Report Released by the California Commission on the 21st Century Economy

A few days after the extended due date for their recommendations, the California Commission on the 21st Century Economy issued a 400+ page report with a few major recommendations to change the California tax system along with the text of the proposed legislative changes.

The recommendations were endorsed by 9 of the 14 commissioners.

The recommendations include moving from a 6 rate to a 2-rate personal income tax and per the commission, yielding a tax cut for everyone. The only deductions allowed would be a large standard deduction and for itemizers, charitable contributions, mortgage interest and property taxes. The state level sales tax would also be phased out (leaving the local sales tax) and the corporate income tax would be eliminated. A new tax - a low-rate business net receipts tax owed by all businesses (other than "small" businesses) would be created. On page 41 of the final report, the Commission suggests that the new tax would replace the revenue from the repealed taxes (and apparently the reduced personal income tax as well). The Commission suggests that the BNRT rate not exceed 4% (while that seems low compared to current tax rates, the BNRT is a form of subtraction method VAT so there is no reduction in the tax base for wages and related expenses, thus leaving a large tax base. The Commission also suggests keeping a research tax credit (which is mainly based on R&D wages - an approach contrary to a consumption tax, such as the VAT). The changes would start in 2012 to give time for the legislature to act.

The Commission also calls for a rainy day fund and creation of an independent tax forum for resolving disputes between taxpayers and tax agencies.

These are some major changes. They will be difficult to understand. Just before posting this, I heard a brief TV news report that noted that the BNRT is comparable to what is used in Europe. That is a stretch. Europe and most of the rest of the world uses a credit invoice VAT, not a subtraction method one. While in theory, they should raise the same amount of revenue, one important difference given that the BNRT is replacing the state-level sales tax is that the sales tax shows up on sales receipts - it is transparent. That is not true for a subtraction method VAT - it will not be clear who ultimately pays that tax, but will likely be some combination of customers, investors and employees.

While the corporate income tax has a lot of complexities for multistate businesses, such as determining how much income to allocate to each state, those complexities will not go away, but will also exist with the BNRT.

It will also be important to carefully look at the distribution of the tax change among income groups. Dropping the top personal income tax rate from 9.3% to 6.5% (with little change in deductions for high income individuals), there will be a significant tax drop for high income individuals. While that can reduce volatility of that tax, does it change the distribution of the tax among income groups more than most people desire?

So, the Commission has given legislators and others a lot to think about. While the proposals may never be enacted, hopefully they will at least lead to thoughtful discussion of what is wrong with our system (and there is plenty - click here) and how it can be fixed.

I've got a short article at the California Progress Report with suggestions on how to evaluate the Commission proposals. And, I'll post more on the particular changes and possible recommendations not made.

What do you think of the proposals?