In 2012 California’s finances were in terrible shape. Proposition 30 was a temporary measure increasing income taxes on households with more than $250,000 of income and increasing sales taxes by .25 percent.
The idea was that, in six years, the state Legislature could impose meaningful tax reform and provide a more stable revenue source for the state treasury.
The sales tax increases imposed by Proposition 30 are set to expire at the end of this year, while the income taxes do not expire until 2018.
The California teachers unions are concerned that their temporary windfall will come to an end. Consequently, they have put Proposition 55 on the ballot which, if passed, would extend the “temporary” income tax for 12 more years but would not extend the sales tax.
Under Proposition 30 the highest stated tax rate is 13.3 percent on income over $1 million. However, because of mechanics in the computation of taxable income, the effective rate is actually higher than 14 percent.
Proposition 30 was retroactively effective, and it caught many wealthy taxpayers by surprise.
Most states have a maximum income tax rate in the 5 percent to 6 percent range, which kicks in around $75,000. In California, our rates for people earning less than $75,000 are comparable.
However, unlike other states, at $75,000 the California personal income tax rates start to increase fairly rapidly.
The biggest problem with California’s tax structure is that it is highly volatile based on the state of the economy.
A significant amount of revenue comes from people working in the technology industries, who enjoy high income when times are good but have to live off savings during bad times.
The revenue estimates included in the Proposition 55 ballot materials anticipate volatility and state that the incremental revenue will vary between $4 billion and $9 billion annually.
Another problem with the tax structure is that the wealthy who have stable incomes are leaving the state in large numbers, further eroding the revenue base.
When I was a practicing CPA in 2012, I had four clients who each paid between $400,000 and $1 million annually in California income tax. By the time I retired in 2015, three of the four had moved out of state. The fourth plans to move to Arizona in the near future.
It wasn’t always like this. In 1974, Ronald Reagan’s last year as governor, income tax was only 27.3 percent of California revenue. Forty years later, income tax accounts for 53.9 percent – almost double the 1974 percentage.
Conversely, sales tax was 35.7 percent of the state’s revenue in 1974 but is only 28 percent today. For historical reference, the sales tax rate in 1974 was 4.75 percent.
Although rates have increased, sales tax has diminished as a revenue source. Sales tax is imposed on goods, but not services.
In 1974, the sale of merchandise represented a greater portion of our economy than it does today. Furthermore, technology has transformed some merchandise into services.
For example, 40 years ago, if I went to the record store and bought a record, that purchase was merchandise subject to sales tax. Today if I download a song from iTunes, it is exempt from sales tax.
Moreover, with the advent of online retailing, sales tax is rarely collected from out-of-state merchants.
All of this has led to a greater reliance on income tax to fund state expenditures.
If we were in business and we could choose between stable and volatile revenue sources we would likely choose a combination of the two, relying on the steady revenue source to cover our fixed operating costs. Yet the state of California has done precisely the opposite.
State Sen. Bob Hertzberg introduced proposals to revamp the California tax system to reduce dependence on income taxes by increasing the sales tax base.
Specifically, the sales tax would be extended to many commercial services (except health care) and the sales tax rate would be dropped by about 3 percent. This provision, if enacted, would add $10 billion in taxes annually, more than offsetting the revenue loss of the expiring Proposition 30 provisions.
The provisions would place the composition of state revenue closer to that of 1974. This would also ameliorate the current volatility in state revenues.
However, our schools have become addicted to the additional revenue provided by the temporary emergency measure of Proposition 30. The teachers unions seek to extend the “temporary” measure another 12 years.
If Proposition 55 passes, that will continue the status quo, discouraging and possibly preventing measured long-term reform.
We cannot be enablers who allow bad tax policies to continue. We must vote “no” on Proposition 55. Meaningful tax reform will not occur if Proposition 55 passes.
Jim de Bree is a retired CPA who resides in Valencia.
