California Loses Nearly $70 Billion Annually Through Tax Breaks

Introduction

Californians need quality public health and schools, access to affordable housing and clean water, and safe roads and neighborhoods along with many more services to live and thrive – no matter one’s zip code. Accordingly, the state’s tax and revenue system must raise adequate revenue to cover the services provided by state and local governments and make ongoing investments to meet the needs of Californians. However, policy choices of the past and present shape whether revenues are equitably raised and who is contributing a fair share of their income to California’s revenue. State policymakers can make the tax and revenue system more equitable by strengthening taxation of Californians with high incomes and wealth while providing more support to Californians with low incomes and Californians of color who have been blocked from income- and wealth-building opportunities.

This 5 Facts explains main concepts associated with tax equity and illustrates how elements of California’s tax and revenue system further or impede the goals of economic and racial equity for households, communities, and the state.

1. Taxes Can Be Progressive, Proportional, or Regressive — Depending on How They Impact People Across Income Levels 

A key aspect to tax equity is how a tax — or a tax system as a whole — impacts households across income levels. One way to measure this is by comparing effective tax rates —meaning the share of one’s income paid in a tax — of people in different income groups. A tax is considered progressive when households with higher incomes have higher effective tax rates than those with lower incomes. The opposite of a progressive tax is a regressive tax. With regressive taxes, people with lower incomes have higher effective tax rates than people with higher incomes. Finally, a tax is considered proportional when people at all income levels have the same effective rates. Progressive taxes are the most equitable taxes, since they ask the most from people who have the most ability to pay.

People with lower incomes must spend larger shares of their income just to meet their basic needs, leaving them with less ability to pay taxes. For example, almost 6 in 10 low-income California households spend more than half of their income on housing alone, compared to just 2% of high-income California households.¹Aureo Mesquita and Sara Kimberlin, Staying Home During California’s Housing Affordability Crisis (California Budget & Policy Center, July 2020), https://calbudgetcenter.org/resources/staying-home-during-californias-housing-affordability-crisis/. Data are for 2018. “Low-income California household” is defined as a household with income below 200% of the federal poverty threshold — roughly $51,000 for a family of four in 2018 — and “high-income California household” is defined as a household with income of at least four times the federal poverty threshold — roughly $102,000 for a family of four in 2018. In other words, after covering the basics, Californians with lower incomes have much smaller portions of their total incomes available to pay taxes than higher-income Californians. It follows that a fair tax system should take a smaller fraction of the income of low-income households.

2. California’s Personal Income Tax Is Highly Progressive, Asking the Most from Those with the Highest Ability to Pay

Californians with higher incomes pay a larger percentage of their income in personal income taxes than people with lower incomes because higher portions of income are subject to higher tax rates.²California’s personal income tax rates range from 1% to 13.3%. The top rate for each tax bracket, or range of income, is only applied to the amount of income that exceeds the income threshold for that bracket. In other words, high-income people face the highest effective tax rates with regard to the personal income tax. Additionally, the state has two refundable tax credits, the California Earned Income Tax Credit (CalEITC) and the Young Child Tax Credit, that provide refunds to families with very low incomes, creating a negative effective tax rate for them. The personal income tax is the state’s largest revenue source.

The progressive structure of the personal income tax also improves racial equity, since Latinx and Black Californians have lower average incomes than white Californians due to racist policies and practices in employment, education, and every other facet of society.³Carl Davis, Marco Guzman, and Jessica Schieder, State Income Taxes and Racial Equity: Narrowing Racial Income and Wealth Gaps with State Personal Income Taxes (Institute on Taxation and Economic Policy, October 2021), 11, https://itep.sfo2.digitaloceanspaces.com/State-Income-Taxes-and-Racial-Equity_ITEP_October2021.pdf; Adriana Ramos-Yamamoto and Monica Davalos, Confronting Racism, Overcoming COVID-19, and Advancing Health Equity (California Budget and Policy Center, February 2021), https://calbudgetcenter.org/resources/confronting-racism-overcoming-covid19-advancing-health-equity/. As a result, the effective state personal income tax rate is lower on average for Latinx and Black families (3.6% and 4.0%, respectively) than for white families (5.0%).⁴Davis, Guzman, and Schieder, State Income Taxes and Racial Equity, 11-12. Tax agencies do not collect racial or ethnic information, so the Institution on Taxation & Economic Policy estimates effective tax rates by race/ethnicity by combining tax data and US Census Bureau American Community Survey data using a methodology explained here: https://itep.org/itep-tax-model/iteps-approach-to-modeling-taxes-by-race-and-ethnicity.

