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Tuesday, December 23, 2008

Focus on Equity to Help Budget and Improve Tax System

The past week has been interesting in terms of budget ideas. The unfortunate reality of our supermajority vote requirement for budgets and tax increases has turned the focus from trying to achieve the vote requirement to trying to develop a plan that only needs a simple majority. So fees were proposed along with shifting our tax mix such that the tax dollars generated remains the same.

There appears to be no focus on whether we are helping the state and the tax system move into the 21st century. With very high sales and income taxes, California remains uncompetitive. If businesses do not want to locate or expand in California, the economy will suffer tremendously. If budget solutions include cuts to education, the state will also suffer.

There are many factors to consider in improving California's tax system as one approach for getting the budget in balance in the short-term and long-term. I think that starting with a focus on equity would be a productive start and would be good for the economy and Californians. I have written about many of these ideas before. Here are a few changes that would make the tax system more equitable and generate revenue. This would be much better than focusing on new fees and tax shifts solely for the purpose of working within a simple majority vote. It would also be better than cutting education spending.

Why focus on equity problems in our tax system? Our tax system has a mix of exclusions, deductions and credits, many of which can be viewed as a form of spending. That is, a state could, for example, write a check to homeowners to help pay for their mortgage, or they could give them the money through a tax deduction. This higher your income, the larger your mortgage likely is and the greater tax subsidy you get for your mortgage interest deduction. I suggest a focus on bringing greater equity to the tax system because it seems very odd to give subsidies to people who don't need them while searching for direct spending cuts. If someone can afford to get over a $500,000 mortgage, they likely don't need large tax subsidies, yet we use tax dollars for that purpose.

A few equity ideas:
  • Cut back the home mortgage interest deduction so that it only covers a principal residence (and not a vacation home too) and gradually reduce the debt limit to $500,000 and gradually phase-out the home equity interest deduction. Homeowners will still get a larger deduction on their federal return so the effect on housing prices will be less than if the federal government also made this change (although the feds should make this change in the future too). Today, if someone has mortgage balances of $1,100,000 on two homes at an interest rate of 8%, they generate a deduction of $88,000. If they are in the top individual tax bracket of 9,3%, the state (all taxpayers) are subsidizing about $8,000 of this homeowner's deduction. That is more than it costs for a resident to attend a CSU for a year.
  • Expand the sales tax base to include the consumption of (i) entertainment (movie tickets, sports tickets, etc.), (ii) digital downloads by consumers, and (iii) personal services such as pet care, personal trainers, and hair salons. This type of consumption by individual consumers is a growing segment of total consumption. Why tax shampoo, but not a wash and cut at the hair salon? There is no reason. Again, there is no reason for people to subsidize the consumption of currently non-taxable personal items. Let's all pay our fair share of sales tax by having the tax imposed on all types of personal consumption.
  • The State will continue to incur costs to reach ambitious carbon emission targets. Let's help the state reach these goals by having people contributing to the problem pay. A carbon tax on utility bills that generate greenhouse gas emissions, as well as a carbon tax on oil purchases would be equitable in having people pay for their GHG emissions. A refundable income tax, similar to the federal earned income tax credit, could be added to help reduce the adverse impact of some of this tax on low-income individuals.

These are just a few ideas - there are others that would make the tax system more equitable and generate revenue. Some of the revenue generated should also be used to reduce our very high sales tax rate. That would also help "sell" the idea of a broader sales tax.

What do you think?

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