Governor-elect Gavin Newsom says he hopes to amend the California tax code to lessen its dependence on income and capital gains taxes paid by the very rich. Yet the last two serious attempts at tax reform were both dead on arrival, and the political dynamics since their failure appear unchanged or even more unfavorable.

With the state overdue by historical standards for another recession, Newsom is well aware of the revenue nightmare that is looming. After the Great Recession hit a decade ago, state revenue plunged nearly 20 percent – leading to harsh budget cuts in education, public health and social services. Since income and capital gains taxes generate about two-thirds of state revenue, volatility is common.

The revenue decline a decade ago led then-Gov. Arnold Schwarzenegger to create a commission that in 2009 recommended slashing taxes on income and capital gains while imposing taxes on broad categories of services including legal work, haircuts and tickets to sports and entertainment events. The goal was a tax code rewrite that was initially revenue-neutral but that could end up creating considerable new revenue because of provisions designed to promote economic growth.

Democrats see income-tax cut as gift to rich

Yet while commission heavyweights like former Treasury Secretary George Shultz and many economists touted the wisdom of the proposal, the commission’s tax-overhaul blueprint was blasted by both parties from the moment it was released.

Democrats said the plan was a giveaway to the rich. Republicans knocked it for expanding government taxation to new areas.

The scheme – dubbed the Parsky plan because Rancho Santa Fe GOP businessman Gerald Parsky chaired the commission – never even came up for a committee hearing.

Six years later, in 2015, state Sen. Robert Hertzberg pushed a similar proposal, but with a twist. Instead of being revenue-neutral, has plan would yield $10 billion in new revenue a year. Yet Hertzberg’s plan was also DOA in the Capitol for the same reasons as Parsky’s.

Now, with the progressive wing in more complete control than ever of Democrats, their antipathy toward the idea of tax relief for the rich may never have been stronger. That was reflected in the recent Sacramento Bee story about Newsom’s interest in revamping the state tax code.

Jessica Bartholow, policy advocate at the Western Center on Law & Poverty, told the Bee that the tax code shouldn’t be changed to help the rich and big business.

“Capital gains is money earned by people who didn’t earn it,” Bartholow said. “If wealthy corporations and people are having an upswing in their interests, then why shouldn’t the poorest people?”

Republicans fear reform would prove bait-and-switch

The strongest voice in support of tax reform the Bee cited was Rob Lapsley, president of the California Business Roundtable. But the basic sentiment conservatives expressed about the Parsky and Hertzberg plans – Sacramento wants to tax even more human activities? – is at least as intense as in 2009 and 2015. There is considerable suspicion that any reform plan would end up as a Trojan horse for much higher taxes.

This is fueled by evidence that Democrats are gearing up for a huge push to hike taxes even though state revenue is at an all-time high. The most high-profile gambit is qualifying a measure for the 2020 ballot that would end Proposition 13 protections against property tax hikes of more than 2 percent a year for commercial and industrial properties.

This tax-hike fervor is already evident in local governments, including some under Republican control. As CalWatchdog reported last month, more than 150 local governments asked voters to raise taxes in the June and November elections. While most of the tax hikes were adopted after campaigns depicting them as crucial to public safety and to maintaining government services, by far the fastest-growing category of local spending is on pension costs, which are predicted to roughly double for California cities from 2015 to 2025.

President Trump’s release last week of a one-page list of his principles for

Because among the deductions Mnuchin seeks to zero out is one that allows taxpayers to deduct state and local taxes from their federal taxable income, some coverage is framing it as a way for Trump to punish liberal “blue” states that both have among the highest state taxes and which voted heavily for Hillary Clinton.

This list starts with California, New York and New Jersey. Yet the notion of this being some sort of partisan payback has a twist: Some of the 28 House Republicans from the three liberal states could be as likely to resist the targeting of the deduction as House Democrats. The Committee for a Responsible Federal Budget estimates that Californians would have to pay some $10 billion more in annual income taxes without the deduction, the most of any single state.

The IRS reports that more than 80 percent of taxpayers making more than $100,000 take advantage of the state and local taxes deduction and more than 45 percent of taxpayers making between $50,000 and $100,000.

But other provisions of Trump’s tax plan, such as doubling the standard deduction, would minimize the hit on those making under $100,000 and very affluent taxpayers would stand to gain from the killing of the alternative minimum income tax.

While trying to figure out how the framework might help or hurt their districts, so far California’s 14 House Republicans have generally stayed out of the tax fray.

Some GOPers leery of ending state tax deduction

But not Republicans in other blue states. Rep. Chris Collins, R-New York, said he opposed ending the deduction. He told Bloomberg News he saw his decision not as being about partisanship or helping or hurting Trump but as about whether he would “stand up for New York.”