3. California’s Sales and Excise Taxes Are Regressive, Asking the Most from Those with the Least Ability to Pay

In contrast to the personal income tax, the sales and use tax is regressive. This is because people with lower incomes need to spend larger shares of their income to cover basic needs, so sales taxes take up larger shares of low-income households’ budgets. The sales and use tax is the state’s second-largest revenue source.

Excise taxes, which are taxes on specific goods including gasoline, alcohol, and tobacco, are also highly regressive. Like sales taxes, excise taxes hit people with lower incomes hardest since any money they spend on items subject to excises taxes will generally make up a larger share of their overall budgets compared to high-income people. In addition, since excise taxes are generally based on the volume of the purchase rather than the price, people at all income levels pay the same tax on a given amount of a product, whether they buy an economical brand or a more expensive brand.⁵Meg Wiehe et al., Who Pays: A Distributional Analysis of the Tax Systems in All Fifty States (Institute on Taxation and Economic Policy, October 2018), 19-20, https://itep.sfo2.digitaloceanspaces.com/whopays-ITEP-2018.pdf. 

The 20% of California families with the lowest incomes pay 7.4% of their incomes in combined state and local sales and excise taxes, compared to 0.8% for the richest 1%. Again, because Black, Latinx, and many other Californians of color are more likely to have low incomes than white Californians, regressive taxes like sales and excise taxes exacerbate racial inequity. 

4. California’s State and Local Tax System Could Be More Progressive

The overall impact of the state and local tax system on Californians is determined by the combination of the progressive personal income tax and regressive sales and excise taxes, as well as other taxes levied by the state and localities — most notably local property taxes and corporate income taxes. The combined impact is a state and local tax system that is regressive for people with lower incomes and progressive for people with very high incomes. The richest 1% of California tax filers pay the largest share of their income in state and local taxes (12.3%), but the 20% of filers with the lowest incomes pay the next highest share (11.4%). While the richest Californians pay a smaller portion of their income in sales, excise, and property taxes than any other group, it is made up for by the larger share of their income that goes to income taxes. Conversely, while the bottom 20% of Californians on average get money back from the personal income tax system via refundable tax credits, this is not enough to make up for paying larger shares of their income in sales, excise, and property taxes.

5. California’s Tax System Rewards Wealth but Doesn’t Tax Wealth

Wealth inequality is even more pronounced than income inequality, and racial wealth gaps are larger than racial income gaps. Many state tax policies contribute to wealth inequality and racial wealth gaps by providing substantial tax benefits to families who have assets like homes and retirement plans — such as the deductions for mortgage interest and property taxes, the partial tax exemption on the proceeds of home sales, and tax-privileged retirement accounts. Black, Latinx, and other people of color receive less of these tax benefits because — due to structural racism and discrimination — they are less likely to be homeowners, to be in jobs with access to employer-sponsored retirement plans, and to have the financial means to save or invest in assets.⁶Kayla Kitson, Promoting Racial Equity Through California’s Tax and Revenue Policies (California Budget & Policy Center, April 2021), 5, https://calbudgetcenter.org/resources/promoting-racial-equity-through-californias-tax-and-revenue-policies; Kayla Kitson, Tax Breaks: California’s $60 Billion Loss (California Budget & Policy Center, January 2020), 6-8, 10-11, https://calbudgetcenter.org/resources/tax-breaks-californias-60-billion-loss. At the same time, accumulated or inherited wealth is not taxed in California. Policymakers can eliminate or limit tax benefits that most advantage wealthy families and explore other options to better tax Californians who have amassed large amounts of wealth. The resulting revenues could then be directed to investments that help families who have been shut out from wealth-building opportunities achieve economic security and build wealth.

Conclusion

There are many dimensions to ensuring that a tax system equitably generates the revenue needed for Californians to care for their families, build healthy communities, and contribute to a strong economy. Policymakers need to consider how any tax policy could have disparate effects on Californians by income, wealth, and race/ethnicity — as well as other factors not discussed in this fact sheet, such as gender, family structure, and income source.

The state’s current tax and revenue system is not fair for all Californians. People with the lowest incomes should not be paying larger shares of their incomes in state and local taxes than most other income groups, and the state’s tax policies should work to narrow racial wealth gaps, not widen them.

