California Considers Tax Changes in Budget Standoff

August 22, 2008

July 1, 2008 came and went without a state budget for California, despite a requirement to pass it by that date. Since then, legislators have dug in and await a plan acceptable enough to gain the requisite two-thirds majority to pass.

The main sticking point is the deficit of somewhere around $15 billion out of a $106 billion general budget. For the better part of the last decade, California government spending has exceeded revenues, with the main cause being inflated revenue expectations during the dot-com boom of the late 1990’s (California income tax collections relied heavily on the very rich, and when their capital gains and dividends collapsed, so did anticipated government revenues). Notwithstanding a balanced budget requirement, the annual shortfalls have been papered over with loans, bonds, transfers, and other short-term fixes.

One side says the problem is too little tax revenue; the other says the problem is too much spending. According to our most recent State & Local Tax Burdens report, California has the 6th highest tax burden in the country, with Californians on average paying 10.5% of their income on state government. Aside from property taxes (limited by Proposition 13), California taxes everything and taxes it high; the top income tax rate is 10.3% and sales tax exceeds 7% statewide and 8% in several counties. The corporate income tax is 8.84%, imposed from the first dollar of profits.

The other night, a Democratic plan was rejected in a party-line vote. This would have added two more brackets to the income tax and raised the top rate to 11% and raised the corporate rate to 9.3% and suspend carryforward of business losses; and about $7 billion in “program cuts, borrowing, and accounting shifts.”

This week, Governor Schwarzenegger (R) offered a different proposal. This would raise the state sales tax “temporarily” for three years by 1 percentage point, followed by a phased-in reduction of 1.25 percentage points; suspend carryforwards of business losses for two years; and create a new film tax credit.

Temporary taxes tend to become permanent (Californians still pay a temporary 1/2-cent sales tax enacted in 1991), and prohibiting carryforwards but allowing carrybacks in a few years is just an accounting shift. Film tax credits, we have noted, aren’t all they’re cracked up to be. And raising income and corporate taxes may just accelerate the move of people and jobs to Nevada and Arizona.

More on California here.

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