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From Governing’s Supplemental information | Introduction
But perhaps it’s better not to joke about it. The mammoth revenue gap is sounding alarms far beyond the state’s borders. In December, two rating agencies lowered California’s bond rating, costing the state millions of dollars in higher interest on money it must borrow. The major culprit in this fiasco is the state’s highly progressive — and volatile — income tax. The typical family of four in California doesn’t begin paying income tax until it earns more than $35,000 — the highest such threshold in the nation. The top tax rate is 9.3 percent, and capital gains are taxed as regular income. So in 2000, a very good year, taxes on capital gains and stock options generated $18 billion. But in 2001, as dot-coms collapsed, capital gains disappeared and stock options turned worthless, those same receipts plummeted to just $8 billion.
”The state tax structure is highly elastic and, increasingly, the spending is inelastic,” says John Ellwood, a professor at the University of California, Berkeley. That’s more true in California than in most states, thanks to ballot measures that have imposed rigid spending demands. Proposition 98 sets a minimum amount that must be provided for primary, secondary and community college education, which will range up to $48.7 billion next year. This funding is scheduled to grow by about 5 percent a year. Added last year was Proposition 49, the after-school program pushed by Arnold Schwarzenegger. The Legislative Analyst’s Office estimates it could add as much as $428 million to annual state costs. And as a decision of the voters, there’s little that can be done to escape it. But California’s voters did the most damage to their fiscal health a quarter-century ago, when they hog-tied the local property tax with Proposition 13, thus requiring California to spend an ever-growing portion of its revenue bailing out strapped localities. Since 1978, the property tax rate has been fixed at 1 percent and increases in assessed property value limited to 2 percent a year, as long as the property remains in the same hands. Local-option sales taxes are limited as well, and so cities and counties are forced to rely on cash from Sacramento. The state hasn’t cut back dramatically on this aid in the current crisis. But the governments are understandably worried. During the mid-1990s, almost $4 billion in property tax revenues was shifted away from localities and into the state’s own school budget. Since 1998, Sacramento has slashed the vehicle license fee, an annual 2 percent tax dedicated to local use, by two-thirds, replacing that money with state funds. Although some observers believed Governor Gray Davis might try to reinstate the full license fee — which would raise almost $4 billion in 2004 — he didn’t support the move in mid-January. His budget-balancing proposals included a 1-cent sales tax boost, an increase in cigarette taxes, a reintroduction of the two top income tax brackets and a strong dose of budget cutting. The truth is, any revenue-raiser faces an arduous path. A two-thirds supermajority is required to pass the budget or any tax increase. Last year’s proposal to raise tax brackets for the most affluent Californians was defeated by one vote in the state Senate, even though it had clear majority support. In the end, the budget raised no new taxes, leaving the state in worse shape than before. California has done reasonably well at maintaining the integrity of its corporate tax structure. It is tough on the creation of tax-dodge subsidiaries, and the law covers a firm’s property and assets, not just its sales. “Given our environment, we have about as good a state corporate tax system as you can,” says Steven M. Sheffrin, dean of social sciences at the University of California, Davis. The rest of the tax code is less efficient. Tax subsidies amount to $30 billion annually, and the legislature has added more of these in recent years in order to secure the votes necessary to pass the budget. The state’s tax administration, too, combines good and bad. It’s a unique system in which multiple agencies split the work. The Franchise Tax Board collects personal and corporate income taxes; while the Board of Equalization handles sales and excise taxes, local property tax oversight and the appeals process for all of these levies; and a third agency, the Employment Development Department, administers the state payroll tax. Consolidating the three would be logical, but it is unlikely, given the turf battles such a move would create. Politics has damaged the Board of Equalization’s image. Increasingly, that five-member group has been composed of term-limited state legislators. They can accept campaign contributions, and are thus subject to considerable doubt about the quality of their decisions in appeal cases. “What they’re doing isn’t illegal,” says one observer, “but it’s very partisan.” In stark contrast, the Franchise Tax Board receives raves for its professionalism. This board strengthened its already solid audit program in 1999 with a nonfiler compliance system that better integrates the tax data the state collects. Copyright © 2003, Congressional Quarterly, Inc. Reproduction in any form without the written permission of the publisher is prohibited. Governing, City & State and Governing.com are registered trademarks of Congressional Quarterly, Inc. |
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alifornia’s combined shortfall for this fiscal year and next is astonishing. At an estimated $35 billion, it is greater than the entire general fund of any other state except New York. It’s enough money to buy 625 million gallons of red ink. Reasonably good red ink, at that.