A proposed constitutional amendment (ACA 11) in California would increase 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. es by $12,250 per household, roughly doubling the state’s already high tax collections, to fund a first-in-the-nation single-payer health-care system. The top marginal rate on wage income would soar to 18.05 percent—nationally, the median top marginal rate is 5.3 percent—and the state would adopt a new 2.3 percent gross receipts taxA gross receipts tax is a tax applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. (GRT), at a rate more than three times that of the country’s highest current pure GRT.
All told, the new tax package is intended to raise an additional $163 billion per year, which is more than California raised in total tax revenue any year prior to the pandemic.
The new taxes would take three forms:
- SurtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services. es atop the current individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. structure beginning at $149,509 in income;
- A graduated-rate payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. system with the top rate kicking in for employees with more than $49,990 in annual income; and
- A gross receipts tax of 2.3 percent, excluding the first $2 million of business income.
Two states currently have payroll taxes for purposes other than funding their unemployment insurance system. In Massachusetts, a recently adopted payroll tax of 0.68 percent is imposed atop the state’s 5.0 percent flat individual income tax. In Nevada, there is a payroll tax of 1.475 percent in lieu of any individual income tax. California would impose a payroll tax of up to 2.25 percent atop an individual income tax that already has a top marginal rate of 13.3 percent.
Similarly, several states have gross receipts taxes in lieu of corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. es. In Ohio, for instance, there is a 0.26 percent gross receipts tax, adopted to replace the state’s corporate income tax, capital stock tax, and business tangible property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. . In California, by contrast, a 2.3 percent gross receipts tax—almost nine times Ohio’s rate—would be imposed in addition to tangible property taxes and an 8.84 percent corporate income tax, and an aggressive one at that, the only state-level corporate income tax in the country with a worldwide 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 while 16 states either implemented or enacted individual or corporate income tax cuts in 2021, and more are looking to join them in 2022, California policymakers want voters to approve five new surtaxes, with a top rate of 2.5 percent atop the current 13.3 percent top marginal income tax rate and the proposed new 2.25 percent payroll tax, for a combined top marginal rate of 18.05 percent. This is more than 7 percentage points higher than the next-highest rates in Hawaii (11 percent), New York (10.9 percent), and New Jersey and the District of Columbia (both at 10.75 percent).
Issues with the proposal abound.
For instance, the payroll tax exempts employers with fewer than 50 resident employees, punishing small businesses for expanding and creating a meaningful tax cliff. Imagine, for instance, the overly simplified hypothetical of a company with 49 employees making $80,000 each. At 49 employees, the company has no payroll tax burden. Hiring one additional employee generates a tax bill of $90,000—more than that employee’s salary!
Gross receipts taxes are widely understood as extremely disruptive and inequitable taxes, because they are imposed on businesses without regard to their profit margins. For low-margin businesses like supermarkets, 2.3 percent of gross receipts may literally exceed current profits even if the company is doing well. For instance, Kroger’s profit margins dipped to 0.75 percent in late 2021 and have historically hovered around 1.75 percent. These taxes are even worse for businesses posting losses, including startups that haven’t turned profitable yet, because they are taxed on their receipts even if their expenditures exceed revenues. For startups, a high-rate gross receipts tax could be disastrous.
The surtax, meanwhile, with additional rates of 0.5 percent to 2.5 percent atop the current income tax, does not take married filers into account. So while California’s state income tax avoids a marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. for most filers by doubling bracket widths (there is already an additional 1 percent above $1 million which is not adjusted), the new surtaxes do not. The $149,509 kick-in of the 0.5 percent surtax applies to individual or household income equally.
Similarly, these surtaxes do not align with current brackets, so they yield a highly convoluted tax system. Add the payroll tax—which is borne economically by taxpayers even if remitted by their employers—and it is essentially 18 brackets, as follows. Taxpayers earning less than $50,000 would face (inclusive of the new payroll tax) double-digit marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. s.
Sources: ACA 11 (2022); Tax Foundation calculations.
These taxes, moreover, could be increased by simple majorities in the legislature, as the bill exempts the three new taxes from the constitution’s supermajority requirements for tax increases. If a future legislature decides that doubling the state’s tax collections was insufficient, the constitution’s supermajority requirement would not stand in its way. And while the new surtaxes are inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. -indexed (the payroll tax’s second bracket is not), the legislature is authorized to suspend inflation indexingInflation indexing refers to automatic cost-of-living adjustments built into tax provisions to keep pace with inflation. Absent these adjustments, income taxes are subject to “bracket creep” and stealth increases on taxpayers, while excise taxes are vulnerable to erosion as taxes expressed in marginal dollars, rather than rates, slowly lose value. at any time, which would lead to the particularly curious case of inflation-indexing the standard income tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. s but not the surtax brackets.
This is not the first time California lawmakers have considered creating a single-payer health system, which previous estimates pegged as requiring $200 billion in additional state funding. This assumes, moreover, that California secures federal approval to redirect approximately $200 billion in federal funding toward a health-care match, since the full cost of the program is about $400 billion per year. Even with that match, the numbers only balance if a single-payer system generates significant cost savings, an assumption that is, at minimum, controversial. And as with prior considerations of one-state single-payer proposals, there are questions of whether residents would still need health insurance to cover them while outside the state, depending on how the program is designed.
The proposal for a $163 billion a year tax increase comes at a time when the California Legislative Analyst’s Office is projecting a $31 billion surplus, after tax collections grew at an annual rate of 30 percent, the fastest in at least four decades. The $163 billion in additional revenue that proponents of ACA 11 hope to generate each year exceeds all state revenue for any year prior to FY 2020.
Like most states, California’s revenues grew rapidly over the past two years. Unlike most states, however, California faces a downside risk in the form of a continuing exodus of taxpayers, accelerated by the rise of remote work and increased workplace mobility. California lost 0.8 percent of its population between April 2020 and July 2021, the fourth-largest decline in the country after the District of Columbia, New York, and Illinois.
Practically doubling state taxes—even if the burden is partially offset through state-provided health coverage—could send taxpayers racing for the exits.Share