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Monday, December 8, 2008

Strategy Perspective on Tax Rates and Budget Crisis

The desparate need to close a significant budget gap in California can easily lead to suggestions of tax rate increases. It can easily seem like the way to go. But ...

Higher tax rates have many adverse consequences that won't help California's fiscal problems in the long-run and perhaps not in the short run either. Consider the following few examples of the problems with increasing California's already very high sales tax or income tax rates.

  • A higher sales tax rate disproportionately harms low-income individuals. In California, it is even worse because our sales tax base is so narrow excluding items likely consumed by high income individuals such as entertainment and personal services while taxing consumption of basic items like clothing and school and work supplies.
  • High rates make California business unfriendly. It's tough to have good high-paying jobs in the state when new and expanding businesses find it is much less expensive in most other states. The Tax Foundation ranks California 48th lowest among the states in terms of business tax climate!
  • Higher rates can lead to greater disrespect for the system and increase the tax gap (the difference between what is owed and what the government collects).
  • Higher rates make deductions of greater value to taxpayers subject to the new higher brackets. That is they get a greater subsidy from the government for their deductions.
  • Raising tax rates to generate revenue to address an eroding tax base, such as our sales tax base, just postpones the real work of modernizing our sales tax to address today's types of consumption (which includes a lot more services and intangibles than it did in the 1930s when the tax base was designed!).

Are there alternatives to higher tax rates while still closing a budget gap? Yes, by broadening the sales and income tax bases, considering new taxes such as ones that will also make polluters pay, and of course, looking for spending efficiencies.

Basically, to improve California's fiscal structure - to remove the continual budget shortfalls, and create a tax system that will move the state forward into the 21st century, the state needs to be more strategic in solving budget problems. I refer to this as moving from the math approach to solving problems, to using the strategic approach to solving problems. For details, please see my article - California Tax Changes: Math versus Strategy, on the California Progress Report.


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