Taxation & Fiscal Policy
California’s taxation policy has come under increased scrutiny during our state’s recent fiscal crisis. Taxes – including income, sales, and property tax payments – bring in most of the money that the state needs to provide Californians critical services like schools, social services, and public safety. Taxes are paid by California residents and large and small businesses.
Some believe our tax structure is fine the way it is, while others believe we should consider changes. A conversation about tax reforms raises many questions, including: How high should our taxes be? How much should individuals at different income levels pay? How much should businesses pay? What economic transactions should be taxed, and what should not be taxed? How can we strike the right balance between allowing tax deductions for things like home ownership and raising a family vs. simplifying the tax laws?
Basic Structure: State and local governments collect revenue from three sources: fees (like drivers’ licenses; the state “car tax,” also known as the vehicle license fee; and state park entry fees), taxes (like state, property, and personal income tax) and intergovernmental transfers between federal, state and local governments. In California, the state pays a larger share of local government costs than most other states. This is in large part due to the passage of Proposition 13 in 1978, a ballot initiative that capped property taxes. When Proposition 13 reduced property tax revenue, which fund local governments and school districts, the state offset the lost revenue by sending billions of dollars to local governments to make up for these cuts. This funding has decreased over the years, however, as the state’s overall fiscal condition has worsened.
It is difficult to raise taxes in California. Proposition 13 also required that state lawmakers need a two-thirds majority vote in each house of the legislature to raise state taxes. Through the initiative process, voters can change state taxes by a simple majority. Raising or lowering local taxes and some fees requires approval by both the elected governing body (a city council or county board of supervisors) and the voters, with a vote threshold that varies among types of taxes and fees from a simple majority to a two-thirds majority.
How much do Californians pay?: One reason that California spends and taxes more per capita than other states is that both incomes and the cost of living here are above the national average. As incomes rise, state and local governments spend more, partly because government employee salaries are higher in states with higher salaries in the private sector. State and local taxes in California were roughly 11.7% of personal income in 2008, compared to 11.0% for the entire U.S. That is, for every $10,000 in income, Californians pay about $70 more in state and local taxes than the average for all states. California does not have the highest taxes in the U.S. The state with the highest taxes is New York, where taxes account for about 14.5% of personal income. Additionally, California’s personal income, corporate income, unemployment, and disability insurance taxes are significantly higher here than elsewhere.
What taxes are lower in California than in other states? Due to Proposition 13, Californians pay lower property taxes than the U.S. average. And although we have one of the highest retail sales tax rates in the nation, 8.25 percent, Californians pay a lower fraction of their incomes in sales taxes than the U.S. average. This is because we exempt more goods and services than other states do, and excise taxes, which are added to specific products such as alcohol, tobacco and motor fuel, are generally lower in California than elsewhere.
State spending: California spends about $11 billion more than the national average (accounting for population differences) on public safety, including police, fire, prisons, and jails. The state spends about $12 billion more than average on government-owned utilities, including state and local departments of water and power. We also exceed the national average in spending on public insurance, health care, public employee pensions and community development (including housing). Californians spend below the national norm on many other programs, including schools (per student spending now ranks near the bottom in the nation), higher education (support for community colleges, CSUs and UCs has dropped dramatically over the past few years), welfare and public roads. The chart below shows a recent proposal for our state spending.
What Californians pay based on income: Overall, state and local taxes in California are regressive, that is, the portion of income that is paid in state and local taxes is higher for low-income families, also less so than the average of all states. The most regressive major tax in California is the sales tax. The poorest 20% of households pay 6.5% of their income in sales taxes, compared to 0.8% for the top one percent. However, California’s corporate and personal income taxes are highly progressive, and more than 75% of total state and local taxes are paid by the wealthiest 1% of households in California.
Key Issues with Designing the Tax/Fee System: Tax systems are influenced by many factors, including political opinion. But there are some principles of tax policy that have been used for many years to think about the effects of different tax systems on taxpayers and the economy. As you discuss the possibility of tax reform, you might consider these principles, including: budget balance, or the idea that what we collect in tax revenues should roughly equal what we spend; volatility, or the degree to which a particular tax system may exacerbate the natural ups and downs in the economy from year to year, which can make it hard for governments to plan; fairness, or the way taxes are distributed among households with different incomes, as well as the differences in taxes among households with the same income but different spending patterns; and simplicity, which is often desired by voters but in conflict with the plethora of different types of taxes, exclusions, deductions and credits built into the system and that voters tend to support.
Here are some, but certainly not all, choices to consider for state tax policy:
- Don’t tinker with our tax structure. It may have its flaws, but it generally works for Californians.
- Consider proposals for improving budget stability, including: “pay as you go” requirements for any law that creates new programs or reduces taxes; prohibiting spending one-time revenues on ongoing programs; or increasing the size of the state’s “rainy day fund” to a targeted 10% of the state budget.
- Think about measures that would bring more fairness to the tax system, like expanding the sales tax base to include services as well as goods, and eliminating the current state income tax deduction for home mortgage interest payments.
- Revisit Proposition 13. Keep the spirit of the measure alive by protecting against reassessment for homeowners but modify its property tax provisions.
- Lower the state legislative supermajority vote requirement for increasing taxes, which may make balancing the budget easier and end the costs and hardships of the annual delay in passing the state budget.
- Lower the vote requirement for local governments to pass special taxes to a simple majority, which would give local governments more power to increase revenue and might better reflect the preferences of local communities.
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