June 6, 2006

Tyranny of California’s Nonpayers

(A version of the following article originally appeared in the June 4, 2006 edition of the Orange County Register.)

If it is true that as California goes, so goes the nation, then taxpayers in every corner of the U.S. should be paying close attention to the June 6 referendum on Proposition 82 – the so-called “Reiner Initiative” after Hollywood director and initiative sponsor Rob Reiner.

Why should taxpayers in Peoria, Des Moines or New York care about a California proposition that would fund a state-wide preschool education program by placing a 1.7 percent surtax on individuals earning over $400,000 and couples earning $800,000? Because it exemplifies how a clever marketing campaign can mobilize people who benefit from government spending but pay little or no income taxes to gang up on those who do pay income taxes and, most likely, will not benefit from the spending.

California is already at a place that the whole nation will soon reach. It imposes a steeply progressive income tax system that places the lion’s share of the burden on those deemed “rich” while exempting millions of lower-income citizens from taxation entirely. Such a system threatens our democracy because it splits America into two classes – a large class that feels no pain from big government and whose appetite is endless, and a smaller class that feels all the pain and is powerless to stop the cycle of taxing and spending. These are the seeds of social discontent.

Nationwide, Tax Foundation economists estimate that 43 million Americans filed a tax return last year and owed zero federal income taxes after they took advantage of the credits and deductions available to them. This means that one of every three Americans who filed a tax return got back every dollar that was withheld from their paycheck throughout the year. Indeed, many got an additional bonus check through programs such as the Earned Income Tax Credit – a welfare program administered through the IRS.

Washington collected $927 billion in income taxes last year, 86 percent of which (or $825 billion) were collected from the top 20 percent of taxpayers, or those earning more than roughly $72,000 per year. The other way of stating this is that the bottom 80 percent of Americans contributed just $0.14 cents out of every dollar of income taxes collected by Uncle Sam.

But it is worse in California. Nearly 40 percent of Californians don’t pay any state income taxes and millions more pay next to nothing. Indeed, the majority of folks earning under $50,000 per year pay no state income taxes.

So who is paying? Families earning over $100,000 per year pay three quarters of the $30 billion in state income taxes California collected in tax year 2003. Theses families are overwhelmingly dual-income couples living in the high-cost suburbs of Los Angeles, Sacramento, San Diego, and San Francisco. Married couples comprise about 43 percent of all taxable state tax returns, but pay 70 percent of all the income taxes to the state. Talk about a marriage penalty.

Proposition 82 would boost the state’s top personal income tax rate to 12 percent. This would not only be the highest rate in the country but, when combined with the top federal rate of 35 percent, would have California’s top-income earners pay income tax rates approaching those levied in socialist countries such as Sweden or France.

When there are so many people outside of the tax system, it is not surprising that these initiatives keep lowering the bar on what is considered “rich.” Just two years ago, Californians passed Proposition 63 which imposed a 1 percent surtax on millionaires to pay for expanded mental health services. Prop 82 lowers the threshold to $400,000. What’s next, $100,000?

Then again, who is more in need of mental health services than a high income person who continues to live and work in California?

Scott A. Hodge is president of the Tax Foundation, a non-partisan tax research organization in Washington, D.C.