California Can’t Give Up Tax Increases

California is awash in plans to raise taxes.

An under-the-radar piece of legislation will functionally increase the top marginal income 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. rate by 1.1 percent in 2024 (with administrative authority to bring it to 1.5 percent), while a pending ballot measure would add a new 1.75 percent surcharge on the income of the highest earners, and Governor Gavin Newsom (D) is proposing a windfall profits tax on top of everything else. If the ballot initiative passes, the state’s top individual income tax rate would soon be 16.15 percent, with the potential to increase to 16.55 percent.

Nationwide, the median top marginal income tax rate will be 5 percent once all currently scheduled rate reductions take effect. Neighboring Arizona will have a 2.5 percent flat tax next year, while Nevada forgoes an 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. altogether, though it does have a modest—and, most importantly, capped—payroll tax. Nearby Washington now taxes capital gains income, but not earned income. Other regional competitors like Colorado, Utah, and Idaho have competitive rates and have each adopted multiple rate reductions in recent years. But in California, the only direction is up.

This despite the fact that the state entered the most recent budget cycle with an unprecedented $97.5 billion surplus. The state’s budget is 35 percent larger than it was pre-pandemic—and that’s after adjusting for inflation. And while the record growth has surely stalled as the stock market falters, these new and proposed taxes have nothing to do with revenue challenges.

The Golden State has had a taxpayer-funded disability insurance program since 1946, the second state (after Rhode Island) to adopt such a program. It is currently funded by a State Disability Insurance 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. of 1.1 percent on the first $145,600 in wage income, yielding a maximum withholding amount of about $1,602. This payroll tax—like those for Social Security taxes at the federal level and unemployment insurance taxes at the state level—has a taxable wage limit, consistent with its design as an insurance program with capped benefits.

With the enactment of SB 951 earlier this month, however, the taxable wage limit has been eliminated, so the 1.1 percent payroll tax applies to all employment income. And while 1.1 percent is today’s rate, that rate is subject to adjustment every year based on program need and is currently authorized to go as high as 1.5 percent. Even at 1.1 percent, eliminating the taxable wage limit means that, as of 2024, California will have a 14.4 percent top marginal rate on wage income.

And it will go a lot higher if California voters approve Proposition 30 this November.

California Proposition 30, which creates a 1.75 percentage point surtax on income above $2 million, would bring the top marginal rate on wage income to 16.15 percent (and 15.05 percent on non-employment income). The tax is projected to raise $3.0 to $4.5 billion per year, with the bulk of the revenue earmarked for zero-emission vehicle infrastructure and purchasing incentives. The proposal has divided those who might normally advocate for additional electric vehicle (EV) infrastructure, as the tax has been championed by Lyft, which would benefit from EV rebates funded by the new tax as it transitions to a zero-emission fleet. Opponents, like Gov. Newsom, have characterized the tax as benefitting a special interest at the expense of the state’s economy.

Notably, like the existing 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. on income above $1 million (which yields the current 13.3 percent top rate), brackets would not be doubled for married filers, creating a marriage penalty. The tax would kick in at $2 million for both single and joint filers. And this bracket’s kick-in, like the existing surtax but unlike other brackets, would not be adjusted for 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. .

With 21 states cutting individual income tax rates since last year, such increases set California at even greater odds with its state competitors.

To top it all off, Gov. Newsom is responding to California’s gas prices—the product, at least in part, of California’s high gas taxes and costly regulatory environment, as well as refinery issues—by calling for a windfall profits taxA windfall profits tax is a one-time surtax levied on a company or industry when economic conditions result in large and unexpected profits. Inheritance taxes and taxes levied on lottery winnings can also be considered windfall taxes on individual profits. on the oil industry.

According to recent AAA price data (October 12th), the average price for a gallon of regular gasoline is $6.25 in California, compared to a national average of $3.92—a premium of about 60 percent over prices elsewhere. Newsom has alleged that oil companies are price gouging California consumers, chalking California’s higher prices up to corporate greed, though he has not offered much by way of an explanation of why every oil company would be greedier in California than in the rest of the country.

If anything, a windfall profits tax on the oil industry would raise prices even higher, while creating further supply problems down the line. Across the country, refinery capacity is already stretched, and this appears to be a particular issue in California. But investing in new refineries is risky: a refinery must be in operation for many years to justify the initial capital investment. And with states, led by California, demanding that all new vehicles be zero-emission by 2030, investors may doubt that they can recoup their investments even if there’s more than adequate demand right now. A tax on “windfall” or “excess” profits would make investment prospects even more dubious.

The oil industry is notoriously high risk and high reward. Large profits in some years help carry companies through lean years that could devastate other industries. The industry’s profit margins are staggeringly high right now, but one doesn’t have to go back very far to see the opposite, and on average, oil industry profits have been below those of many other industries. In fact, the energy industry’s 10-year equity return was negative until the upswing in 2021, and profits remained low until 2022. A windfall profits tax that hits hard in 2022 after a decade of lean years makes it much less likely that the necessary investments will be made in the future. And consumers will pay the price.

A windfall profits tax is not without precedent. In 1980, President Jimmy Carter unveiled a windfall profits tax on the oil industry, resulting (according to the Congressional Research Service and other researchers) in reduced domestic production.

California is no stranger to high taxes, and the state has enough going for it that its economy can withstand higher tax burdens than would be viable in other parts of the country. But there’s always a tipping point. The growing exodus of businesses and individuals from California to more taxpayer-friendly climes should be an encouragement to pump the breaks, not hit the accelerator.

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