New York and New Jersey don’t have Proposition 13-style protections against rapidly rising property taxes, as California does. Being able to deduct property taxes from federal income helps lessen the blow of soaring real-estate values, Rep. Tom Reed, R-New York, told Bloomberg. Reed said he was open to Trump’s plan but wanted to know more about how it would affect his state.

But the property-tax deduction still saves California billions, according to Tax Foundation estimates. Even though increases in annual property taxes are capped by Proposition 13 at 2 percent, the state still has the 17th highest effective property tax rate, according to wallethub.com.

Mnuchin’s main argument for a much simpler tax code with lower rates – that it would lead to explosive growth – echoes a tax-policy debate nearly a decade ago at the state Capitol.

In late 2008, Gov. Arnold Schwarzenegger appointed a high-profile group of academics, business figures and politicians to serve on his Commission on the 21st Century Economy. The bipartisan panel – chaired by Rancho Santa Fe investor Gerald Parsky – produced a report in September 2009 that sought the creation of a much simpler tax code with lower income taxes that addressed the state’s traditional reliance on volatile capital-gains tax revenue by broadening what could be taxed to include services.

Parksy depicted the proposed tax code as the first in history designed specifically to promote economic growth by removing tax provisions that encouraged tax avoidance and discouraged attempts to expand business operations. He stressed it would be initially revenue-neutral before eventually producing what he said would be a tax revenue bonanza.

Push for similar tax reform in California went nowhere

What happened next suggests the difficulty Trump could face in getting House and Senate majorities for sweeping tax reform. Despite high-profile support from Schwarzenegger and former Treasury Secretary George Shultz on the right and former Gov. Gray Davis and UC Berkeley author-professor Christopher Edley Jr. on the left, the proposal was dead on arrival in the Legislature.

Democrats couldn’t stomach its income-tax cuts for the rich. Republicans didn’t like new taxes on services and feared that attempts to overhaul the state tax code could be hijacked in the Legislature as a way to sharply increase taxes as state revenue plunged during the Great Recession.

Trump’s framework wouldn’t add a broad new category of taxes, so it may fare better than Parsky’s plan did with Republicans. But the harsh reception the California plan got reflects the leeriness about changing the status quo of taxation among powerful vested interests. That’s one reason that Congress hasn’t made a serious effort at tax reform in more than a generation – since the 1986 package pushed through Congress with the guidance of Reagan White House Chief of Staff James Baker and House Ways and Means Committee Chairman Dan Rostenkowski, D-Illinois.

Actually, nearly half of the state’s personal income tax revenue comes from the top 1 percent of earners — 150,000 individual tax returns. And personal income tax revenue is 65 percent of total revenue, which means the One Percent provides 33 percent of the state’s total revenue. 

Besides volatility of the revenue stream — the One Percent’s personal income comes largely from capital gains, which are generally tied to the stock market — what happens if a Mark Zuckerberg or a Larry Ellison — #6 and #7 on Forbes’ list of wealthiest people in the world — leaves the state?

In New Jersey, another top-heavy state, one billionaire relocated to Florida, leaving as much a $140 million hole in the budget. 

Few in California dispute the over-reliance on top earners is an issue. It’s in Gov. Jerry Brown’s budget summary and even the credit rating agencies Moody’s and Standard & Poor’s have warned against it. However, there is conflicting opinions of what needs to be done. 

There could be tax reform, but is that a flattening of the tax code? Or a shift to sales tax on services? Higher property taxes? Would the solution be revenue neutral, meaning tax increases in one area are offset with decreases elsewhere? And what are the new consequences that might come with new tax dependencies? 

What requires a frank discussion has so far drawn only whispers. Many on the left feel that while this is a problem, the state is on a good path, with reduced debt, a growing reserve fund, increased education spending and moves to address the state’s unfunded liabilities.

Republicans, on the other hand, lose sleep over the more than $400 billion in debt (including unfunded liabilities), the warnings from credit agencies and outside groups saying the state will falter in an economic downturn and a proposed 12-year extension of a “temporary” tax imposed on the wealthiest of residents that they see as only perpetuating the problem. 

“I’m very concerned about where we’re at today,” said Assembly Republican Leader Chad Mayes of Yucca Valley. “You’ve got a very few people paying a vast majority of the revenue collected by the state. That doesn’t put us in a very good spot.”

A downturn is coming likely sooner than later

It’s a question of when, not if, an economic downturn will occur. In Gov. Jerry Brown’s budget introduction released earlier this year, it warned that California is in “its seventh year of expansion, already two years longer than the average recovery.”

“While the timing is uncertain, the next recession is getting closer, and the state must begin to plan for it,” the introduction continued. “If new ongoing commitments are made now, then the severity of cuts will be far greater — even devastating — when the recession begins.”

