California's Troubled, Outdated Tax System

Annette Nellen's Profile
 

Three tax initiatives/propositions will appear on the November 2012 California ballot. This is a poor way to change the tax law.  Voters have to take the proposal as it with no opportunity for improvement. Fortunately, the two tax rate increase ones are temporary. The three initiaves are:

  1. Temporary Taxes to Fund Education. Guaranteed Local Public Safety Funding. Initiative Constitutional Amendment (No. 1578) - Governor Brown's initiative to help balance the budget.
  2. Tax for Education and Early Childhood Programs. Initiative Statute. (No. 1574) - Molly Munger's proposal to get more funding for schools.
  3. Tax Treatment for Multistate Businesses. Clean Energy and Energy Efficiency Funding. Initiative Statute (No. 1550) - proposes to only allow the single sales factor apportionment formula and use the revenue generated for clean energy projects.

I will have more on these proposals later including suggestions for how to analyze them and their pros and cons.

What I want to note here is a statement in The Economist of 6/16/12 in an article "Not quite Greek, but still weak."

California's budget problems begin with a tax system that is out of date. For most of the last century, sales taxes, which are relatively stable, were the state's main source of revenue, whole more volatile income taxes were less important. But that was when California's economy was still based on making things. Today it is a service economy, and services are exempt from sales tax."

The Economist has it right.  The tax system is out of date. Elected officials and voters tend to make the problems worse by raising the tax rate rather than fixing the base (what is subject to tax) for the income and sales taxes. As I note in my paper on California's Tax Problems:

Most of the specific tax problems in California’s existing tax structure described below can be solved by fixing the tax base - they cannot be solved with a rate increase. A rate increase would make most of these problems worse."

For more details on many of these problems, please see my papers and op eds here.

What do you think about California's tax system and current proposals for the ballot?

 

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Member's Profile

I agree that the system is out of whack and tax increases not only make the people's goodwill go away but their dollars also, especially in terms of sales. And raising taxes in a bad economy is always the wrong thing to do. So yes, we need to fix the underlying system not raise taxes every two months. Specifically for the proposals above, I have a school-aged son who has to go to a private school because our hometown school is so underfunded that I would neglect my duties as a parent if I sent him there and the other schools in our district are so overcrowded (for just this reason) that I cannot get him in any where else. So yes I would love for education to get back the funding it needs and deserves, BUT, especially in California we are already paying so much taxes it feels like living in Europe - without all the benefits of those high taxes. And education is ALWAYS the first thing to get cut no matter what. For me it's the same conclusion - a tax increase won't fix the problem, fix the underlying system.

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(Software Company CEO)

I would say we have several issues. While I enjoy reading the Economist I would state they don’t have the full problem pegged. Sales taxes really aren’t a stable source of revenue that is being minimized since we don’t build things anymore – that is more VAT tax thinking. Property taxes were the real stable source of revenue that most local governments use – and that has been a mess ever since Prop13 years ago.

Assuming blue sky thinking – regardless of how realistic it might be – some changes that would be helpful would be:
1) Sales taxes part one – taxing online sales the same as in state sales. Believe this is coming. There is no longer a justification for online to get preference – and the current impact of this is encouraging people not to have stores in California (to avoid the tax) rather than any growth benefit for the state.
2) Sales taxes part two – probably do need to apply to services as well. As a software company we go with the regulations – and there is no tax on most software these days (subscription or maintenance services). Why this product/service escapes taxes is more about history and interpretation and less about any real justifiable revenue base solution.
3) Business Income tax part one – the option to base your tax on employees in the state or revenue in the state is another provision that penalizes California employers and gives an advantage to out of state providers. Whatever logic there was for this is long since gone and this penalty for those of us located in the state needs to go.
4) Business Income tax part two – really the use of income tax is a mess – everything from the definition of income and the many loopholes and adjustments given – should be thrown away. We should go to a gross receipts tax with no deductions (say 2%). This would again help level the playing field between companies that have tax strategies that offshore ownership of IP or shipping location or whatever. Businesses benefit from services provided by the state – and should pay for the services. If there are any incentives needed to encourage companies through tax regulations they would be tax credits and not deductions or other items.
5) Business Property Taxes – Prop 13, for all of its radicalness to cap government’s ability to tax – removed property taxes as the stable local tax source. We now send all of our property tax money to the state (adding bureaucracy) and getting back what they decide to give us. This is not to mention some of the other negative impacts of Prop13 in terms of competitive fairness. It would be better to let schools get their first funding locally – and let those areas that need subsidy get that from the state – than our current mess.
I’m sure there is more to discuss – but figured to add my two bits.

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