California Prop 55 - Kicking the can down the road

California always has budget problems. In 2012, temporary tax increases were voted in to raise both the state sales tax rate and the top personal income tax rate. These put California at the top among state for high tax rates. These provisions expire soon, but budget problems remain. So, Prop 55 on the November 2016 ballot calls for extending the income tax rate increase.

Per the "findings" in Prop 55:

"Unless we act now to temporarily extend the current income tax rates on the wealthiest Californians, our public schools will soon face another devastating round of cuts due to lost revenue of billions of dollars a year. Public school funding was cut to the bone during the recession. Our schools and colleges are just starting to recover, and we should be trying to protect education funding instead of gutting it all over again. We can let the temporary sales tax increase expire to help working families, but this is not the time to be giving the wealthiest people in California a tax cut that they don’t need and that our schools can’t afford."

The continuing increased rates kick in on taxable income over $250,000.  Prop 55 would result in 9.3% not being the top personal income tax rate. Instead, brackets about $250,000 would include 10.3%, 11.3% and 12.3%.  With the longstanding mental health tax, the rate on income over $1 million would continue to be 13.3% through 2031. Yes, 2031!  That's a bit hard to picture.

How many people in California have income in this range? Using IRS zip code data for 2014, here are percentage for a few selected California zip codes based on $200,000 or more of AGI (after itemized deductions, fewer would have taxable income over $200,000 and the IRS doesn't report for taxable income over $250,000):

Fresno 93728           < 1%
Sacramento  95816    5%
San Jose 95125        19%
Torrance  90503         8%

This is not representative of course, but it is safe to say that less than 5% of California individual filers have to deal with the top rates.  And for the top temporary rate of 12.3% on taxable income over $500,000, less than 1% are affected.  Of course though, many in this range have a few million of annual income which is why the increased rates at the top can bring in millions of dollars.

I call this kicking the can down the road because instead of improving our tax system, we are applying a band-aid.  Here are a few things that would be better:

• Lower individual tax rates and broaden the base by eliminating or cutting back on exclusions, deductions and credits. This also makes the system more equitable, transparent and simple.
• Broaden the sales tax base and lower the rate. The California sales tax is still based on the 1930's economy when the tax was created. We just tax consumption in the form of tangible personal property and do not tax digital items, personal services, entertainment or utilities. Thus, the sales tax base continues to shrink as items, such as books and music, move from taxable tangible form to non-taxable digital form. This is crazy.  Also, some of the items we don't tax are ones that higher income taxpayer spend more money on such as food, utilities for their large homes, entertainment and personal services.
• The state wants to reduce greenhouse gas emissions. Governor Brown just signed SB 32 and AB 197 calling for further reductions. A carbon tax or increased gasoline excise tax would help reduce emissions and generate revenue.
• "Splitting the roll" on real property taxes to tax business property at a higher rate and/or modify the valuation approach. Prop 13 rates and valuation limits have inequitable effects among businesses that are not as relevant for businesses

What do you think?

Also see my California Tax Reform website.