Tax reform

As a starting point, both sides agree some kind of tax-code overhaul is necessary. However, that’s about where the agreement ends. 

Senate Budget Chairman Mark Leno told CalWatchdog the state is “to a certain degree overly dependent on the highest wage earners,” and suggested increasing the vehicle licensing fee (the “car tax”) because it’s more stable, although he conceded the toxicity of the issue makes it difficult. For example, Congressman Ted Lieu, when he was in the state Senate in 2012, pitched the idea of increasing the car tax, but relented only five days later after backlash from hundreds of constituents, including his wife.

Another idea Leno, the San Francisco Democrat, pitched was extending sales tax to services, to reflect a shift in the state’s economy away from manufacturing, which he again agreed was “a difficult conversation to have.” He lauded the efforts of Sen. Robert Hertzberg, D-Van Nuys, who is sponsoring legislation to do just that. 

David Wolfe, legislative director for the right-leaning Howard Jarvis Taxpayers Association, suggested a simplified tax code — not quite a flat tax rate, but close. Wolfe said with the proper analysis sales tax on services is an idea “worth considering,” but it would require cuts elsewhere for their support.

“Of course, the overall sales tax rate would need to be lowered in order to make it revenue neutral because the base is being broadened,” Wolfe said.

Additional burdens

There are a few programs that limit the state’s flexibility, even though the individual programs may be beneficial:

• Prop. 13 capped the rate property taxes could increase annually at two percent.  
• Prop. 98 requires that a large percentage of the state’s general fund be spent on education. 
• Prop. 2, also known as the Rainy Day Fund, sets aside a certain amount of money annually to buffer the budgetary effects of an economic downturn. However, even if fully funded it would only reserve 10 percent of the general fund tax revenues.

“While a full Rainy Day Fund might not eliminate the need for some spending reductions in case of a recession, saving now would allow the state to spend from its Rainy Day Fund later to soften the magnitude and length of any necessary cuts,” according to Brown’s budget explanation. 

Prop. 30 extension

It’s likely that voters will consider a 12-year extension to Prop. 30, which is a “temporary” tax on top earners and a quarter-cent sales tax increase.

It was approved during the last downturn primarily to avoid deep cuts in education. It is set to expire in two years, but proponents saw this campaign cycle as more favorable. 

The Prop. 30 extension only perpetuates the state’s over-reliance on personal income tax, said Carson Bruno, a research fellow at Stanford University’s Hoover Institution. 

“Prop. 30 doubles down on this problem by making the income taxes even more reliant on the highest earners,” Bruno said. 

Bruno agreed Prop. 30 expiring would leave a hole in the budget, but said legislators should have been preparing for this, as it was “temporary.”

“If they haven’t been doing that then that’s kind of irresponsible,” Bruno said.

By Chriss Street

The Great Recession was primarily caused by the collapse in economic demand as 70 million baby boomers born between 1946 and 1964 moved out of their peak spending years in their mid-30s to mid-50s and into retirement in their late 50s and early 60s.  The U.S. government over the last five years squandered $7.6 trillion on Keynesian demand-side stimulus programs, trying to resuscitate this demographically shrinking demand.

With only 23 million born between 1995 and 2012 in Generation Z, this population is just too small for demand-side stimulus to revive the economy.  America is now deep in debt, facing 23 million unemployed, and needs to fund the baby boomer’s retirement.  Consequently, politicians are being forced to abandon demand-side stimulae and re-embrace supply-side economics.

The Revolutionary War was sparked by Great Britain’s demand that the American Colonies pay increasingly higher taxes to support England’s expanding national debt.  Once independent, the new U.S. Constitution’s Commerce Clause established a free-trade zone among the states and passed the Sinking Fund Act of 1795 to require a significant amount of tax revenue be set aside each year to quickly pay off any outstanding national debt.  These policies created an economic boom that allowed the United States to be debt-free by the 1830s.

This concept of encouraging long-term economic growth by lowering taxes on income and reducing regulatory burdens that serve as barriers for people to produce goods and services is referred to as “supply-side economics.”  The Founding Fathers understood that a greater supply of goods and services produced increases demand by lowering prices for consumers.

But during the Great Depression, Washington politicians abandoned supply-side and imported Keynesian “demand-side” economics from Great Britain.  Demand-side economics argues that, in the “short-run,” productive activity is influenced by aggregate demand (total spending in the economy) and that aggregate demand may not always equal aggregate supply (the total productive capacity of the economy), because private-sector decisions often lead to “inefficient market outcomes.” Therefore, government should create demand through targeted spending.  Armed with this smoke screen, U.S. short-term spending has risen every year since 1948, as politicians always found some inadequate market demand that needed more spending.