California policymakers can make the tax and revenue system more equitable. This includes ensuring that Californians with high incomes and wealth pay their fair share to support critical state services, providing further support for Californians with low incomes — such as by increasing and expanding refundable tax credits and making other tax credits refundable to benefit more low-income households — and eliminating or reforming tax benefits that primarily help wealthy Californians. Moving toward more robust taxation of Californians with higher income and wealth would also generate revenues that can be spent equitably to help more low-income households and Californians of color live and thrive, and expand opportunities to build wealth for themselves, their children, and their communities.

Introduction

Legacies of historical racist policies and ongoing discrimination in areas such as education, employment, and housing have barred many Californians of color from economic opportunities. As a result, Californians of color — particularly Black, Latinx, and American Indian Californians — are less likely to have high incomes and to have built enough wealth to be able to weather periods of income loss, retire comfortably, and pass on wealth to their children. These barriers have also made Californians of color more likely to have experienced health and economic consequences of the COVID-19 crisis. One area policymakers should consider in efforts to address these inequities is the state’s tax and revenue policies. Although these policies may appear race-neutral, they can play a significant role in either worsening existing racial and ethnic income and wealth disparities or promoting greater equity for Californians. A policy need not be explicitly racist in order to have racially inequitable outcomes.¹ Because many current state tax policies privilege Californians with higher incomes and wealth, they widen existing racial inequities. Policymakers can also use tax policy as a tool to promote racial equity, both by making the tax code itself more equitable, and by raising revenue to invest in the social and economic well-being of Californians of color.

1. Legacies of Racist Policies Have Led to Significant Racial Income and Wealth Inequality in California

Centuries of racist policies, from enslavement, land theft, and genocide to educational and residential segregation, inadequate employment antidiscrimination laws, overpolicing and overincarceration of communities of color, and other forms of ongoing discrimination have locked many people of color out of opportunities to build income and wealth.² As a result, American Indian, Black, Latinx, and Pacific Islander Californians are less likely to have high incomes than white and Asian households.³ For example, Black households represent only 3% of the richest one-fifth of California households, even though they make up 6% of all California households.⁴ Latinx households represent 14% of the richest fifth compared to 30% of all households. And while American Indian and Pacific Islanders make up very small shares of California households, they represent even smaller shares of the richest 20%.⁵ There are also stark differences in wealth — assets minus debts — between racial and ethnic groups. The median wealth of Black and Latinx families in the United States in 2019 was $24,100 and $36,100, respectively, compared to $188,200 for white families.⁶ This racial wealth gap leaves Black and Latinx families at a significant disadvantage in their ability to weather crises like the current COVID-19 pandemic and recession, to save for retirement, and to pass wealth on to their children.

2. Many Tax Breaks Benefit People with Higher Incomes, Worsening Racial Inequities

California is expected to lose over $60 billion in state revenues in 2021-22 to personal income tax breaks, some of the largest of which provide the majority of benefits to high-income families.⁷ For this reason, many tax breaks disproportionately benefit white and Asian Californians and provide little to no benefits to many other Californians of color. For example, many tax benefits are only available to those who opt to “itemize” their tax deductions, and people who itemize tend to have higher incomes. California’s four largest personal income tax deductions provide more than three-quarters of their benefits to families with incomes over $100,000, who are generally the richest 20% of families, while providing nearly no benefits to those with incomes below $20,000.⁸ American Indian, Black, and Latinx Californians are more likely to have low incomes, so they are less likely to benefit from these tax breaks.

3. Costly Tax Breaks for Homeowners Are Less Likely to Benefit Californians of Color

California provides several tax benefits for homeowners, including the deductions for mortgage interest and property taxes, which are respectively projected to cost the state $4.1 billion and $3 billion in 2021-22. Racist policies and practices have blocked many Californians of color from homeownership, so they are less likely to benefit from these tax breaks. In California, Black, Latinx, and Pacific Islander households own homes at rates below the state average of 55%, while American Indian, Asian, and white households own homes at rates at or above the state average.⁹ In addition, many homeowners of color have lower-valued homes — largely due to residential segregation and racially biased appraisal practices — and therefore generally lower mortgage interest and property tax expenses, resulting in smaller tax benefits for these expenses.¹⁰ Moreover, these tax benefits are unlikely to help many families of color become homeowners, since the main barrier to homeownership is down payment costs, not mortgage interest or property taxes.¹¹ By rewarding families who would have purchased homes anyway instead of helping families of color become homeowners, these tax breaks protected by policymakers perpetuate the racial wealth gap. Better-targeted assistance such as down payment assistance or a first-time homebuyer tax credit may be more likely to increase homeownership among these families.

