The California Budget: A Work in Progress

The seemingly constant budget struggle in California took an interesting turn last week when the Governor ordered the termination of 10,000 state employees, while lowering another 200,000 workers’ wages to $6.55/hour. Since then, the State Controller refuses to comply with the Governor’s orders. California’s desperate financial situation has prompted desperate proposals, including higher taxes.

A Los Angeles Times article outlines Governor Schwarzenegger’s recent proposal to increase the state sales tax 1 cent to help close the budget gap. California currently levies a state sales tax of 7.25%, the highest in the nation. In addition to the state tax, local governments also utilize sales taxes, resulting in rates around 8% across the state. This temporary tax hike would yield a projected $5 billion per year, far short of settling this year’s $15 billion deficit.

Expanding the sales tax base provides a better alternative for revenue generation. California, like many states, exempts quite a few transactions from the sales and use tax. Services, groceries and entertainment top the list of California’s exemptions. Removing some exemptions from the state tax code would increase the size of the tax base, leading to higher revenues without a rate increase or comparable revenues with lower tax rates. California can make up roughly $7.4 billion by removing exemptions on certain transactions. $2.7 billion of the potential revenue stems from transactions taxed in numerous other states (see chart below), with another $4.7 billion in lost grocery tax exemptions.

Groceries receive sales tax exemptions in many states. These exemptions, sold to the public as relief for the poor, generally provide relief to middle-class Americans. The millions of low-income families and individuals on food stamps are already exempt from taxes on groceries. The California Legislative Analyst’s Office estimates state and local governments lose out on roughly $4.7 billion annually by exempting groceries. (Full report available here.) California’s exemption also protects candy, snack foods and soda.

California needs more than a temporary fix. Schwarzenegger is also calling for a constitutional amendment granting the Governor power to cut spending when the state falls into the red ink. Such a measure may push the lines of executive budget authority, but the state certainly needs some sort of reform. If California could learn to rein in spending and add stability to the state revenue portfolio, financial crisis may become less chronic.

Estimated annual revenue from exempt items taxed in many other states:

(Amounts in millions)

Source: California State Board of Equalization, Sacramento Bee

For more on tax policy in California, see our California State Tax Policy and Data page.