California’s Up-and-Down Revenue Stream: Is State Tax Reform, Up, Down…or Out?

Tuesday, July 21, 2015

California may be parched and arid, thanks to a historic drought.  Meanwhile, Sacramento is awash with money – about $6.7 billion more than government bean counters were counting on as recently as January.

And whom to thank for this windfall? Try a surge in capital gains tax revenue, plus a temporary tax increase on upper-end earners – Proposition 30 – that voters approved in November 2012.

As such, California faces something of a conundrum. On the one hand, money will continue to pour into Sacramento in the immediate future, prompting more budget debates such as the one last month when the argument wasn’t whether to spend, but instead which rosy revenue estimate to enact (in the end, it was Governor Jerry Brown’s less-enthusiastic projection that prevailed).

Now, the bad news: revenue forecasts are the California state government’s version of yo-yo dieting. What you see today isn’t what you saw five years ago – and may not be the case five years from now.

So what’s California’s problem? In a nutshell, it’s a revenue system that’s overly reliant in personal income taxes. In 1950, 10 percent of the Golden State’s fiscal take came from the income tax. Today, that figure is closer to two-thirds (nearly double what it was a quarter of a century ago).

Moreover – and alarming for a nation-state of over 38 million residents – a select few Californians are driving the revenue train.  Almost half of California's income taxes come from the state’s top 1 percent of earners (as compared to 41 percent and 40 percent in Connecticut and New Jersey).

This is why one of the more important ballot fights to watch next year will be the anticipated effort to extend or make permanent some or all of Proposition 30. Take away that measure, which raised income taxes on those earning more than $250,000 until 2019 (to 13.3%, the nation’s highest rate) and imposed a sale tax increase until 2017, and America’s biggest blue state could be looking at red ink.

There are two things we know about California and spending for the foreseeable future.

First; no one’s looking to trim spending. Although Governor Brown coaxed lawmakers into spending $2.1 billion less than they desired, the $115.4 billion general fund budget signed by Governor Brown last month is still $7.4 billion more than the previous year’s spending plan.

Second, lawmakers don’t lack for new spending ideas. This summer, California’s State Legislature will engage in two “extraordinary” legislative sessions – one, to figure what to about the current $1 billion hole in the state’s Medi-Cal health program; the other to create permanent and sustainable funding (i.e., a push for taxes and fees) for infrastructure repair and maintenance

This leaves Sacramento with one of two paths to take; the first being to continue with the status quo: relying on boom-or-bust revenue and raising taxes. In 2016, that could include an increase in California’s tobacco tax and maybe a run on the state’s fabled Proposition 13 and its cap on business and residential property taxes.  In fact, Democratic lawmakers already have proposed going after the business side of Proposition 13.

The other course of action: reforming California’s tax system so as to make the revenue stream more reliable. In theory, that shouldn’t be difficult; in April, State Controller Betty Yee announced a nine-member “expert panel” to analyze tax-reform proposals from varied perspectives. Such analysis would begin with the September 2009 report published by Governor Arnold Schwarzenegger’s Commission on the 21st Century Economy, which listed numerous ways to modernize, stabilize, and simplify what it deemed to be “an outdated tax system.”

Of course, that report went nowhere with the State Legislature. Six years later, it remains to be seen if there’s a genuine appetite for tax reform under the Capitol Dome; though there are at least two promising ingredients: a pair of ambitious lawmakers touting the idea (Controller Yee and State Senator Robert Hertzberg) and, not to be overlooked, a lame-duck Governor on the prowl for legacy items.

In this issue of Eureka, we explore California and its yo-yo like revenue system of up’s and down’s. That includes:

Additionally, the Facts on the Issue for this issue of Eureka have been provided by California Common Sense, a non-partisan non-profit think tank dedicated to opening government to the public, developing data-driven policy analysis, and educating citizens about how their governments work.

And before all of that, we have this podcast offering an insight on California’s revenue picture and what the immediate future may hold given voters’ whims and the partisan divide in Sacramento.

We hope you enjoy this latest installment of Eureka – and that it gets you thinking about where California stands and if we’re moving in the right direction.