With today being Tax Day — the deadline for filing personal income taxes — it’s a natural opportunity to reflect on what the federal tax bill enacted late last year, the Tax Cuts and Jobs Act (TCJA), means for California. It’s also a chance to highlight the divergent paths pursued by California and by our federal policymakers, and what this says about future choices our state could make.
We often point out that tax policy choices are not only a means to an end, allowing us to collectively generate the resources needed to invest in building strong and vibrant communities, but can also be ends in themselves, with the potential to broaden (or seriously constrain) economic opportunity.
The Federal Path: A Wrong Direction for Our Nation — and Our State
In late December 2017, President Trump signed the TCJA into law after Congress — with 12 of California’s 14 Republican House members voting “yes” — approved this deeply flawed tax plan. The TCJA heavily favors corporations and wealthy households, substantially increases the federal deficit, and paves the way for major federal cuts to services that help middle- and low-income households afford the basics and access economic opportunity. Notable provisions of the tax plan include:
- Cutting the corporate tax rate by well over a third, from its prior 35% to just 21%, the largest one-time reduction in US history.
- Allowing so-called “pass-through businesses” — partnerships, S-corporations, and sole proprietorships — to shelter up to 20% of their business income from federal taxation.
- Cutting the top personal income tax rate, which applies to just the wealthiest households, from 39.6% to 37%.
- Doubling the amount of estate value that is exempt from the estate tax; the exemption level was previously $5.49 million per person ($10.98 million for couples). In addition to reducing federal revenues, boosting the exemption to over $10 million per person (and more than $20 million for couples) means fewer households are subject to the estate tax at all, which, as we’ve noted before, already only applies to a small fraction of the wealthiest households.
- Capping the mortgage interest deduction (MID) for future home purchases at $750,000 of mortgage debt, down from the previous cap of $1 million. This is a particular blow to families who are saving to purchase a home in very-high-cost areas in the US, many of which are in California, and so puts owning a home out of reach for many middle-income California families.
- Weakening the Affordable Care Act (ACA) by eliminating its “individual mandate,” which requires most people to have health insurance or pay a penalty. Ending the individual mandate will likely cause health insurance premiums to increase, as we have discussed earlier, and could mean 13 million fewer Americans with health coverage by 2027, including an estimated 1.7 million here in California.
Meanwhile, parts of the bill that the GOP leadership claimed would benefit middle- and low-income families actually provide very little for most families and make these parts of the tax bill temporary, even as the provisions favoring corporations and wealthy households are permanent. As we noted in an earlier post, in the initial years of the TCJA, the wealthiest taxpayers and corporations receive the largest tax cuts, while lower- and middle-income taxpayers receive, on average, much more modest reductions. By 2027, the TCJA continues to provide big tax cuts to the richest taxpayers, at the same time that those at the bottom of the income scale would face higher taxes due to expiring tax cuts.
Conservative proponents of the TCJA argued that the tax cuts would pay for themselves by generating significant economic growth. However, the CBO recently reported that the tax cuts will add significantly to the federal deficit and federal debt. The CBO estimates that the tax cuts will increase projected deficits by $1.9 trillion from 2018 through 2028, even after accounting for any effect of the TCJA on economic growth.
Despite proponents’ claims of economic benefits, these results are not accidental. Tax cuts for the wealthy and corporations, and increases in deficits and debt, eventually have to be paid for, leading to cuts in vital programs and services. In the lead-up to the TCJA, Republicans in Congress passed a budget framework calling for $5.8 trillion in cuts over the next decade to key federal supports like Medicaid, Medicare, SNAP food assistance (CalFresh in California), student aid, and affordable housing, among a wide range of cuts to domestic programs. More recently, as part of the plans to renew the federal Farm Bill, Republican congressional leaders have proposed cuts in eligibility for the SNAP program that would increase hunger and hardship by taking food assistance away from many struggling Americans.
For California, the implications of the fiscal path pursued by federal policymakers are significant on many levels. A budget framework slashing Medicaid and a range of other critical services would amount to cutting funding for the state governments that help deliver these programs, forcing state leaders to make difficult choices between reducing services for low-income households and maintaining them at the expense of the state’s fiscal health.
The combined effect of the pathway chosen by federal leaders is to bankroll major tax giveaways to wealthy households and major corporations, increase deficits and debt, and pave the way for future cuts to publicly funded supports that help individuals and families attain economic security.
