Over the next 12 months — between now and the November 2016 general election — Californians will engage in a robust and far-reaching debate about the state tax system and how it could better support much needed public investments. A confluence of factors — the boost in voter turnout that accompanies a presidential election year, a lower threshold for the number of signatures needed to place a measure on the 2016 ballot (due to low turnout in the 2014 election), and the impending expiration of sales tax and income tax rate increases (after 2016 and 2018, respectively) passed by voters through Proposition 30 in 2012 — have thus far brought us the following mix of potential proposals:
- Extending elements of Proposition 30: Two proposals have emerged that would continue the use of higher personal income tax rates for the wealthiest Californians, while allowing Proposition 30’s sales tax rate increase to expire:
- “The School Funding and Budget Stability Act“ would extend Proposition 30’s income tax rate increases through 2030. Budget-related formulas provide a minimum funding guarantee for K-12 schools and community colleges that is partially based on General Fund revenues in certain years (Proposition 98). To the extent that increased tax revenues from this ballot measure increase General Fund revenues, funding for education could increase as well. This measure also would exclude these additional revenues from calculations for the requirement under Proposition 2 (2014) that a portion of state revenues be allocated to the state reserve fund and paying down budgetary debt.
- “The Invest in California’s Children Act“ would make the personal income tax rate increases under Proposition 30 permanent and impose new higher rates on individual filers earning more than $1 million a year and married filers earning more than $2 million a year. The resulting revenues would go to special funds designated for K-12 schools, community colleges, the California State University and University of California, early education programs, and Medi-Cal.
- Commercial property tax reform: Earlier this year, Senators Loni Hancock and Holly Mitchell introduced a bill (SCA 5) that would make it so that commercial and industrial properties are assessed at their market value, to level the playing field between companies on long-held property and companies on newly acquired property. This change would close loopholes that companies can exploit around the definition of “change of ownership.” The Make It Fair coalition plans to pass this corporate property tax reform measure by ballot initiative if the Legislature doesn’t take action, although not in 2016.
- Sales tax extension: Senator Robert Hertzberg is supporting some form of overhaul of the state tax system, which would include extending the sales tax to better account for our economy’s shift from goods to services, the vast majority of which are not subject to sales tax in California. The specifics are reportedly evolving, and Senator Hertzberg plans to bring his proposal back in 2016.
- Tobacco tax: A recent special legislative session for funding Medi-Cal (the Medicaid program in California) failed to produce a bill, but an increase to the state tobacco tax, which has been unchanged since 1998, remains under consideration as one possible way of funding the Medi-Cal program. The Save Lives California coalition is committed to passing a ballot measure in 2016 that would increase the state tobacco tax by $2 per pack, if the Legislature doesn’t pass such an increase first.
- Oil severance tax: Hedge fund billionaire and climate change advocate Tom Steyer and NextGen Climate are considering a ballot measure that would impose a severance tax on the extraction of oil and gas.
A Framework for Evaluating Tax Proposals
How should Californians evaluate these and other potential tax proposals? Certain aspects of tax policy can be complex, but you don’t have to be an expert to understand the generally agreed upon principles of good tax policy:
- Equity. Taxes should be levied in a fair manner: based on ability to pay, and such that taxpayers in similar circumstances are taxed similarly.
- Adequacy. Tax revenues should be sufficient to fund the level of public services and supports that residents desire.
- Economic efficiency and growth. To the extent possible, tax structures should track economic growth and should not alter the economic decisions people make — unless that is a goal of the tax, such as the tobacco tax, which aims to discourage smoking.
- Ease of administration/accountability. To the extent possible, taxes should be simple to administer, helping the system produce the revenues it’s expected to, and making it easier to hold people accountable. It should be clear what individuals and corporations pay into — and receive from — the tax system, and the responsibility for collecting taxes should be aligned with the responsibility for spending those revenues.
As significant as these principles are, it is even more important to remember that the tax system itself is not the most important outcome. Yes, Californians should want an efficient and optimally running tax system, but ultimately, the most important question Californians should ask is whether the tax system supports its chief goal: improving outcomes and conditions for Californians.
Staying Focused on Desired Outcomes and on What We Need to Get There
Californians should avoid dwelling on concerns that are unnecessary detours on the way to a robust and well-informed discussion about tax policy and desired outcomes.
For instance, some argue that a clearer definition of the need for revenues be identified before our state can have further conversations about tax policy. Such considerations are beside the point in a state where middle wage workers have seen their wages stagnate, even amid the state’s recent economic recovery, while a variety of programs that help create economic opportunity continue to operate at historical and/or recession-era lows:
- In K-12 education, California’s per pupil spending remains significantly below the rest of the US;
- Support for low-income seniors and people with disabilities (Supplemental Security Income/State Supplementary Payment program) remains below the January 2009 level, when grants peaked prior to being deeply cut;
- Recession-era cuts to the state’s welfare-to-work program (CalWORKs) have left the maximum household grant at a level that’s less than half of the federal poverty line; and,
- State funding for subsidized child care and preschool slots remains more than $770 million lower than prior to the recession, after adjusting for inflation, a reduction of more than one-fifth.
