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To solve budget woes, California eyes higher taxes on the rich

Democratic legislators would impose a top rate of 11 percent, up from 9.3 percent.

By / July 26, 2008

The California State Capitol Building in the capital city of Sacramento.

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Sacramento, Calif. - For the "have-mores" of California, the tax man cometh.

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Facing a $15 billion budget shortfall, Californian legislators are calling for tax hikes on the rich. That's despite the Golden State already having one of the most progressive tax structures, meaning the wealthy pay much higher rates than the poorest.

Top earners here could face a double whammy if Democratic leaders in Washington succeed next year in rolling back President Bush's tax cuts and allow Social Security withholding on income beyond the current $102,000 cap.

Political leaders are zeroing in on the upper echelons of the state's taxpayers because that's where much of the economic growth has taken place in recent years, say analysts. The strategy isn't without risks: Just as globalization has enriched the elite, it has also increased their ability to relocate if the tax climate gets too uncomfortable.

"Structural inequality has been rising at a level we haven't seen since before the Great Depression," says David Gamage, a tax and public-finance expert at the University of California at Berkeley. "And the natural response, both psychologically and economically, is to make the tax system more progressive,"

There's a sense in Sacramento that the state's recurring budget deficit has finally grown so large that it can't be papered over with borrowing and accounting sleights of hand; either spending has to be cut, new revenues tapped, or both.

Gov. Arnold Schwarzenegger (R) has proposed expanding the state's lottery and cutting spending.

Skeptical about lottery revenue, the majority Democrats in the legislature responded with a budget plan that includes fewer cuts and a plan to create two additional tax brackets above the current 9.3 percent ceiling. Joint filers making more than $321,000 a year would pay 10 percent; those making over $642,000 would pay 11 percent. These and additional tax increases would bring in $8.2 billion.

Governor Schwarzenegger hasn't ruled out tax hikes, but many of his fellow Republicans in the legislature – who are needed to pass a budget – have signed antitax pledges. They argue for spending cuts and a spending cap.

Budgetmakers missed the July 1 deadline. Schwarzenegger is threatening to withhold pay beyond minimum wage for all state employees until the budget gets done. The state Senate plans a budget vote on Tuesday.

If tax increases and rollbacks happen here and in Washington, D.C., Californian millionaires would see combined federal and state income taxes jump from a current 41.7 percent level to 51.4 percent. That's according to William Ahern, spokesman for the Tax Foundation, a pro-growth tax-research group based in Washington.

For high earners, the grass may start to look greener on the other side of California's borders, says Mr. Ahern. Arizona's top rate on income is only 4 percent; Nevada and nearby Washington have no income taxes at all.