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Friday, September 18, 2009

CA Commission on 21st Century Economy Report and Vote Due 9-20-09

The California Commission on the 21st Century Economy had its first public meeting in January 2009 and is to issue its report, which should indicate how the 14 commissioners voted on the proposal, on 9/20/09 (the original deadline of 4/15/09 was extended twice).

The proposals discussed at their final meetings on 9/10 and 9/14 are fairly bold - reducing the personal income tax for high income individuals, and replacing the corporate income tax and state level sales tax with a business net receipts tax. The big question is - are these appropriate changes to improve California's tax system to make it one appropriate for the 21st century economy.

Well, I'd say "yes and no."

Yes - 21st century improvements offered in the Commission's plan include:
  • Reducing the sales tax for businesses. This will reduce (but not eliminate) a flaw with our current sales tax in that it is a pyramiding tax. We make businesses pay sales tax on equipment. That tax makes its way into the price of the goods sold by the business on which customers pay sales tax again. Most states do not make businesses pay sales tax on manufacturing equipment (or sometimes R&D equipment is also exempt). This reality makes California very uncompetitive for manufacturing - why pay an extra 9.25% on manufacturing equipment when you can avoid it in most other states? However, the proposal reduces the sales tax for all taxpayers and still makes businesses pay the local portion of the sales tax. Thus, businesses have the continued complications of sales tax and other states still look more competitive. So, while this proposal helps move us into the 21st century economy where businesses face fierce global competition, it doesn't go far enough.
  • Elimination of the corporate income tax - why not? Small companies either don't owe it or owe very little. Large multitstate companies work to reduce their state income tax with the help of tax professionals and the state legislature that provides a lot of tax credits. Elimination of this tax might lead companies to want to locate more payroll and property here as doing so won't raise their CA corporate income tax (because there would not be one) and would lower their state income taxes elsewhere. However, our high sales tax would still be a deterrent. Big question - which should be eliminated for corporations - the sales tax or the income tax? Definitely the sales tax. That along with the option of a single sales factor should make California attractive to manufacturers and R&D operations - activities with high wage labor that should boost state tax collections.

No - aspects of the plan that don't move us into the 21st century:

  • Flattening the personal income tax. For years, the trend has been a growing income gap between individuals with the highest incomes and those with the lowest. What is the point to reduce the top income rate and eliminate some deductions, such as the medical deduction that might benefit a middle-income taxpayers? AND, at the same time continuing to allow for deductions of interest on home equity loans (something only homeowners can get, not apartment dwellers), a vacation home (something also for higher income individuals) and on up to $1.1 million of debt! Greater equity could be achieved by eliminating inequitable deductions like the parts of the overly generous home mortgage deduction.
  • I've written before about ways to reduce the volatility of the personal income tax while not necessarily giving a tax cut to high income individuals (here).
  • The business net receipts tax - it is not clear if this moves us into the 21st century. I've heard a lot of misstatements about this tax which concerns me. For example, it has been likened to the European VAT. However, all of Europe and most of the rest of the world use a credit invoice VAT that appears on sales invoices (it is a transparent tax and a non-pyramiding one). The BNRT is a subtraction method VAT. Only Japan uses a version of this and Michigan. I've heard that the BNRT is better because it has a broader base. Broader than what? I'm concerned that people mean compared to the corporate income tax. That is correct - the BNRT has a broader base because wages are not deductible, BUT, we should not be comparing the bases of the BNRT and the corporate income tax because they are two different types of taxes!! The BNRT is a consumption tax while the corporate income tax is an income tax. Perhaps those saying it has a broader base mean in comparison to the sales tax. That might be, but it is not clear. Compared to the sales tax we have today in CA, the BNRT has less pryamiding, so represents a narrower base, rather than a broader one. Of course, in that it applies to all businesses, not just those that sell tangible personal property, the base is broader. But, how does the narrowing and broadening aspects of the BNRT compare to our current sales tax?
  • Where is a polluter pays tax? CA has ambitious greenhouse gas emission reduction targets. One way to help us reach them would be to increase the cost of carbon-based fuels, such as gasoline. So, why not increase the gasoline tax? That would help our tax structure tie to our state strategic goals and raise some revenue. Some of that revenue could be used to provide a rebate to low-income taxpayers.

That's just a few comments. I hope the final report will have a longer narrative on the personal income and sales tax changes (there is only a detailed explanation for the BNRT). While statutory language has been provided, it is hard to know if the changes are the correct ones if we don't have detailed explanatory text to go along with it.

For more information:

Questions for you:

  1. How many commissioners do you think will vote for the plan?
  2. Would you vote for the Commission's plan? Why or why not?

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