4. Refundable Tax Credits Increase Racial Equity by Boosting Incomes for Low-Income Californians of Color

Refundable income tax credits are the only tax credits that help families with very low incomes.¹² As a result, these credits are more likely to benefit American Indian, Black, and Latinx Californians, who are more likely to have low incomes due to racist economic, education, and employment policies and practices. California has two refundable tax credits, the California Earned Income Tax Credit (CalEITC) and the Young Child Tax Credit, which boost the incomes of Californians with incomes under $30,000.¹³ Around 3 in 4 Californians eligible for the CalEITC are people of color, including about half who are Latinx.¹⁴ However, the amount the state spends on these two credits is only about 2% of all state spending on tax breaks for individuals. Policymakers could improve racial equity in the state by increasing the CalEITC and the Young Child Tax Credit or by converting other tax benefits into targeted, refundable credits, which would provide greater benefits to lower-income families of color.

5. Taxing Wealth and High Incomes Would Reduce Racial Inequity and Raise Revenue to Help More Californians Thrive

Even before the COVID-19 crisis devastated many communities of color, racist policies and discrimination blocked many of these Californians from accessing well-paying jobs, safe and affordable housing, and a quality education. Meeting these critical needs and building a more equitable California where everyone can thrive will require significant investments supported by additional revenues. Raising needed revenues equitably means asking more from Californians with the greatest ability to pay. Policymakers could significantly narrow racial income and wealth inequality by using these revenues to help people of color boost their incomes and build wealth in the long run. State leaders could explore raising top income tax rates, eliminating or cutting back tax breaks that primarily benefit higher-income people, or tapping into the state’s vast wealth with a tax on inheritances, estates, or net worth. California does not directly tax wealth and does not currently have an inheritance or estate tax. Inheritances make up a significant share of the total wealth for many, yet people of color are much less likely to receive inheritances.¹⁵ Reinstituting a tax on large inheritances could reduce the racial wealth gap, especially if the revenues were used to increase wealth-building among Californians of color who have been historically locked out of such opportunities.¹⁶

Policymakers Can Build a More Equitable California by Improving Tax and Revenue Policies

 The racial, ethnic, and economic inequities that have been made painfully clear by the COVID-19 pandemic and recession are nothing new for California’s communities of color. The inequities are the product of centuries of policies and practices that have put Californians of color, particularly Black, Latinx, and American Indian Californians, at a significant economic disadvantage. California’s leaders need to do more than help the state recover from the current crisis; they need to change how the state raises and allocates resources to address the long-standing inequities hurting Californians of color.

Policymakers should start by re-examining and restructuring the state’s tax and revenue system. The goals of this effort should be twofold. First, policymakers should make the tax code itself more equitable by limiting or eliminating tax breaks that primarily benefit the already wealthy and expanding or creating new tax benefits that reach Californians with low incomes and help families build wealth. For example, the state could increase the CalEITC and Young Child Tax Credit, increase the existing renter’s tax credit and make it refundable, provide a tax credit for first-time homebuyers with low and middle incomes, and provide better-targeted incentives to save for retirement.¹⁷ Second, policymakers should explore opportunities to raise sufficient revenues from those who have been provided the most advantage by past racist and classist policies to fund investments to support Californians who have been provided the least advantage. Investments could include moving toward universal health care, making child care, housing, and higher education more affordable, and expanding children’s savings accounts or creating a “baby bonds” program to help families save for their children’s futures.¹⁸ Policymakers have an opportunity to improve the state’s tax code to make the investments needed now to ensure that more Californians have the ability to achieve economic stability and build wealth for their families and future generations.

Endnotes can be found in the publication PDF here.

Introduction

Yet, profitable corporations are contributing less in taxes that support these public services, as a share of their California income, than a generation ago. This Issue Brief shows how far corporate taxes have fallen as a share of corporate profits in California, explains several reasons for the decline, and points to inequitable policies that provide larger benefits to corporations that are thriving than to small businesses and Californians who are struggling to live and work in the state. By examining and limiting corporate tax policies that benefit multinational corporations and big businesses, California policymakers have an opportunity to advance a more equitable tax structure, raise revenue for critical services, and achieve a vibrant state and economy that serves more people.