of gasoline. by 14 cents per gallon
  • Shift an additional one-quarter of one cent of the sales tax from counties to the state
  • $1.4 billion additional in liquor taxes
  • Aggressive use tax collections through nexus redefinition
  • Introduce withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. for independent contractors (one-time revenue shift)
  • Expand sales tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. and reduce rate by 2 percentage points

(Thanks to Gerald Prante, Mark Robyn, and Micah Cohen for research assistance with this post.)