Weekly Economic Update – October 1, 2018 – CA and Taxes

The L.A. Times is publishing a series called The Next California and part one, Can California’s next governor fix the state’s problems? was released last week.  Not surprisingly they have pointed out something that the majority of public officials, business and civic leaders have known for years – CA’s tax system is stuck in the 20th century, while our economy is moving forward into the 21st century.  A few years ago I drafted a white paper on this issue for the L.A. Coalition and since then, what has struck me the most, is the fact that the state’s budget continues to grow unchecked and a large majority of Californians are content with fewer and fewer people paying the tab.
When Jerry Brown first became governor in 1975, the general fund budget was under $10 billion.  When Jerry’s former chief of staff Gray Davis was in office in 2000 the budget was $100 billion.  When I wrote my tax paper in 2014 the budget was $150 billion.  The current budget is $200 billion and nearly 70 percent of its revenue comes from the personal income tax.  In 2016, the top 1 percent of filers paid nearly 46 percent of income tax revenue and .007 percent of CA’s nine million taxable returns financed approximately 25 percent of the state budget.  The L.A. Times illustrated this point with micro data that showed just under $1 billion in state revenue coming from nearly 9,000 tax returns filed in 94301 (Palo Alto) in 2016 — more revenue than from any other ZIP Code in California.
There are two points that continue to be raised in light of this imbalance – CA’s tax system creates too much volatility, when the economy declines the state’s budget and all that it finances – schools, social services, parks, health care, to name a few, get cut back drastically.  In 2009 Governor Schwarzenegger faced a $39.5 billion funding gap. Secondly, more and more people are making the argument that CA’s high tax climate and outdated tax structure are driving out businesses, workers and investors.  It is safe to say that indirectly forcing people to move because the state cannot foster the creation of enough good paying work opportunities, affordable housing units and properly funded public schools, will have long-term consequences. The other issue that seems to escape attention is the increasing burdens – fines, fees, utility and sales taxes and license requirements – that local authorities are imposing on the middle and lower classes each year with little oversight.  
The latest Census Bureau data, from July 2016 to July 2017, shows that more people moved out of CA to other states, than moved in from other states. In other words, CA lost people due to domestic migration.  During that 12-month period, CA saw a net loss of just over 138,000 people, while Texas had a net increase of more than 79,000 people. Arizona gained more than 63,000 residents, and Nevada gained more than 38,000.
The majority of those moving are lower-income residents, although more middle-class residents are doing the same.  The state’s general fund is barely impacted by this flight.  According to the Legislative Analyst’s Office, households making $50,000 or less make up nearly 60 percent of tax filings but make up just 2 percent of revenue.  As more jobs are created in our growing economy, this flight will start to have an impact.
There is also a growing concern that the state will lose more individuals who are making more than $500,000 or more a year.  Two things are driving this.  Proposition 55, a ballot initiative past just a couple of years ago, continues to impose a higher personal income tax on CA’s high wage earners until 2030, generating up to $9 billion in additional revenue each year.  At some point we need to pay attention to how the state is spending this additional money.  Is it being used for one-time expenses or long-term programs.  Is it truly funding public schools and teachers or paying for unfunded state pensions and health care plans.  As some point in the next five to seven years, the odds are CA’s will vote once again to continue this tax again.
For now I would argue that those who are trying to preserve their wealth will be more mobile, then those who are looking to create wealth.  CA is still a land of endless opportunity to still do that.  But for know, we have to pay attention to the lose of those who fund our broken tax system and those who are creating and supporting skilled talent.  The slow and steady decline of jobs in entertainment, manufacturing and aerospace jobs throughout the past three decades was very similar to the slow leaking of a ballon.  One hundred jobs here and there add up pretty quickly.
For now experts predict a generally upbeat forecast for the state’s economy in the near term. Brown’s own Department of Finance projects continued growth in the civilian labor force, wages and salaries and construction through 2021, albeit at a slower pace than California’s recent gangbusters expansion.  And by next summer, the state’s cash reserves will total $15.9 billion, and  that should provide some protection in the next recession, but the LAO estimates that a mild recession would lead to a $40-billion decline in revenues, leading to a $20-billion deficit. A moderate recession could slash revenues by $80 billion, leading to a $40-billion shortfall.
As for now, the core of my white paper highlights the flaws of our tax system and the same items that continue to be discussed in Sacramento.  State Sen. Bob Hertzberg (D-Van Nuys) continues to call for a sales tax on services.  And a partial revision of Proposition 13 — a so-called “split roll” that would tax commercial properties based on market value, instead of purchase price — has gained popularity in liberal quarters and may be on the ballot in 2020, but it faces stiff resistance from business interests.  Environmentalists have encouraged a tax on extraction from California’s oil or natural gas reserves, a move fiercely opposed by oil companies.
Gubernatorial candidates, policy and political experts say true overhaul would require a combination of multiple proposals, spreading the pain evenly among interest groups.
As a reminder here is where the two Gubernatorial candidates stand:
Gavin Newsom
On Record:  ”I’m going to assert an ideal, absolutely, unequivocally, without hesitation we need to reform our tax code in this state. And if there’s nothing that the Trump tax cuts have proven, it’s the exposure now we have and the vulnerability we have with the 13.3 percent tax code, 8.84 [percent] on the corporate side, a very high regressive sales tax and then this sort of stale debate around Prop 13’s split roll…I think this is a multi-year effort. I’d rather have this debate than just have an isolated debate around Prop. 13 split roll and another stale debate around oil severance tax. Let’s throw it all in the hopper. Let’s modernize our tax code. Let’s incentivize for the kind of behavior we’re looking for which is growth and inclusion and let us be more competitive, and let us be bold…”
John Cox
On Record: “I don’t understand why Florida and Texas are able to operate without an income tax. And we have the highest in the nation. Not only that, by the way, we have the highest sales taxes. The highest gas taxes. And people tell me, by the way, oh but our property taxes are much lower, well I beg to differ and he says the state needs to overhaul its tax system.”  Though be states that the regulations in CA are way, way worse than the tax bite.