One of the frequently cited causes of California’s budget crisis is “revenue volatility” – the fluctuations in state income tax revenues that occur when income tax collections, primarily taxes collected on capital gains, rise and fall during boom and bust periods. In fact, a key goal of the Governor’s Commission on the 21st Century Economy is to recommend changes to California’s tax system to reduce revenue volatility. But many of those who argue for reducing revenue volatility ultimately seek to reduce taxes on capital gains, which would overwhelmingly benefit the highest-income earners.
Reducing taxes on capital gains would exacerbate an already stunning rise in income inequality. Recently released IRS data show that the average inflation-adjusted income of the nation’s wealthiest 400 taxpayers quadrupled between 1992 and 2006, while that of all other taxpayers increased by just 28.0 percent. While this analysis looks at the nation as a whole, there’s little reason to suspect that California’s trend would differ significantly. What explains this disparity? The highest-income taxpayers derive most of their income – 62.8 percent – from capital gains, which ballooned sevenfold (595.2 percent) between 1992 and 2006, after adjusting for inflation, while the majority of taxpayers’ income comes from wages and salaries, which increased by just 38.5 percent.
Reducing taxes on capital gains would shift the cost of public services from the wealthy to low- and middle-income taxpayers who earn nearly all of their income from work. Moreover, changing the way California taxes capital gains would reduce the rate of growth in personal income tax revenues over time. Far from being the cause of California’s budget woes, the personal income tax has provided the strongest growth over the long haul of any of the state’s major revenue sources. Much of this high rate of growth reflects the significant gains posted by the highest-income earners, which in turn reflects a substantial rise in capital gains and other income from investments. Cutting taxes on capital gains and/or the highest-income Californians would be like killing the goose that laid the golden egg because it only lays eggs four years out of five. Four golden eggs are still better than none.
— Alissa Anderson and Jean Ross