California panel proposes tax overhaul

A long-awaited report on a tax overhaul for California is finally in, with recommendations that include flattening the tax code, eliminating state sales tax, and levying a wide-ranging business tax.

Now comes the hard part: getting lawmakers behind it.

California's bipartisan "Commission on the 21st Century Economy," formed just under a year ago, on Tuesday released its report suggesting ways to modernize the state's tax laws and end the budget deficits that have plagued the state for decades. Gov. Arnold Schwarzenegger welcomed the commission's report and called for a special session of the legislature to discuss the proposal before the end of the year.

"The commission answered the question posed to them by the governor, which was: Can you come up with a system to reduce the state's boom-and-bust cycle of revenue flow?" says Mark Baldassare, president of the Public Policy Institute of California (PPIC). "The question now is will any of this have any political legs?"

Some of what the commission proposes has not been seen or tested in California or any other state, and has already been criticized.

Key recommendations of the plan include reducing the number of tax brackets from six to two, eliminating the corporate tax and the state sales tax, and establishing the business net receipts tax (BNRT). The commission recommends a five-year phase-in to smooth the transition and limit negative impacts on any particular segment of the economy. It also suggests the creation of a independent tax dispute forum for resolving disputes.

A controversial business tax

"California's top wage earners would be the clear winners under the commission proposal," says Jessica Levinson, political reform director for the Center for Governmental Studies in Los Angeles.

he says that a tax that covers more business sectors is a giant leap forward for the state's tax structure which was created when farms and factories dominated the economy. "Now the technology and services industries dominate our state's economy and those industries will be taxed," she says.

Others are less enthusiastic. Such a tax could end up operating like European-style value added tax, says Kris Vosburgh, chief spokesman for the Howard Jarvis Taxpayers Association (HJTA), the state's largest tax group with 200,000 members.

"[S]uch taxing schemes hide the true scope of the tax burden from the ultimate consumer," says Mr. Vosburgh.

In the short term, "ordinary taxpayers might seem to be the winners, but most of them probably realize that the affected businesses will pass the costs along to them," agrees Jack Pitney, a political scientist at the Claremont McKenna College.

The HJTA embraces the flattening out of income tax rates, however, because it "will help to slow the exodus of California's best and brightest individuals whom should be encouraged to stay in the state," says Vosburgh.

Igniting debate

Experts say the commission's recommendations are unlikely to be adopted by the legislature because a two-thirds vote is required.

"There is something in this report for both liberals and conservatives to dislike, and in fact some of the commission members did not sign the report," Ms. Levinson points out.

"The commission proposes to replace a volatile tax system with an uncertain one. That is a very difficult approach to sell during a time of economic turmoil," adds Mr. Pitney.

Governor Schwarzenegger acknowledged the difficulties ahead Tuesday, saying, "People are scared of new things."

The report may not be a permanent fix to the state's budget woes, but it could ignite a discussion about creating a tax code that reflects the new economy, says Levinson.

"This isn't the end of the road," she says. "It is likely just the beginning."