The California Path: Investing in the Foundations of Broadened Prosperity
In contrast to the recent choices made at the federal level, California in prior years has pursued an alternative pathway. In 2012, California voters supported Proposition 30, temporarily raising the personal income tax (PIT) rates for very high earners through 2018 and the state sales tax rate by a quarter-cent through 2016. Then, in 2016, California voters approved Proposition 55, which extended the higher PIT rates through 2030. The increased revenues for these measures, in combination with economic growth, has helped lay the groundwork for a range of policy choices that benefit individuals, families, and communities across our state. These include creating, and later expanding, a state Earned Income Tax Credit (CalEITC); raising the state minimum wage; increasing funding for K-12 schools by nearly $20 billion; beginning to reinvest in child care and preschool; expanding health care coverage; and enacting a new retirement security option for private sector employees. Last year, Governor Brown and state legislative leaders passed a 10-year, $54 billion package of transportation and infrastructure investments funded through the first increase in the state’s gas tax in 23 years and other fuel- and vehicle-related fees. Also last year they enacted a housing package that provides new funding for affordable housing and asks California voters to approve a $4 billion housing bond this coming November.
Alongside these and other areas of progress, the state maintained and improved its fiscal health, in many cases with the approval of California voters. This has included creating and building up a new state rainy day fund, putting in place a series of reforms to help more sustainably fund state retirement systems (with admittedly more work to do), and paying off shorter-term budgetary debt that was incurred during prior fiscal crises.
What’s more, these choices have been matched by improving economic conditions in our state — increases in personal income, decreases in the unemployment rate and increases in overall employment, and one of the longest periods of economic expansion in postwar history.
In short, the pathway that California has opted to pursue positions the state to build on this recent progress through future choices that we can make to broaden and deepen economic opportunity.
Key Tax Choices Could Lie Ahead for California
The issue of taxes is likely to remain front and center in California, even after this Tax Day has passed. State leaders are considering a number of options for responding to the TCJA, with an eye toward protecting California’s fiscal health and ensuring that smart public investments, including those mentioned above, can be sustained. California’s responses will likely play out over the next couple of years as the state learns more about the implications of the TCJA for California residents, public investment, and the fiscal health of state and local governments.
Looming near on the horizon, our state’s voters could have the opportunity to weigh in on several tax initiatives on the November 2018 ballot. And, these generally stand in stark contrast to the California pathway outlined above.
One such ballot measure, put forth by the California Association of Realtors, would allow homeowners who are 55 or older, and whose property taxes have been kept artificially low by the restrictions imposed by Proposition 13 (1978), to take their low property tax base with them after selling their existing home and buying another home anywhere in the state, with no limit on price or the number of times they can change homes. (Currently, they can only take their lower property tax base with them once, only to one of 11 counties that permit the transfer, and only if the new home has a lower value than their current home). According to the Legislative Analyst’s Office (LAO) analysis, this measure would reduce property tax revenues to local governments: “In the first years, property tax losses would be several hundreds of millions of dollars per year, with schools and other local governments each losing a few hundred million annually. Over time these losses would grow, likely reaching several billion dollars per year in the long term, with schools and other local governments each losing a few billion dollars annually.” The measure amounts to intergenerational warfare, permanently holding down property taxes for Californians 55 years and older at the expense of investments in schools, housing, infrastructure, supports for low-income families, and other vital local services.
Another measure (currently in two versions), sponsored by the California Business Roundtable, seeks to change the rules for how local and state governments can impose taxes, fees, and other charges. Most notably, this measure would raise the vote threshold for approving local general taxes from a simple majority to two-thirds of the electorate and, further, would expand the definition of taxes to include some charges that local and state governments currently treat as non-tax levies. The LAO analysis of the proposed changes notes that they could lead to a “potentially substantial decrease in annual local revenues, depending upon future actions of local governing bodies, voters, and the courts” and also indicates that roughly half of recently enacted local tax measures would have failed under the proposed higher threshold. By expanding the definition of what is a tax, and requiring a two-thirds vote by the electorate, this measure would largely tie the hands of local governments as to raising the revenues needed to adequately fund schools, public safety, housing, infrastructure, supports for low-income families, and other vital local services.
The November ballot also will likely include a measure calling for the repeal of the gas tax and other transportation-related taxes that were part of the last year’s transportation package, noted above. What’s more, the measure would require the Legislature to obtain voter approval to impose any similar taxes in the future. In other words, the measure would undo the core funding for a much-needed and long-overdue investment in the state’s transportation infrastructure while also making it harder to approve such investments in the future.
All three of these tax measures, which could appear on the November statewide ballot, stand in stark contrast to California’s overall approach to raising revenues, and to the progress our state has made, in recent years. Moreover, all three measures seek to permanently limit the options that state and local leaders have for making the kinds of public investments that foster sustained economic growth, broaden economic opportunity, and benefit families and communities across our state. And, much like last year’s federal tax bill, these three tax-related proposals seek to concentrate the benefits of economic growth in a smaller number of hands at the expense of everyone else.
On this Tax Day, we look ahead to the prospect of state policymakers deliberating on how to respond to the federal tax bill and to a November 2018 ballot that will likely ask Californians to vote on several potentially harmful tax measures. It’s an opportunity to consider: Will California continue to lead and, in so doing, build on our recent progress?
Stay tuned for the Budget Center’s analyses of tax proposals, and related policy issues, in the coming months.
— Chris Hoene