California revival

California’s own President Ronald Reagan revived supply-side economics in the 1980s with Reaganomics.  The policy ended the oil windfall profits tax to stimulate oil production, passed the Economic Recovery Tax Act of 1981 and the Tax Reform Act of 1986 to cut taxes and eliminate deductions, and instituted a payroll tax to begin a “sinking fund” to reduce the accumulated liability of Social Security and Medicare.  Although Reagan was never able to reduce total spending, he did start a huge economic boom that lasted until 2001 and led to huge United States Treasury surpluses in the late 1990s.

Most Americans do not realize that Reagan’s biggest ally for his supply-side encouragement of economic growth was the demographics of the baby-boomers.  Studies demonstrate that 50 percent of all durable (cars and houses) and non-durable (food and clothing) expenditures are directly related to household demographics.  Spending tends to peak as families grow and people reach their mid-30s to mid-50s.  Then spending declines rapidly after the mid-50s.

When Reagan began Reaganomics in August 1981, the first baby-boomers born in 1946 were just turning 35 years old.  By the time those first baby-boomers hit 55 in 2001, the NASDAQ over-the-counter index of growth stocks had risen from 190 to more than 5000, a jump of 2,600 percent.  As the boomers hit 55 and begin to retire through 2019, only 30 percent as many Generation Z members will replace them in the work force.

Politicians love demand-side economics because they get to look busy spending lots of money creating “demand” for their crony capitalist friends.  On the other hand, a part-time Congress could manage a supply-side economic policy, because the policy is set once to encourage long-term economic growth.

But as we have been observing, the United States government will go bankrupt long before politicians can “create” enough demand to replace the shrinking consumption spending as the baby-boomers continue to rapidly retire.  Having tripled the national debt since 2001 and recently suffering a credit downgrade, Congress has no other viable option than supporting a return to supply-side economics to encourage growth.

I expect Congress to soon update President Reagan’s playbook for supply-side growth.  The United States has the world’s largest oil and gas reserves and last year those proven reserves rose by the highest amounts ever recorded.  Much of the un-tapped oil is on federal land and Congress will begin deregulating the energy market to capture huge royalty payments on higher energy production.

Congress will also deregulate the utility industry.  This will encourage up to $6 trillion in private-sector capital spending for new pipelines and refineries across the nation to connect and distribute new production.  Corporate taxes and crony tax deductions will be slashed and individual taxes and deductions will be reduced.

America is on the verge of a huge economic expansion.  Enjoy the ride!

Chriss Street appears on “THE AMERICAN EXCEPTIONALISM RADIO TALK SHOW”
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“GOP inflicts its own wounds” is a common theme, as well as one headline that ran over the weekend. This op ed was about California Republicans, and full of the requisite preachy scrutiny. And while it could be argued that the GOP may be the fastest growing minority in California, Presidential politics this season are another animal altogether.

What most pundits seem to be missing is that the Republican Presidential primary is performing an invaluable service, and the mainstream media is covering it every step of the way.

Newt Gingrich, Rick Santorum, Ron Paul and Mitt Romney, the four remaining Republican Presidential candidates have successfully highlighted important issues that have been shoved under the rug under the Obama administration. Voters are now talking about energy and domestic oil production, nationalized health care and the cost of Obama’s plan, the sputtering economy, tax increases and tax reform, the escalating national debt, the cost of Medicare, welfare expansion, phony green subsidies, national security, the attacks on conservative talk radio and religious liberty, and the Obama administration’s attack on churches.

Republicans are lapping it up. “Republican Candidates Pressed to Prove Conservatism,” another recent headline, was almost as laughable as the atheistic media asking “tougher questions about faith” of the candidates.

With liberal media attempts to choose the Republican candidate, they are actually keeping the ideas and issues of all four candidates in the spotlight, as well as assisting voters with valuable issue information.

The daily vetting of the Republican candidates only serves as a significant reminder that President Obama never received this kind of intense scrutiny when he was candidate Obama.

But most in the media don’t see it this way. “After one campaign and more than three years in the White House, President Barack Obama’s life is an open book – he’s written two of them – and he does not face a primary fight that might leave him bloodied and vulnerable,” wrote William Endicott, a former deputy managing editor of the Sacramento Bee.

Endicott claimed that the prolonged GOP primary is making the job of Obama’s opposition researchers a great deal easier. That may be true. But the more important issue Endicott missed is that the prolonged primary is also allowing Republicans to stay on the issues, which Obama, his administration, and the media, are running the other way from.

Distractions about contraception and faith, pushed by the mainstream media, only serve to make the important issues stand out more.

MAR. 19, 2012