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Sunday, November 6, 2011

California Budget Problems and Possible Solutions

This is a slide from a 10/27/11 presentation by the Legislative Analyst's Office on California's Budget Woes. I encourage you to look at the entire slide deck to get a better understanding of some of California's significant budget problems that include current revenue shortfalls and large future liabilities such as over $150 billion of unfunded pension and retiree health benefits.

Some people are not concerned with the volatility of the personal income tax (PIT) saying that just means the tax is tracking the economy. That is, incomes go up, so does the tax base. But as the LAO indicates on the slide above, the PIT is more volatile than the economy. That harms the ability of this tax to fund government expenditures, which is the key purpose of a tax. Worse yet for California is that the PIT provides over half of state revenues. This is far greater than the role it played in 1969-1970 as shown in the following LAO slide.For my list of California tax system weaknesses - check out this page.

The last slide (#36) notes that tax reform is a possible solution, but that it is "an incredibly difficult task with no clear consensus on what to do." That's sure true. Unfortunate but true. And, after Prop 26 (Nov 2010), any tax reform will need a 2/3 vote of the legislature. Any tax bill that needs a 2/3 vote will be labeled as a tax increase which will lead many Republicans who have signed the no new tax pledge to not vote for the measure even though it would help the state tremendously.

Here are a few tax and budget reforms that California needs:
  1. Expand the sales tax base to include digital goods and personal services. Transition in the changes, provide vendors with a refundable credit to help cover their new compliance costs, and don't apply the tax to purchases by businesses. Use some of the new revenue to cover our deficit and the rest to lower the sales tax rate.
  2. Work with Congress to get legislation passed that allows the state to collect sales and use tax from remote vendors.
  3. Phase out the mortgage interest deduction for debt on a second home, for home equity debt and for acquisition debt greater than $500,000.
  4. Change the senior exemption to be based on income rather than age.
  5. Eliminate the choice of apportionment to move to a single sales factor with all sales sourced based on market.
  6. Increase the gasoline excise and tobacco excise taxes.
  7. Enact an oil severance tax with the revenues to go into the General Fund with no earmark.
  8. Create a rainy day fund to start in 2 years. Funding of it should include 10% of taxes paid on capital gains.
What do you think? What would you suggest for California tax reform?


Randy Eickhoff said...

Professor Nellen, why are all of your recommendations or suggestions for budget reform increases in taxes rather than reduction or streamlining of programs to lower the overall cost structure? California is one of the highest taxed states and it seems our "leaders" don't understand how to manage costs in a down economy.

Professor Nellen said...

Randy, thanks for the comment. My focus is on improving the tax system. I am sure there are spending cuts, particularly spending efficiencies that can be implemented.

To note a tax cut, although revenue neutrality would be needed, we should phase-out the pyramiding in the sales tax. That is, businesses should not be paying sales tax on their purchases. Today, their sales tax represents about 30% of total collections. What they pay gets built into the price of goods (and likely in lower worker wages). Then buyers pay a tax on a tax - pyramiding.

Not all spending cuts are in agency budgets because there is a lot of spending in the tax law in the form of special deductions, credits and exemptions. This spending needs to be reduced too.

Randy Eickhoff, CPA said...

Professor Thanks, as we know, sales taxes are regressive and hurt those on the lower end of the income scale. Would a lower sales tax help spur the economy in California?

Businesses have already figured out that this is a tough place to do business and that a short drive to Nevada or Arizona will increase their working capital through reduced taxes and lower labor costs. I have to wonder how our politicians rationalize any additional tax increases given the structure they have put into place.

ProCPA said...

Professor Nellen, as you are aware the move to market based apportionment would punish the out of state companies. If you go in that direction, how about tapping into the vast imports from Asia in the form of import duties? Currently in China a Mercedes SUV that costs $93K in US, sells for $300K in China after all import duties. That sure would improve our trade deficit and put cash in CA pockets. I am sure you would be fighting against a strong Asian lobby in CA. But the fight may be worth it.