With state-local infrastructure suffering from underinvestment and statewide water needs that are highlighted by — but go well beyond — California’s current drought, the issue is not whether the scope of the state’s needs is sufficient to justify a higher level of ongoing revenues. There will undoubtedly be questions about prioritizing among needs, but the larger issue — whether additional tax revenues are critically needed to support eroding state systems — is not really an open question.
Others will seek to raise up the issue of revenue volatility, arguing that volatile taxes, particularly personal income taxes, should be avoided in favor of predictable revenue sources for the sake of budget planning. But the volatility question is essentially a question of adequacy and economic growth: Can a volatile revenue source provide the funds needed over time and does the revenue generally keep up with sources of economic growth? Although the personal income tax, and the capital gains component of that tax in particular, has fluctuated dramatically in recent years, it has also grown faster and kept up with the economy better than have other taxes. Meanwhile, the corporate income tax and sales tax both have declined as a share of the economy, and the housing bubble proved that property taxes could be volatile as well. Ultimately, short-term volatility is far preferable to the alternatives — taxing less well-off Californians more and generating less revenue. Yes, a system based on such alternative approaches might be more predictable, but it would also hover on the brink of collapse, rather than capturing the upside of economic and revenue cycles.
It’s also important to keep in mind that the volatility of California’s revenue system cannot be addressed solely through the state’s tax structure; trends in the economy and income and wealth distribution weigh heavily on the matter, too. Although the personal income tax might be more volatile than other tax sources, all of California’s tax sources are volatile because more and more wealth is being concentrated in fewer and fewer hands. High-wealth individuals and households make significantly more in income and capital gains (reflected in the personal income tax), spend far more in absolute dollars (reflected in the sales tax), and invest in significantly higher-value properties (reflected in the property tax) — making all of the state’s tax sources subject to greater degrees of fluctuation than in the past. Managing volatility is not about changes to the state’s tax code that make the system less fair and less adequate. Managing volatility requires using the higher revenues that accompany growth periods to invest in broadly shared economic gains, thereby reducing inequality and supporting a stronger overall state economy.
The answer to the volatility question also lies in smart management of the state’s revenue stream, putting away some of the available revenue growth during the good times for a rainy day and paying down budgetary debt. In fact, Californians last year took steps to make these kinds of set-asides automatic, by passing Proposition 2 in 2014. Proposition 2 requires that the state automatically contribute to the state’s rainy day fund and make payments on budgetary debt. These allocations are scaled based on expected annual revenues, with rainy day fund contributions and debt payments increasing when capital gains tax revenues are above average. Reconciling how some of the emerging revenue proposals described earlier interact with Proposition 2 is going to be a key consideration given the need to strike the right balance between investing in key programs and services and protecting the state’s fiscal health.
Prioritizing Fairness and Adequacy in Order to Improve Outcomes for Californians
The core principles of good tax policy noted above — equity, adequacy, economic efficiency and growth, and ease of administration/accountability — are a sound basis for understanding and evaluating revenue proposals. But this doesn’t mean that each of these principles should — or even can — be given equal weight, since in a given revenue proposal there can be trade-offs or tensions between the different principles. It’s typically necessary, then, to place certain tax policy principles above others. At the Budget Center, we prioritize the principles of equity and adequacy in assessing emerging tax policy proposals.
Public investments benefit everyone. The family juggling multiple jobs who receives public assistance that helps make child care affordable is able to participate in the economy and raise the next generation of California talent. The low-income student who receives tuition and living expenses support to attend the California State University, the University of California, or one our state’s community colleges goes on to perform higher-skilled work and ultimately sharpens the leading edge economy that California boasts. An economically sustainable strategy for economic growth requires a system that recognizes that we are all in this together — that economic opportunity, accessible regardless of income level, benefits the entire economy and all Californians. But, this requires public investment, which means revenues. When designing public revenue systems, from a sense of basic fairness, we should continue to prioritize the ability to pay as a consideration.
As for adequacy, our tax system quite simply must raise enough money to fund what we want to collectively provide. This includes the public investments needed to ensure that participation in a robust economy as well as a high quality of life is within everyone’s reach. California also requires an adequate tax system that is designed to keep up with a growing economy and population.
As the 2016 election draws closer, we may well see more tax proposals emerge. Policymakers and voters should keep the principles of good tax policy and optimizing outcomes for Californians in mind as they evaluate proposals. We at the Budget Center will provide our analysis and assessment as well, as details of proposed legislation and ballot initiatives solidify and the range of policy options becomes clearer.
— William Chen and Chris Hoene