California targets budget-busting tax code

It was intended to help reform California’s tax system and avert the wild revenue swings that have caused the state’s crippling deficits. But the tax overhaul plan proposed by a blue ribbon commission could just arrive dead in the water.

Just under a year ago, Gov. Arnold Schwarzenegger and state legislative leaders created the 14-member, bipartisan “Commission on the 21st Century Economy” to find ways to modernize state tax laws. The idea was to achieve a more stable revenue stream and one reflective of the world’s eighth largest economy. California’s $1.8 trillion Gross Domestic Product (GDP) is 13 percent of the US GDP, but the state makes headlines year after year for its giant budget deficits.

The commission’s final report is not yet in (it was due Sunday), but the draft reforms floated at the commission’s public hearings have already been widely criticized.

The reform plan involves phasing out the corporate and sales tax and flattening income tax to just two levels: a 2.75 percent rate for married couples making up to $56,000 annually and 6.5 percent for those making more. Itemized deductions would remain only for mortgage interest, property tax, and charitable contributions.

The resulting reduction in revenue from personal income tax – from 44 percent of revenue to 31 percent – would be made up by expanding the business tax to include new sectors such as lawyers, engineers, business consultants. The business tax is one of the more controversial proposals, in part because it is untested.

Dramatic shift

“These proposals represent a stunning sea change in state tax policy that would increase California’s budget deficits and shift the cost of financing public services onto low-and middle-income Californians,” said Jean Ross, executive director of the California Budget Project in a statement.

“With budget gaps expected for the foreseeable future, we should be working to solve our state’s problems, not creating larger ones,” she added.

More time is needed to study changes to the tax system, say some lawmakers. “[W]e want this reform to get it right,” says Jim Evans, communications director for state Senate President Pro Tem Darrell Steinberg (D). “What we need to do with an issue of this magnitude is take our time and study carefully the changes we intend to make.”

One problem with the commission , say some experts, may be that the commission suffers from the same problem as the state legislature: gridlock.

“Some members clearly want to raise more revenue, while others are trying to deal with the volatility issue,” says Jon Coupal, president of the Howard Jarvis Taxpayers Association, which has 200,000 members. “Trying to get consensus in this state is going to be very, very difficult.”

Mr. Coupal says he thinks the state’s existing tax structure could smooth out the bust years with money from the boom years, if there was just spending discipline.

Getting reforms through

The governor may call for a special session to deal with the proposed tax reforms, but analysts say they won’t be easy to pass.

Californians now disapprove of Governor Schwarzenegger’s performance by a two-to-one margin and they disapprove of the legislature by a three-to-one margin, says Jack Pitney, political scientist at Claremont McKenna College.

“So passage of tax reform depends on an unpopular governor persuading an even more unpopular legislature to take a politically risk move,” says Mr. Pitney. “Such things seldom happen on this planet.”

Other reforms in prisons, water policy, and education are also crowding the legislative agenda.

“They [state lawmakers] have got a lot on their plate and these are very complex issues in very tough times,” says Mark Baldassare, president of the Public Policy Institute of California in Sacramento.